AFM 101 Chapter 3 Notes - Chapter 3 Notes How do business...

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Chapter 3 Notes How do business activities affect the income statement? The operating cycle: The time it takes for a company to purchase goods, pay suppliers, sell goods, and collect money for the goods. The long term objective is always to turn cash into more cash . This saying means to generate more cash not to borrow more. 1. Purchase Goods and services 2. Pay cash to suppliers 3. Sell goods and services to customers 4. Receive cash from customers The reason why businesses need financing from creditors is because there will be a point in the cycle where they will not have enough cash. In order to grow and sell more and more goods, they must borrow cash until they generate enough cash from operating activities to pay back creditors. - By shortening this cycle, a company can increase profits and grow faster. The extra money from a faster cycle can be used to buy more inventory, buy capital assets (reinvest into company), pay off debt or distribute to the owners. Periodic Assumption means that the long life of a company can be reported in shorter periods - This is used for income statement as it only takes a period of time in the company’s life - Two questions arise when doing periodic assumption 1. Recognition issues: When should the effects of the operating activities be recorded 2. Measurement Issues: What amount should be recognized The income statement has 3 major sections 1. Results of continuing operations 2. Resutls of discontinued operations Profit is the sum of the first 2 sections 3. Earnings per share Continuing operations - includes operating revenue , which are increases in assets or settlements of liabilities from ongoing operations o Usually earned when a sales happen (work done and expected to be paid) o Sometimes companies receive cash/ credit payment in exchange for a promise to provide the good or service at a later time. Revenue is not earned in this case. Instead a liability account called deferred revenue is created. Once the good/ service is made, then the liability is settled - Includes operating expenses
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