Generated by AskSia.ai — graphs, formulas, traps
Assets = Liabilities + Equity (must always balance)Every transaction affects at least two accounts — that's double-entry bookkeeping. The two sides keep the equation in balance.
| Account type | Normal balance | Debit ↑/↓ | Credit ↑/↓ |
|---|---|---|---|
| Asset | debit | ↑ increases | ↓ decreases |
| Liability | credit | ↓ decreases | ↑ increases |
| Equity | credit | ↓ | ↑ |
| Revenue | credit | ↓ | ↑ |
| Expense | debit | ↑ | ↓ |
Equity = Capital + Retained Earnings = Capital + ΣRevenue − ΣExpense − DividendsExpanded equation: Assets = Liabilities + Capital + (Revenues − Expenses) − Dividends. Tracks how operations flow into equity.
Revenue is an equity-source account → credit increases it. Many students debit revenue when receiving cash. Wrong: debit Cash, credit Revenue. The asset (Cash) gets a debit; the equity-source (Revenue) gets a credit.
| Method | COGS uses | Inflationary period |
|---|---|---|
| FIFO (first-in-first-out) | oldest costs | lower COGS, higher net income |
| LIFO (last-in-first-out) | newest costs | higher COGS, lower net income |
| Weighted average | blended cost | middle ground |
| Specific ID | exact items | for big-ticket (cars) |
COGS = Beg Inventory + Purchases − End InventoryLower of cost or market (LCM): conservative principle — write down inventory if market value drops below cost. Required by GAAP. Doesn't write up.
In deflationary periods (rare but possible), LIFO gives lower COGS (newest items cost less) and higher net income — opposite of the typical inflation analysis. Always check direction of price movement before applying the FIFO/LIFO heuristic.
| Line | Calculation |
|---|---|
| Revenue | sales × units |
| − COGS | direct cost of products |
| = Gross Profit | margin available for ops + return |
| − Operating Expenses | SG&A, R&D, depreciation |
| = Operating Income (EBIT) | core business profitability |
| − Interest Expense | cost of debt |
| = EBT (pretax) | before taxes |
| − Tax Expense | government share |
| = Net Income | bottom line |
EPS = (Net Income − Preferred Dividends) / Avg Common SharesRevenue recognition (ASC 606): recognize when performance obligation is satisfied, not when cash received. 5-step model: identify contract → performance obligations → transaction price → allocate → recognize.
Net income includes non-cash items: depreciation, accruals, deferred revenue. A profitable company can run out of cash. Always check cash flow from operations alongside net income.
Accrual accounting: revenue and expenses recognized when earned/incurred, not when cash flows. End-of-period adjustments correct the books to match the timing.
| Type | What's true | What we record |
|---|---|---|
| Accrued revenue | earned, not yet received | Dr A/R, Cr Revenue |
| Accrued expense | incurred, not yet paid | Dr Expense, Cr Payable |
| Deferred revenue | cash received, not yet earned | Dr Cash, Cr Deferred Rev (liab) |
| Deferred expense | cash paid, not yet used | Dr Prepaid (asset), Cr Cash |
Bad debt expense (allowance method): Dr Bad Debt, Cr Allowance for Doubtful AcctsMatching principle: recognize expenses in the same period as the revenues they helped generate. Foundation of accrual accounting.
Deferred = cash flowed but transaction not yet 'earned' → liability or prepaid asset. Accrued = transaction earned but cash hasn't flowed → A/R or accrued payable. Direction of cash flow is the key distinguisher.
| Ratio | Formula | Tells you |
|---|---|---|
| Current ratio | CA / CL | can pay near-term debts? >1 healthy |
| Quick ratio | (CA − Inv) / CL | same, excluding slow-to-sell inv |
| Cash ratio | Cash / CL | strictest liquidity |
| Ratio | Formula | Use |
|---|---|---|
| Gross margin | (Rev − COGS)/Rev | pricing power |
| ROA | NI / Avg Assets | asset productivity |
| ROE | NI / Avg Equity | shareholder return |
| Debt/Equity | Total Liab / Equity | leverage |
| Interest coverage | EBIT / Interest | can pay interest? >3 healthy |
ROE = (NI/Rev) · (Rev/Assets) · (Assets/Equity)Decomposes ROE into profitability × turnover × leverage.
Analysis tip: compare to industry peers + own historical trend. A 'low' D/E for one industry might be high for another. Banking is highly leveraged; tech less so.
'Current ratio of 2' isn't good or bad alone. Compare against industry average and own past. A current ratio doubling year-over-year while sales drop is a warning, not progress.
Total Assets = Total Liabilities + Equity| Type | Examples |
|---|---|
| Current (≤ 1 year) | Cash, A/R, Inventory, Prepaid |
| Non-current | PP&E (net), Intangibles, Goodwill, LT investments |
| Liability | Examples |
|---|---|
| Current | A/P, Short-term debt, Accrued expenses, Deferred Revenue |
| Long-term | Bonds payable, Long-term loans, Pension obligations |
WC = Current Assets − Current Liabilities. Positive = healthy short-term position. Many firms target a level of WC; too high suggests inefficient capital use.Goodwill: intangible asset, only created when acquiring another company at a premium over book value. Not amortized; tested for impairment annually.
Mark-to-market vs historical cost: most assets recorded at historical cost. Trading securities, derivatives, and some real estate use fair value. PP&E nearly always historical cost minus depreciation.
Retained earnings is cumulative net income kept in the business, not literal cash sitting around. A company with $100M RE could have $1M cash if it reinvested all profits in equipment. Never confuse equity items with cash.
| Section | What's there | Healthy sign |
|---|---|---|
| Operating | NI ± non-cash items ± WC changes | positive, growing |
| Investing | capex, acquisitions, asset sales | negative (investing in growth) |
| Financing | debt issuance/repay, dividends, buybacks | varies (debt paid down good) |
ΣCF (op + inv + fin) = Δ Cash on balance sheetFree cash flow = CFO − Capex (cash available to all investors)Free cash flow is what's left after operations + maintaining the asset base. Used in valuation (DCF). FCFE deducts interest + debt repay (cash to equity holders only).
Depreciation reduces NI but no cash leaves. So operating cash flow adds it back. Many students subtract it again on CFO — wrong. Always add back any non-cash expense to NI when starting from indirect method.
| Keyword | Use § from | Approach |
|---|---|---|
| 'journal entry for…' | § ① | identify accounts, debit / credit per type |
| 'find equity' | § ① | A − L = E |
| 'expense or asset?' | § ⑤ | matching: expense if used in period, asset if benefit future |
| 'gross margin / GM' | § ② | (Rev − COGS)/Rev |
| 'EPS' | § ② | (NI − pref div) / avg common shares |
| 'revenue recognition' | § ② | 5-step ASC 606; recognize when performance obligation met |
| 'list balance sheet items' | § ③ | Current vs non-current, A vs L vs E |
| 'goodwill / intangibles' | § ③ | only from acquisition above book value; impair, not amortize |
| 'cash flow from ops (indirect)' | § ④ | NI + depr ± WC changes |
| 'free cash flow' | § ④ | CFO − Capex |
| 'capex / investing' | § ④ | investing section, usually negative |
| 'dividends / buyback' | § ④ | financing section |
| 'accrued vs deferred' | § ⑤ | cash direction: accrued (no cash yet), deferred (cash already) |
| 'depreciation method' | § ⑤ | SL: (Cost−Salv)/Life. Double-declining for accelerated. |
| 'closing entries' | § ⑤ | zero out temp accounts (Rev, Exp, Div) → Retained Earnings |
| 'FIFO / LIFO impact' | § ⑥ | inflation: FIFO higher NI, LIFO higher COGS |
| 'inventory turnover' | § ⑥, ⑦ | COGS / Avg Inv |
| 'lower of cost or market' | § ⑥ | conservatism: write down only |
| 'current ratio / quick ratio' | § ⑦ | liquidity: CA/CL or (CA−Inv)/CL |
| 'ROE / ROA / DuPont' | § ⑦ | NI/Eq, NI/Assets; DuPont: NM × turnover × leverage |
| 'debt / equity ratio' | § ⑦ | Total Liab / Equity; context-dependent threshold |
Net income includes non-cash items (depreciation, accruals). A company can be profitable on paper while running out of cash. Always look at cash flow statement alongside income statement — they tell different stories.
Memorize: assets normal debit, liabilities/equity normal credit. Revenue increases by credit (it's an equity source). Expense increases by debit (it reduces equity). This is the foundation of every journal entry — get it backward and the whole problem collapses.