1. Construct a Brandywine’s Income Statement. This income statement summarizes the company’s performance during 2007. It reflects how much money the company brought in as revenues, how much spent on expenses, and the difference between the two is the net income profit. All figures above are in terms of millions. Excel rounded the depreciation value which was 1.5 to 2 and net income of 1.5 to 2 as well which gave total expense of 11 which is actually 10.5 million. I will attempt to explain the major components of this Income Statement. Revenue is the first major component. The primary goal of a not-for-profit corporation is financial viability which is generally given in a mission statement in terms of service to the community (Gapenski, 2008).
Because most not-for-profit establishments follow a tedious set of requirements, they usually have a tax-exempt status and can accept and or issue tax-exempt bonds (Gapenski, 2008). Revenues usually represent sales, but because there isn’t any clientele or shareholders, revenues must be re-invested into the company. In this case, revenues can be represented by donations, cash received, payer obligation, net patient service, interest earned on investments, and or rental income. Expenses would be the second component of my income statement.
It is simply the cost of doing business. A company has to spend money in order to make money (Gapenski, 2008). Some examples of Brandywine expenses could include cost of sales such as utilities, buildings, salaries, labor, maintenance, administration expense, and depreciation and amortization. Net income is the last, but certainly not least. It is what is left after all expenses have been accounted for (Gapenski, 2008). It is often referred to as a company’s bottom line (Gapenski, 2008). Again, being that this is a not-for-profit establishment, all profits have to be re-invested into the corporation.
2. What are Brandywine’s 2007 net income, total profit margin, and cash flow? To interpret the income statement, revenues for 2007 were 12 million. Expenses other than depreciation totaled 75% of total revenues which is 9 million. Showing my work, I know that revenue minus total expenses equals net profit. To get the expense amount, I simply multiplied 75%*12 million to get 9 million plus 1.5 million of depreciation equaled 10.5 million of total expenses. Now, I subtract 10.5 million from 12 million of total revenue to get a net profit of 1.5 million. The equation for profit margin is net income of 1.5 million divided by 12 million of total revenues equal 0.125 * 100% equal 12.5 % profit margin. Cash flow equals net income of 1.5 million plus non cash expenses or depreciation of 1.5 million totals 3 million. Depreciation has to be added back to get cash flow even though there is no cash value (Gapenski, 2008).
3. Supposed the company changed its depreciation calculations such that its depreciation expensed doubled. How would this change affect Brandywine’s net income, total profit margin, and cash flow? If we doubled the depreciation amount, it would give us 3 million. Recall that the equation for net income is total revenue minus total expenses, so we subtract total expenses of 12 million from 12 million of total revenues leaving a 0 net profit. We would experience a big difference of 1.5 million of net profit if the depreciation value doubled. For the profit margin, the equation is net profit of 0 divided by 12 million of total revenue is 0 % profit margin. Note that we have gone from a 12.5 % profit margin to 0%. Cash flow is net income plus non cash or depreciation value, so we add 0 plus 3 million to give us a cash flow of 3 million which is no change from initial figure.
4. Explain the difference between cash and accrual accounting. Be sure to include a discussion of the revenue recognition and matching principles. According to Gapenski 2008, the cash method is the process by which an economic event is recognized when a cash transaction actually takes place. It is considered simple and easy to use. Some might want to use this method when just starting a small business. Cash accounting does a good job of tracking cash flow, but does a poor job of matching revenues earned with monies laid out for expenses (Epstein, 2011). The accrual method is recognized when an obligation is created. This method is considered more complicated, yet it provides a better picture of true economic status of a business.
Most would say that this is the preferred method according to generally applied accounting principles (Gapenski, 2008). It has two key components such as the revenue recognition that requires that revenues be recognized in the period in which it was earned while the matching principle requires that an organization’s expenses be matched with revenues in which it is connected to. One might want to use this principle once a small business has gotten on its feet. The accrual method does a good job of matching revenues and expenses, but it does a poor job of tracking cash (Epstein, 2011).
Because you record revenue when the transaction occurs and not when you collect the cash, your income statement can look profitable even if you don’t have cash in the bank (Epstein, 2011). 5. Explain the difference between equity section of a not for profit business and an investor-owned business. According to Gapenski 2008, the financial statements of investor- owned and not-for-profit firms are similar except for transactions such as tax payments that are applicable only to one form of ownership. They both strive to increase assets and decrease debts and other liabilities; however, the difference lies within the line of business (Gapenski, 2008). One difference in the balance sheets of a not-for-profit organization and a for-profit business is the name or title shown in its heading. In a nonprofit, the name of this financial statement is the statement of financial position. In the for-profit business this financial statement is the balance sheet (Accounting Coach, 2011).
Another difference is the section that presents the difference between the total assets and total liabilities. The nonprofit’s statement of financial position refers to this section as net assets, whereas the for-profit business will refer to this section as owner’s equity or stockholders’ equity (Accounting Coach, 2011). The two types of equity shown on a business balance sheet are retained earnings and new stock sales whereas on a not-for-profit financial statement there can be retained earnings, but it can’t sale common stock to raise funds (Small Business, 2011). Non profit establishments raise funds through grants and donations for specific causes such as needs, healthcare, and education (Ramjee, 1999). Assets for investor-owned firms include furniture, computers, equipment, investments and security deposits; however, a not-for-profit organization’s assets are not as complex (Ramjee, 1999).
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