## Financial Accounting

An understanding of balance sheet math is needed in order to proceed. For project managers not familiar with the balance sheet idea from the domain of financial accounting, here is a quick overview. First, the balance sheet is nothing more than a graphical or tabular way to show a numerical relationship: y = a + b. However, this relationship is not functional since all three of the variables are independent and, because of the equality sign, a relationship exists among the three that makes them interdependent as well. Thus, a change in one requires a change in another to maintain equality among the three. This equality is called "balance" in the accounting world, and the process by which if one variable changes then another must change in a compensating way to maintain balance is called "double entry accounting."

Second, accountants would understand the equation this way: assets ("y") = liabilities ("a") + equities ("b"). That is their "accounting equation." If assets increase, then so must either or both liabilities and equity increase in order to maintain balance. In fact, any change in the variables must be compensated by a change in one or two of the other two variables.

There is an important business concept to go along with the math: assets are property of the company put in the custody of the company managers to employ when they execute the business model. Assets are among the resources to be used by project managers to execute on projects. Assets are paid for by liabilities (loans from outsiders) and capital, also called equity. Equity is the property of the owners and liabilities are the properties of the creditors of the company. Thus, some stakeholders in the project arise naturally from the accounting equation: the financiers of the assets! As noted, these are the suppliers (accounts payable liabilities), creditors (long-term and short-term notes), and owners or stockholders (equity owners).

An asset cannot be acquired — that is, its asset dollar value increased — without considering how its acquisition cost is to be paid (increase in liability or capital, or sale of another asset). An asset cannot be sold — that is, its dollar value decreased — without accounting for the proceeds. Typical assets, liabilities, and equity accounts are shown in Table 1-2. A balance sheet for a small company is shown in Table 1-3.

 Assets Liabilities and Capital Employed Current Assets Current Liabilities Cash on hand \$10,000 Vendor payables \$3,000 Receivables \$40,000 Short-term notes \$35,000 Finished inventory \$15,500 Work in process \$5,500 Long-Term Assets Long-Term Liabilities Buildings \$550,000 Mortgages \$200,000 Software and equipment \$250,000 Supplier loan \$35,000 Equities or Capital Employed Capital paid in \$400,000 Retained earnings \$170,000 Stock (\$1 par) \$98,000 Total Assets Total Liabilities and Equities \$906,000 \$906,000 Notes ■ Cash on hand is money in the bank. ■ Receivables are monies owed to the business on invoices. ■ Finished inventory is tangible product ready to sell. ■ Work in process is incomplete inventory that could be made available to sell within one year. ■ Buildings, equipment, and software are fixed assets that are less liquid than current assets. Notes ■ Vendor payables are invoices from vendors that must be paid by the business, in effect short-term loans to the business. ■ Short-term notes are loans due in less than a year. ■ Mortgages are long-term loans against the long-term assets. ■ Capital paid in is cash paid into the business by the
 Software is usually stockholders in considered an asset excess of the par when the capitalized value of the stock. development, purchasing, or licensing ■ Retained earnings cost exceeds certain are cumulative predetermined earnings of the thresholds. business, less any dividends to the ■ The supplier loan is stockholders. money loaned to a supplier to finance its ■ Stock is the paid-in operations. par value, usually taken to be \$1 per share, of the outstanding stock. In this case, there would be 98,000 shares in the hands of owners.
 Assets Liabilities and Capital Employed Current Assets Current Liabilities Cash in checking and savings accounts Monies owed to suppliers Monies owned by customers (receivables) Short-term bonds or other short-term debt Inventory that can be sold immediately Long-Term Assets Long-Term Liabilities Overdue receivables Mortgages Loans to suppliers Long-term bonds Investments in notes, real estate, other companies Overdue payables Plant and equipment Equity Software (large value) Cash paid in by investors for stock Retained earnings from operations and investments
 Notes ■ Current assets are Notes ■ Current liabilities are generally those generally those due assets that can be and payable within one turned into cash year. Some companies within one year. may assign a shorter Some companies period. may assign a shorter period. ■ Long-term liabilities are less liquid than current ■ Long-term assets liabilities, but are less liquid than nevertheless have a current assets, but cash value in the nevertheless have a marketplace. cash value in the marketplace. ■ Equity is the monies paid in by owners or ■ The dollar value of monies earned from all accounts on the operations and left side must equal investments. These the dollar value of funds finance the the accounts on the assets of the business, right side. along with the liabilities.