The Crimson Press Curriculum Center

First Page and the Assignment Questions:
Financial accounting is concerned with the meaning of items on the balance sheet, the income statement, and the statement of cash flows. Financial management focuses on the way managers can affect these items. In particular, financial management is concerned with the choices that managers make about (a) the use of debt or equity to finance assets, (b) the structure of debt, (c) the magnitude of net income, and (d) the management of cash. This note is concerned with these matters.

LINK TO THE BALANCE SHEET

Recall that the asset side of the balance sheet shows what an organization owns or has claim to, whereas the liabilities and equity side indicates how the assets were financed. In most organizations, some portion of the assets are financed with liabilities (debt) and some portion with equity. In this regard, one of the major questions that an organization must ask itself is how much debt it should have on its balance sheet, and what the term of that debt should be, i.e., how long the payment period should be. We can examine this issue by using the balance sheet in Exhibit 1.
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Exhibit 1. Balance Sheet for Homeworks, Inc.
As of January 31

Assets                                                                                               Liabilities & Equity
Cash                                                       $7,200                Accounts payable           $3,000
Supply inventory                                         4,500                   Interest payable                      50
Total current assets                                  $11,700                Total current liabilities        $3,050

Equipment                                         $6,000                                 Note payable                5,000
Less accumulated depreciation          100   5,900                Contributed capital            $10,000
                                                                                                        Retained earnings         (450)
Total   assets                                                 $17,600                 Total liabilities & equity    $17,600
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   Note that Homeworks has three kinds of debt on its balance sheet: (1) accounts payable, which is debt that is owed to its vendors, (2) interest payable, which is interest on debt that has been incurred but has not yet been paid to the lender, and (3) a note payable, which is the principal on the debt. The accounts payable usually are due within a month, and it is highly likely that the interest payable is due soon also. Because the note payable is non-current, we know that it is due in over one year from the date of the statement, but we don’t know the exact terms of the loan. Unless we know these, we cannot say with certainty whether Homeworks has too much debt or not.