The Big R-Book

♣28♣Financial Accounting (FA)

While financial accounting is not a subject that is part of most programs for mathematicians or data scientists, it does help us to understand how companies work. Accounting is a vast field and is the details tend be dependent on the country of residence and operation. In this chapter, we present only a very brief and general introduction to the subject that will be valid in most countries, and that will help us to understand asset classes and their pricing easier.

28.1 The Statements of Accounts

The process of accounting is essentially registering what happens in the company so that we are able to understand how good the company is doing and to some extent how future looks like. This necessarily implies dealing with both flow variables (cash entering or leaving our books for example) and stock variables (e.g. the reserve of cash, the pile of raw materials, etc.). In order to make sense of this continuously changing reality, one usually employs a standardized approach that consists of daily updating the books and taking regular snapshots. These snapshots are called “statements of accounts” and consist of

• income statement,
• profit and loss statement, and
• balance sheet.

28.1.1 Income Statement

Definition: Income Statement

The Income Statement is all cash income minus all cash expenses.

The income statement informs about cash flow and is therefore, backwards looking only and focuses only on a narrow part of the reality: the cash. Its importance ...