Notes on Introduction to Accounting and Finance

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1. Simple Overview 🔗︎

The three most important financial statements are: Balance Sheet, Income Statement, and Cash Flow Statement.

  • Balance Sheet:

    • Investors’ equity + Creditors’ rights constitute assets.
    • Reinvestment of assets forms Operating Assets and Investment Assets.

  • Income Statement:

    • Operating assets generate expenses/costs and revenues, forming core profit.
    • Investment assets generate investment income.

  • Cash Flow Statement:

    • Inputs from investors’ equity and creditors are Financing Cash Inflows.
    • Asset investment is an Investing Cash Outflow.
    • Operating assets generate Operating Outflows and Operating Inflows, forming Net Operating Inflow.
    • Investment income generates Investing Cash Inflows and Financing Cash Outflows.

2. The Work of Accounting 🔗︎

The work of accounting is not just bookkeeping, but includes the following processes:

  1. Bookkeeping: Recording all information (such as cash, fixed assets, share capital, intangible assets, inventory, short-term loans, accounts payable, operating revenue, accounts receivable, cost of goods sold, administrative expenses, selling expenses, financial expenses, etc.).
    • Debit: Can be understood as cost.
    • Credit: Can be understood as revenue.
    • The core of bookkeeping is to record “debit” and “credit” information.
  2. Posting:
    • Calculating depreciation (e.g., annual depreciation of fixed assets).
    • Amortizing intangible assets (e.g., patent rights, trademark rights, etc.).
  3. Adjusting Entries:
    • Classifying operating revenue, cost of goods sold, and administrative expenses into the income statement.
    • The credit of operating revenue = the credit of profit; the debit of cost of goods sold and administrative expenses = the debit of profit.
  4. Closing Entries:
    • Transferring profit to the statement of retained earnings.
  5. Reporting:
    • Finally generating the Balance Sheet:
      • Debit Side: Cash, Accounts Receivable, Inventory, Original Value of Fixed Assets, Accumulated Depreciation, Net Value of Fixed Assets, Intangible Assets, Total Assets.
      • Credit Side: Short-term Loans, Accounts Payable, Total Liabilities, Share Capital, Capital Surplus, Retained Earnings, Owner’s Equity, Liabilities and Owner’s Equity.
      • If debits and credits are equal, the accounts are balanced.
  • Capital Surplus:
    • Example: Pre-investment share capital is 4 million. Someone invests 4 million for a 20% stake, which ultimately corresponds to 1 million in share capital. The extra 3 million is the capital surplus.
  • Subsidiary Handling:
    • If not a controlling stake, the financial statements are not consolidated.
    • Subsidiaries may hide profits through advertising business, etc.
  • Intangible Assets:
    • Includes patent rights, non-patented technology, trademark rights, copyrights (IP), land use rights, franchise rights (franchise stores).
    • A brand cannot be sold independently and is not an intangible asset.

3. Operating Asset Analysis 🔗︎

3.1 Important Formulas 🔗︎

  1. Inventory Turnover Ratio:
    • Formula: Inventory Turnover Ratio = Cost of Goods Sold / Average Inventory (monthly).
    • Average Inventory = (Beginning Inventory + Ending Inventory) / 2.
    • Example: If the inventory turnover ratio is 7.29, it’s equivalent to turning over once every 12 / 7.29 ≈ 1.5 months.
    • Inventory needs to consider provision for inventory depreciation.
  2. Gross Profit Margin:
    • Formula: Gross Profit Margin = Gross Profit / Operating Revenue.
    • Gross Profit = Operating Revenue - Cost of Goods Sold = (Selling Price - Unit Cost) × Sales Volume.
    • Gross Profit Margin can also be expressed as: 1 - Unit Cost / Selling Price.

3.2 Significance of Gross Profit Margin 🔗︎

  • Reflects the company’s growth, management performance, core competitiveness, and potential issues.
  • Ways to increase gross profit margin:
    • Low-Cost Strategy (high volume).
    • Differentiation Strategy (low asset turnover, high R&D investment).

3.3 Product Competitiveness 🔗︎

  • Reflected in Gross Profit Margin and ability to manage upstream and downstream payments and collections.
    • Upstream: Suppliers (focus on cash, accounts receivable, notes receivable, etc.).
    • Downstream: Customers (focus on prepayments, accounts receivable, etc.).
  • If the gross profit margin decreases and the inventory turnover ratio also decreases, it indicates that the product is not selling well.

3.4 Accounts Receivable Analysis 🔗︎

  • Points of concern:
    • Internal personnel involved.
    • Debtor.
    • Aging of accounts.
    • Provision for bad debts (may hide profits).
  • Collection management ability:
    • Compare the changes in sales revenue, notes receivable, accounts receivable, and advances from customers between the end and beginning of the period.

3.5 Payment Management Ability 🔗︎

  • If the sum of ending inventory, notes receivable, and accounts receivable is much larger than inventory, and the increase in construction in progress and fixed assets is not significant, it indicates a strong ability to manage payments to suppliers.

3.6 Production Capacity Efficiency 🔗︎

  • Formula: Production Capacity Efficiency = Current Period Output (Operating Revenue) / (Fixed Assets + Intangible Assets).
  • Relationship between fixed assets and inventory:
    • Red Ocean Market: More fixed assets, large scale of core business.
    • Blue Ocean Market: Less inventory, high gross profit.

3.7 Financial Risk Indicators 🔗︎

  • The “three highs” that reflect poor management level:
    • High financial expenses.
    • High level of a certain asset.
    • High short-term loans.
  • Important indicator for evaluating profit:
    • Net Operating Inflow / Core Profit = 1.2 to 1.5 is optimal.

4. Problems with Feasibility Reports 🔗︎

  • Economic development has inertia, no cycles.
  • Policies are continuously favorable.
  • Competition and substitute products are not fully considered.
  • Resource constraints are not fully considered.

5. Several Ways to Make Money 🔗︎

  1. Earning from price differences in trading:
    • Product, physical arbitrage.
  2. Earning from advertising:
    • e.g., a subsidiary hiding profits through its advertising business.
  3. Earning from financial arbitrage:
    • Information asymmetry, financial arbitrage.

6. How to Look at a Company 🔗︎

6.1 Competitiveness 🔗︎

  • Gross profit margin, profit margin, upstream and downstream relationships.

6.2 Expansion Strategy 🔗︎

  • Analyze Investment Assets and Operating Assets on the balance sheet.
  • The proportion of operating profit and investment income, whether the company is focused on its main business.

6.3 Business Model 🔗︎

  • Gross profit margin, asset turnover ratio.

6.4 Risk Analysis 🔗︎

  • Operating risk and financial risk:
    • Cash flow statement.
    • Whether operating cash flow is positive.

7. Supplementary Information 🔗︎

7.1 Financial Fraud in Agriculture 🔗︎

  • The agriculture industry is prone to financial fraud because it is heavily influenced by natural factors and difficult to account for.

7.2 Intangible Asset Amortization 🔗︎

  • Intangible assets are amortized annually, so the ROA (Return on Assets) should be relatively high (about 15%).

7.3 Fair Value 🔗︎

  • The market value of held stocks and other realizable assets.

7.4 Financial Expenses 🔗︎

  • Be cautious when the proportion of financial expenses significantly exceeds 30%.

7.5 Factoring Funds of Large Companies 🔗︎

  • Large companies may set up factoring funds (company capital injection + bank financing). Suppliers can get financing from the factoring company but must pay interest, thereby increasing the gross profit margin.

7.6 Advances from Customers 🔗︎

  • Advances from customers are one indicator of a company’s strong market position.

7.7 Cash Flow 🔗︎

  • A positive operating cash flow indicates that the company is able to earn money.