notes-business-startups-startups-stAccounting

Contents

todo: beware of adding too much to this page that go beyond the need-to-know-basics; remember this book isn't intended to be 'anything that you are likely to eventually need to know when running a company', it's just supposed to be 'just the basics so that you can get started and you know what else is out there to learn, and you know what you don't know'; it's supposed to be a thin book that you can read through quickly, not something that takes a whole quarter/semester to read.

basic accounting

i don't know anything about accounting and all this may be wrong.

some basic stuff to know about

the four statements: Balance Sheet, Income Statement, Statement of Owner's Equity, Statement of Cash Flows

revenue/sales revenue is usually gross (with respect to cost of sales); exception is when you are essentially taking orders for another company, and similar things (see http://www.investopedia.com/ask/answers/102714/what-are-difference-between-gross-revenue-reporting-and-net-revenue-reporting.asp )

net sales: http://smallbusiness.chron.com/difference-between-net-revenue-net-sales-cost-sales-gross-margin-64043.html

cost of sales/cogs (cost of goods sold)

gross profit: http://www.investopedia.com/terms/g/grossprofit.asp revenue - cost of goods sold

Gross Margin: http://www.investopedia.com/terms/g/grossmargin.asp

gross margin percentage: (gross profit)/sales

gross margin percentage vs markup: http://en.wikipedia.org/wiki/Gross_margin http://en.wikipedia.org/wiki/Markup_%28business%29 gross margin percentage = (revenue - costs)/revenue markup = (revenue - costs)/costs gross margin percentage = markup/(1 + markup)

gross margin dollars vs gross margin as percent of revenue: http://smallbusiness.chron.com/difference-between-gross-margin-dollars-percentage-revenue-24412.html

variable vs fixed costs

earnings: synonymous with bottom line, net income, net earnings. http://en.wikipedia.org/wiki/Net_profit

net profit margin: net profit/revenue. http://www.investinganswers.com/financial-dictionary/financial-statement-analysis/net-profit-margin-2233

working capital: http://www.investopedia.com/terms/w/workingcapital.asp

operating cash flow

operating margin

depreciation and amortization

capitalizing expenses

double-entry accounting

changes to working capital: http://www.investopedia.com/ask/answers/071114/how-do-changes-working-capital-affect-companys-cash-flow.asp http://www.wikinvest.com/metric/Changes_in_Working_Capital Changes to working capital are one thing that causes cash flow to differ from net income. Some things that are counted as net income yet are not positive cash flows are represented as a positive change to working capital. For example, if you close a sale with a client, but they haven't paid you yet, then (assuming you are using accrual accounting, and that you've delivered the item they bought), you accrue the revenue immediately (your Accounts Receivable increases) but no cash came in; Accounts Receivable is part of your working capital, so this would cause a positive change in working capital.

free cash flow: http://www.investopedia.com/articles/fundamental/03/091703.asp

free cash flow margin

EBIT

ebitda: Ben McClure. A Clear Look At EBITDA http://www.investopedia.com/articles/06/ebitda.asp Lisa Smith. EBITDA: Challenging The Calculation http://www.investopedia.com/ask/answers/010915/what-difference-between-operating-margin-and-ebitda.asp http://exitpromise.com/adjusted-ebitda/

ebitdar: http://www.investopedia.com/terms/e/ebitdar.asp

ebitda margin

basis point: 1/100th of a percentage point (a percentage point is itself 1/100th of the total quantity, so a basis point is 1/10000 of the total) ("Like percentage points, basis points avoid the ambiguity between relative and absolute discussions about interest rates by dealing only with the absolute change in numeric value of a rate. For example, if a report says there has been a "1% increase" from a 10% interest rate, this could refer to an increase either from 10% to 10.1% (relative, 1% of 10%), or from 10% to 11% (absolute, 1% plus 10%). If, however, the report says there has been a "100 basis point increase" from a 10% interest rate, then we know that the interest rate of 10% has increased by 1.00% (the absolute change) to an 11% rate." -- http://en.wikipedia.org/wiki/Basis_point)

current liabilities: "A company's debts or obligations that are due within one year." http://www.investopedia.com/terms/c/currentliabilities.asp

current ratio, quick ratio/acid test ratio, cash ratio: http://www.investopedia.com/ask/answers/011315/what-difference-between-current-ratio-and-acid-test-ratio.asp http://www.investopedia.com/terms/a/acidtest.asp http://www.investopedia.com/terms/q/quickratio.asp http://www.investopedia.com/university/ratios/liquidity-measurement/ratio1.asp http://www.investopedia.com/terms/c/currentratio.asp

the revenue cycle

lifecycle of a capital expense: (not well-known terms, just things i think about)

total return

market share

market capitalization

an accounting identity http://en.wikipedia.org/wiki/Accounting_identity

ROI (return on investment)

ROE (return on equity)

ROA (return on assets)

sales growth

eps growth

investment valuation ratios: http://www.investopedia.com/university/ratios/investment-valuation/

PEG ratio

P/E ratio

price/book ratio

price/cash flow ratio

price/sales ratio

dividend yield

enterprise value

enterprise value multiple

internal rate of return

http://en.wikipedia.org/wiki/Factoring_%28finance%29

accrual vs. cash accounting

Historical cost principle

Matching principle

Revenue recognition principle

Full disclosure principle

GAAP

https://www.business-case-analysis.com/materiality-concept.html

Conservatism convention

http://www.myaccountingcourse.com/accounting-principles/cost-benefit-principle

http://www.myaccountingcourse.com/accounting-principles/

http://www.dwmbeancounter.com/tutorial/theorybook.html

Industry Practices Convention

The Accounting Equation: Assets = Liabilities + Equity

The Accounting Cycle

accounting Source Document

accounting journal entry

general ledger

debits, credits

accounting adjusting entries

accounting closing entries

Accounting leverage: http://en.wikipedia.org/wiki/Leverage_%28finance%29#Corporate_finance ("Accounting leverage is total assets divided by the total assets minus total liabilities.")

asset turnover: revenue/(total assets) http://www.investopedia.com/terms/a/assetturnover.asp

DuPont? analysis: http://www.investopedia.com/terms/d/dupontanalysis.asp

total assets

number of employees

earnings per employee

Selling, General and Administrative Expense (SG&A) Rate (SG&A expenses/sales)

when you say "x to y" this means x divided by y, e.g. "performing loans to nonperforming loans" means (performing loans)/(nonperforming loans)

see [1] for industry specific KPIs from Businessweek 2014 Year Ahead Figures and Facts

see also/copy over from Self:notes-business-accounting

http://news.morningstar.com/classroom2/course.asp?docId=145093&page=6

book value and its irrelevance for software startups

Let's pretend you create a new company with 100 shares, and sell those 100 shares to investors for $1000.

You spend $100 on desks. Then every year for 9 years you pay $100 to programmers to write software. You don't sell anything during this period. Let's imagine that you are a perfect marketer and project manager, and so at the end you have a piece of software that would cost anyone else at least $900 to clone, and which is highly in demand. Let's say that you then go into cryogenic suspension for 100 years and then at then end, because you are a perfect marketer, you find that nothing has changed and the product would still cost anyone else at least $900 to clone, and is still highly in demand.

You might think of yourself as possessing a $900 asset.

If you capitalized the expense of paying the programmers, initially the outward cash flow would turn into an asset on the balance sheet. But over time this expense would be amortized. So, after enough time has passed, the book value of your company would decay to just $100, the amount you could sell the chairs for.

So in this sort of situation, the balance sheet is good for tracking historical costs, but not good for tracking the value of the company. When discussing the value of a company like this, the book value wouldn't come into the discussion. The market value of companies like this tends to be much higher than their book value. People classify industries as 'balance sheet industries' if they are industries in which the book value tends to be a very relevant guage of the actual value of the company (an example of a balance sheet industry is finance; a financial institution's value is mostly tied up in the value of the financial assets that it holds, rather than intangible capital like software that it created).

This may seem strange; shouldn't the balance sheet reflect what people tend to think the company is worth? But it makes sense if you think of the purpose of accounting not to estimate the value of the company, but only to keep track of where the money is going (costs and income), and of the financial health of the company; and if you reflect that the methods of accounting put emphasis on providing clarity on the method to be followed, at the occasional expense of de-emphasizing unreliable subjective information (although accounting is not completely objective). Accounting looks at past and present data, but the valuation of a company is about its predicted future performance, and because no one can predict the future, the valuation is inherently more subjective (unless a market price is available; in which case the valuation as a number is objective, but the justification for that valuation in terms of other data about the company may be unavailable). Accounting provides only a subset of the quantitative information which is relevant to decision-making about a company.

(note: one thing wrong with the above is that in theory amortization of capital would occur over its useful life; but in fact the 'useful life' must be guesstimated in advance, for example a company might think it's software product is very valuable right up until the year when it realizes suddenly that it is obsolete; but i bet that accounting-wise, that company would have started amortizing the cost of producing the software before that realization)

(note: if another company were to buy this company, the difference between the book value of the bought company and the higher price the acquirer actually paid would be reflected on the acquirer's books as 'goodwill', and the value of that goodwill would be updated anually; so if there existed a company almost all of whose value was contained in acquisisions then maybe its book value would mean something, at least insofar as you trust the acquirer's accountants to be able to figure out the value of all those intangibles; but most acquirers also have their own business lines which exist outside of acqusitions).

links

Tools:


todo:

" kevin 11 hours ago

Here's the biggest offenders I see when talking to founders:

  revenue vs GMV
  (if you give GMV, give me your cut/margin)
  contract vs LOI
  burn vs expenses
  users vs customers 
  (customers pay)
  signups vs users vs active users
  (you should give active with time interval and measurement of active. 
   eg. logged in last 30 days)
  profitable vs cash flow positive

Others people should know:

  diff between retention rate vs churn rate
  (both should be given with time interval. 
   eg. 30 day retention rate is...
       monthly churn rate is...)
  voluntary churn vs involuntary churn
  gross vs net
  top line vs bottom line

reply "

-- https://news.ycombinator.com/item?id=10098724

"

numlocked 14 hours ago

It's amazing to me how deeply ingrained software profit margins are into the start-up world. That calculator...we're an ecommerce company that holds inventory...I spent 30 seconds searching for how to set gross margins on the revenue then realized it assumes all revenue is 100% gross margin. In most businesses (read: anything other than software and maybe pharma), manipulating margin is one of the biggest levers (maybe THE biggest) you have to affect profitability.

Not to mention other big levers like working capital (and potentially running a business with negative WC and generating cash, a la Amazon)....

hantusk 6 hours ago

... Gross profits is net revenue minus cost of goods sold. Cost of goods sold is only the direct cost of goods, and does not include any operating expenses.

Net revenue is Gross revenues minus discounts, returns and allowances.

reply

" -- https://news.ycombinator.com/item?id=10390666 https://news.ycombinator.com/item?id=10392027

todo/links:

LLC vs C corporation vs S corporation vs sole prioriatorship

LLC taxed as a corporation

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"Depreciation and Amortization

Depreciation and amortization fall under the category of operating expenses. Depreciation is an expense that takes into account the estimated useful life of plant and equipment. For example, if you purchase an asset for $10,000 and estimate that it has a five-year useful life, the annual depreciation expense is $2,000. Amortization works the same way but pertains to intangible assets such as goodwill, patents and copyrights. " -- [2]

"Operating income is a similar measure to earnings before interest and taxes (EBIT), but EBIT also includes nonoperating income -- nonrecurring or extraordinary items such as a lawsuit settlement. While EBIT is one measure of profitability, financial analysis goes further by excluding depreciation and amortization, as both are noncash expenses. Financial analysts consider EBIT and EBITDA a more accurate picture of a company's true profitability and use these metrics to value a company. Corporate finance practitioners use EBIT and EBITDA to value businesses as takeover targets and as measures for return on investment." " -- [3]

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good quick summary of income statement:

http://www.gotopotter.com/2014/02/gross-profits-operating-income-net-income-and-ebitda/

non-operating income: http://www.accountingcoach.com/income-statement/explanation/4

net income vs retained earnings:

http://www.investopedia.com/ask/answers/070615/what-difference-between-earnings-and-income.asp

"Earnings typically refer to after-tax net income" [4] "Net income (NI) is a company's total earnings (or profit); " [5]

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