Frequently Asked Questions

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LIFO inventory valuationLIFO stands for Last In First Out. It affects the calculation of the gross profit on inventory items when a sale is made.

When calculating the inventory costs for an item sold, LIFO uses the values of the latest inventory acquired to calculate the profit on the sale.

The alternative to using LIFO is to use FIFO (First in First Out).

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FIFO inventory valuationFIFO stands for First In First Out.

It is used in the calculation of the cost of inventory items when a product sale is made.

When calculating the inventory costs for an item sold, FIFO uses the costs of the oldest available inventory to calculate the gross profit or loss on a sale.

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EBITDAThe abbreviation EBITDA stands for Earnings Before Interest, Taxes, Depreciation & Amortization.

It is a way to look at Earnings that are the result of Business Operations only.

EBITDA separates non-cash items (depreciation and amortization) and non-operating items (taxes and Interest) from the bottom line earnings that result from operating the business.

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GAAP-accountingThe abbreviation stands for Generally Accepted Accounting Principles. Accountants use these standards to prepare financial statements and conduct audits.

GAAP standards cover all areas of financial statement preparation, including when and how to recognize revenue, inventory valuation methods, disclosures, capitalization of expenditures, etc.

This wide ranging set of standards insures that financial statements are easily compared and give investors and business owners a relative sense of security that the statements accurately reflect the business’ true financial results.

Financial Statements for publically held companies are always prepared according to GAAP standards.

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Working capital words highlighted on the white backgroundBusiness Working Capital is calculated using Balance Sheet accounts. By subtracting Current Liabilities from Current Assets you can easily see the amount of cash or cash equivalents (assets that can quickly be converted to cash) you have available to run your business.

The formula is:

Current Liabilities – Current Assets = Working Capital

Working Capital is an indicator of your business’ liquidity and overall health. A situation where Current Liabilities exceed Current Assets is a red flag that your business is heading for a cash flow or liquidity problem.

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statement-of-cash-flowsAlong with a Profit and Loss Statement (P & L) and a Balance Sheet, a Statement of Cash Flows is part of a complete set of business financial statements.

The Statement of Cash Flows shows where the funds you used to operate your business and pay your expenses came from.

It will show if the funds were generated by operations & sales, by borrowing, by sale of assets, or by capital investment.

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depreciation expenseDepreciation is an accounting technique used to spread the cost of an asset purchase (e.g., equipment) over the useful life of the asset.

The idea is that if you make a large capital purchase, such as a building or equipment, the equipment or building isn’t “used up” in one year. You will use the asset to produce income for several or many years to come.

Depreciation matches up the future income produced by having the equipment with the cost of the current purchase. It also acknowledges that equipment wears out over time.

For example, if you buy a piece of manufacturing equipment for $50,000 you’ll presumably use that equipment for a number of years. So instead of taking the full $50,000 cost as an expense this year, you’ll spread it over several years.

Different types of assets have generally agreed upon “useful lives” and these schedules are used to calculate depreciation.

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calculating amortizationAmortization, like depreciation, is a way to write off the expense of an asset over several years.

As examples, Amortization can be applied to intangible items, such as, “Goodwill” on the Balance Sheet or for spreading the costs of tangible expenses related to start-up costs over time.

Different write-off time periods are used for different types of assets.

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Balance Sheet Goodwill valueGoodwill is an Intangible Asset that is shown on the Balance Sheet during the purchase or valuation of a business.

Goodwill is amortized over a set period of years, similarly to depreciation.

Goodwill from an accounting standpoint is the value placed on intangible company assets such as reputation or customer list value. Intangibles are non physical items (e.g., copyrights or patents) that are expected to support future business earnings.

Goodwill value, when added to the Book Value of a company’s assets, will usually increase the actual purchase price of the company.

When selling a company, the dollar amount assigned to Goodwill is usually subject to significant negotiation.

Different industries have different types of intangible assets that will affect the purchase price of a business.

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cost of goods soldThe term COG or Cost of Goods Sold represents the actual cost of manufacturing or producing the goods you sell.

It does not reflect operating costs such as advertising or marketing.

It is strictly the cost of all items required to create your finished product, including the cost of “freight in” to get the raw materials or parts to your business.

It is also referred to as the Cost of Sales.

Your COG & how you value your inventory will affect your profits and taxes.

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