1. Accounting Principles and Procedures Flashcards
What is Accounting?
The process of recording financial transactions relevant to a business.
What is Accounting Principles?
Rules and guidelines for companies when reporting financial data.
Companies Act 2006 – recognises two reporting frameworks:
- GAAP (UK) Generally Accepted Accounting Practice - body of accounting standards published by the UK’s Financial Reporting Council (FRC).
- International Financial Reporting Standards (IFRS).
What is the importance of Accounting Principles?
- Monitor profit and loss and company performance.
- Use the information for future business planning
- Assessment of Financial Strength of Tendering Contractors.
- Determine current market position and assessment of competition
- Requirement to submit annual financial statements to Companies House under Companies Act 2006
What are the different key financial statements?
- Balance Sheet
- Profit and Loss Account
- Cash Flow Statement
What is the difference between Management and Company accounts?
- Management accounts are used internally by the managers of the business.
- Financial accounts are company accounts required by law and audited by a Chartered Accountant.
What is a Balance Sheet?
A balance sheet is a statement showing a business’s financial position at a point in time.
ASSETS = LIABILITES + STOCKHOLDER EQUITY.
Shows a business’s assets and liabilities at a given date, usually at the end of a financial year. It tells you how much the owes (assets) and owes (liabilities)
Assets = things the business owns that you get a future benefit from e.g. physical assets like property and non-physical assets like brand and goodwill.
Current assets = assets to be used within 1 year
Non-current (fixed) assets = plant, machinery and equipment etc.
Liabilities = amounts a business owes due to past transactions e.g. wages and loans
What is a Profit and Loss Statement?
A summary of a business’s income and expenditure transactions usually prepared on an annual basis.
INCOME - COSTS = PROFIT / LOSS.
P&L Accounts demonstrate how the revenue is transformed into the net income - how the actual income the business receives transfers into profit for the year.
Typically includes Income, expenditure, plus any adjustments for liabilities.
Revenue = income the business receives from its business activities e.g. money from things it sells
Expenses = outgoings that arise as the entity performs its business activities e.g. costs incurred in order to provide their service.
What is a Cash Flow Statement?
Cash flow shows the actual receipts and expenditure and includes VAT.
Reviewing cash flow can identify potential shortfalls in cash balance i.e. where you may not have enough cash in the business to pay suppliers etc.
Review cash flow helps ensure businesses can afford to pay suppliers and employees i.e. the cash coming in is enough to cover the cash going out.
Struggling companies should review cash flow daily.
Healthier companies should review cash flow weekly or monthly.
How would you assess a contractor’s financial accounts?
Request a copy of the contractor’s company accounts for the last 3 years which would include the Profit & Loss Statement, Balance Sheet and Cash Flow Statement.
I would then be able to assess:
- If the contractor had been profitable in the last few years.
- Calculate their liquidity ratio by looking at their assets vs their liabilities to see if they would be able to cover losses under a contract and stay solvent.
I would always caveat any advice given to a client on a contractor’s financial position and recommend that further advice is sought through financial reports and a qualified accountant.
What are the main types of ratio analysis used to assess a company’s financial strength?
- Liquidity – the ability of the company to pay its way (solvency). More companies fail due to cash flow than any other reason.
- Current Ratio = Liquid assets / Liabilities
- Investment/shareholders – information to enable decisions to be made on the extent of the risk and the earning potential of a business investment.
Return on Investment (ROI) = (Gain – Cost) / Cost
• Gearing – information on the relationship between the exposure of the business to loans as opposed to share capital.
Net Gearing = Net Debt / Equity
• Profitability – how effective the company is at generating profits given sales and/or its capital assets.
Gross Margin = Gross profit / Net Sales
• Financial – the rate at which the company sells its stock and the efficiency with which it uses its assets.
Asset Turnover = Net Sales / Total Assets
What is the difference between a Sole Trader, Partnership, Limited, and a LLP?
- Sole Trader
A person who is the exclusive owner of a business, entitled to keep all profits after tax has been paid but liable for all losses (unlimited liability). - Partnership
A business organization in which two or more individuals manage and operate the business. Both owners are equally and personally liable for the debts from the business. - Limited
In a limited company, the shareholders’ liability is limited to the capital they originally invested. If such company becomes insolvent, the shareholders personal assets remain protected. Shares in a private limited company are not offered to the general public (distinguishing it from a public limited company - plc.) - Limited Liability Partnership (LLP)
A limited liability partnership (LLP) is a partnership in which some or all partners have limited liabilities. It therefore exhibits elements of partnerships and corporations. In an LLP, one partner is not responsible or liable for another partner’s misconduct or negligence.
What is the Companies Act 2006?
The Companies Act 2006 is the main piece of legislation which governs company law in the UK.
Sets out that companies must submit their annual financial account to companies house and HMRC.
Covers various different areas including:
- Registration of a Company
- Appointment and Duties of Directors
- Requirement for Auditing of Financial Accounts
