17. Financial Statements

Question 1

<p>How is Finance Cost defined?</p>

Answer 1

<p>interest paid by a business on any borrowed money</p>

Question 2

<p>How is Finance Income defined?</p>

Answer 2

<p>interest received by a business on any money help in deposit accounts</p>

Question 3

<p>What are Financial Statements?</p>

Answer 3

<p>There are 2 main financial statements that all companies are required to produce, by law for each financial year. They are:
<br></br>- Statement of financial position (balance sheet)
<br></br>- Statement of comprehensive income (profit & loss account)
<br></br>
<br></br>Unincorporated businesses are also required to create financial statements, but they will not be as detailed as those required by companies. However, they will usually take a similar format to those listed above.</p>

Question 4

<p>What is the Statement of Comprehensive Income?</p>

Answer 4

<p>- Otherwise known as an income statement or profit and loss account, the statement of comprehensive income will record the income and expenditure of a business over a period of time.
<br></br>- The period of time is usually 1 year (but can vary from 6 months to 18 months)
<br></br>- It will be used to calculate whether a business has made a profit or a loss over the accounting period.</p>

Question 5

<p>What are the Key Parts of the Statement of Financial Income?</p>

Answer 5

<p>- Revenue
<br></br>- Cost of Sales
<br></br>- Gross Profits
<br></br>- Selling Expenses
<br></br>- Administrative expenses
<br></br>- Operating Profit
<br></br>- Finance Costs
<br></br>- Profit for the Year (net profit)
<br></br>- Profit for the year (net profit) after tax</p>

Question 6

<p>What is the Revenue section of Statement of Comprehensive Income?</p>

Answer 6

<p>- This is the money the business receives from selling goods and services.
<br></br>- Revenue must not include VAT. This is because VAT does not belong to the business</p>

Question 7

<p>What is the Cost of Sales section of Statement of Comprehensive Income?</p>

Answer 7

<p>- This refers to the production costs of a business
<br></br>- More specifically it relates to direct costs, such as raw materials and labour</p>

Question 8

<p>What is the Gross Profit section of Statement of Comprehensive Income?</p>

Answer 8

<p>- This is the cost of sales subtracted from the revenue
<br></br>- It is the profit made before the deduction of general overheads</p>

Question 9

<p>What is the Selling Expenses section of Statement of Comprehensive Income?</p>

Answer 9

<p>A business is likely to incur a range of expenses that are directly related to the selling its products e.g. sales commissions, advertising, distribution and promotional costs.</p>

Question 10

<p>What is the Administrative Expenses section of Statement of Comprehensive Income?</p>

Answer 10

<p>- These are the general overheads or indirect costs of the business e.g. office salaries, expenses claimed by senior staff, stationery supplies, IT expenses etc.</p>

Question 11

<p>What is the Operating Profit section of Statement of Comprehensive Income?</p>

Answer 11

<p>- If the selling and administrative costs are subtracted from gross profit we get the operating profit
<br></br>- The operating profit is the profit generated from the firm's core acitivites
<br></br>- It does not include any income from financial investments made by the business</p>

Question 12

<p>What is the Finance Costs Section of Statement of Comprehensive Income?</p>

Answer 12

<p>- If a business borrows money it will have to pay interest to the lender.
<br></br>- The amount paid will be entered in the statement as a finance cost
<br></br>- However, a business may also recieve interest if it has money in deposit accounts this will appear as finance income in the account</p>

Question 13

<p>What is the Profit for the Year (Net Profit) section of the Statement of Comprehensive Income?</p>

Answer 13

<p>- If the cost of finance is subtracted from the operating profit the net profit for the year is determined
<br></br>- This is the profit before taxation</p>

Question 14

<p>what is the Profit for the Year (Net Profit) after tax section of the Statement of Comprehensive Income?</p>

Answer 14

<p>- This is the amount of money that is left over after all expenses, including taxation, have been deducted from revenue
<br></br>- It is often referred to as the 'bottom line'
<br></br>- The money belongs to the owners of the business,
<br></br>- In case of a limited company it belongs to the shareholders, Some of it may be retained</p>

Question 15

<p>What are the different Stakeholders that would be interested in the Statement of Financial Income?</p>

Answer 15

<p>- Shareholder
<br></br>- Managers & Directors
<br></br>- Employees
<br></br>- Suppliers
<br></br>-Government</p>

Question 16

<p>Why would Shareholders be interested the Statement of Financial Income?</p>

Answer 16

<p>- Naturally the owners of a business will be interested in its performance
<br></br>- Shareholders are likely to be interested in the profit made by the business - particularly the profit for the year (net profit) after tax
<br></br>- Rising profits are an indicator of improving performance --> probably calculate the net profit and gross profit margin from the statement of financial income to assess performance more rigorously
<br></br>- It is also possible to gauge the growth of the business by looking at the statement of comprehensive income --> if the revenue is rising this suggests that the business is growing</p>

Question 17

<p>Why would Managers & Directors be interested in the Statement of Financial Income?</p>

Answer 17

<p>- Since managers and directors are responsible for running the business, they are likely to use key information in the statement of comprehensive income to monitor progress
<br></br>- For example, they might be setting annual targets for growth in revenue or profit for the year (net profit).
<br></br>- Changes in the revenue, for example will show how fast a company has grow and whether targets have been met</p>

Question 18

<p>Why would Employees be interested in the Statement of Financial Income?</p>

Answer 18

<p>- If employees, or their representatives, are seeking a wage increase, it may be helpful to have access to some of the information in the statement of comprehensive income when presenting a claim</p>

Question 19

<p>Why would Suppliers be interested in the Statement Financial Income?</p>

Answer 19

<p>- Before a supplier accepts an order form a new customer on trade credit, it is prudent to carry out a check on their creditworthiness
<br></br>- One way to do this is to look at the trading history of the customer
<br></br>- If the customer can provide several years of authenticated accounts, this might help to show whether the customers is able to pay what is owned at the end of the credit period
<br></br>- If the statement of comprehensive income show that a customer is consistently profitable, this might be enough proof for the supplier</p>

Question 20

<p>Why would Government be interested in the Statement Financial Income?</p>

Answer 20

<p>- Companies have to produce a statement of comprehensive income by law
<br></br>-It is needed by the tax authorities to help assess how much tax a business has to pay
<br></br>- HMRC collects taxes on behalf of the government and requires all business owners to provide documentary evidence of the profits or losses made by the business ever year
<br></br>- Also, the ONS (Office for National Statistics), a government agency, may have an interest in business accounts because it collects economic data, which is collated and presented for public consumption</p>

Question 21

<p>What are the section of a Statement of Financial Position?</p>

Answer 21

<p>Previously known as the balance sheet, the Statement of Financial Position catalogues the a businesses assets and liabilities on a particular date in time.
<br></br>
<br></br>It is broken down into 3 section:
<br></br>- Assets
<br></br>- Liabilities
<br></br>- capital</p>

Question 22

<p>What is the Asset section of the Statement of Financial Position?</p>

Answer 22

<p>- These are items that a business owns or uses. They are divided into current or non-current assets.
<br></br>- Current assets, such as raw materials and inventory (stock) are used up in the production process.
<br></br>- Non-current assets, such as factories and machinery, are used repeatedly over a period of time. A business would expect to retain these assets for beyond the next accounting period.</p>

Question 23

<p>What is the Liabilities section of the Statement of Financial Position?</p>

Answer 23

<p>- These are debts that of a business, money owed to other parties. Again they will be categorised as either current or non-current.
<br></br>- These may be short term, an overdraft or a supplier who’s provided trade credit, or long term, such as a mortgage, bank loan or hire purchase agreement</p>

Question 24

<p>What is the Capital section of the Statement of Financial Position?</p>

Answer 24

<p>This is the money provided to the business by the owners or shareholders. It is a source of funds usually used to purchase assets.</p>

Question 25

<p>What are the pieces of Key Information in the Statement of Financial Position?</p>

Answer 25

<p>- Non-current Assets
<br></br>- Current Assets
<br></br>- Non-current Liabilities
<br></br>-Current Liabilities
<br></br>- Net Assets
<br></br>- Equity</p>

Question 26

<p>What is in the Non-current Asset section in the Statement of Financial Position?</p>

Answer 26

<p>- Goodwill --> This is a non-physical asset of a business, it is the amount the business is worth above the value of net assets. Goodwill exists if a company has built up a good reputation and its customers are likely to return
<br></br>- Other intangible assets --> e.g. brand names, copyrights, trademarks and patents
<br></br>- Property, plant and equipment --> These are the tangible assets that the business owns,
<br></br>- Investments --> These are the financial assets owned by the company e.g. the shares held in other companies. If investments are listed under non-current assets it means that they are not expect to be sold for at least 12 months</p>

Question 27

<p>What is in the Current Asset section of the Statement of Financial Position?</p>

Answer 27

<p>- Inventories --> This refers to stocks of raw materials and components, stocks of finished goods and work in progress
<br></br>- Trade and other receivables --> These are trade debtors, prepayments and any other amount owed to the business that are likely to be repaid within 12 months
<br></br>- Cash at bank and in hand --> This is the money held by a business on the premises or in bank accounts</p>

Question 28

<p>What is in the Current Liabilities section of the Statement of Financial Position?</p>

Answer 28

<p>- Borrowing --> Any short-term loans or bank overdrafts taken out by the business
<br></br>- Trade and Other Payables --> Trade creditors and other amounts owed by the business to suppliers or goods services and utilities
<br></br>- Dividends Payable --> When the balance sheet is prepared *(at the end of the financial year perhaps) it is possible that the company has decided how much it will pay the shareholders in dividends. However the money has not yet been paid so it appears in the balance sheet as dividends payable
<br></br>- Current Tax Liabilities --> Corporation tax, employees' income tax and any other tax owed by the business that must be repaid within 12 months</p>

Question 29

<p>What is in the Non-current Liabilities section of the Statement of Financial Position?</p>

Answer 29

<p>- Other loans and borrowings --> Money owed by the company that does not have to be repaid for at least 12 months e,g, bank loans and mortgages
<br></br>- Retirement Pension Obligations --> Companies need to show any money owed to past employees in the form of pension obligation
<br></br>- Provisions --> Provisions have to be made if a company is likely to incur expenditure in the future, such expenditure might arise as a result of agreements in contract or warranties.</p>

Question 30

<p>What is in the Net Asset section of the Statement of Financial Position?</p>

Answer 30

<p>- Net assets is simply the value of all assets minus the value of all liabilities
<br></br>- It will be the same value as shareholders' equity at the bottom of the balance sheet</p>

Question 31

<p>What is in the Equity section of the Statement of Financial Position?</p>

Answer 31

<p>- Share Capital --> The amount of money paid by shareholders for their shares when they were originally issued. It does not represent the current value of those shares on the stock market. Share capital is not usually repaid to the shareholders in the lifetime of a company
<br></br>- Share Premium Account --> this shows the difference between the value of new shares issued by the company and their nominal
<br></br>- Other reserves --> Refers to any amounts owing to the shareholders not covered by the other entries under equity
<br></br>- Retained Earnings --> The same as retained profit. It is the amount of profit retained by the business to be used in the future</p>

Question 32

<p>What Stakeholders would be interested in the Statement of Financial Position?</p>

Answer 32

<p>- Shareholders
<br></br>- Managers and Directors
<br></br>- Suppliers
<br></br>- Others</p>

Question 33

<p>Why would Shareholders by interested in the Statement of Financial Position?</p>

Answer 33

<p>- Shareholders might use the balance sheet to analyse the asset structure of the business
<br></br>- This shows how the funds raised by the business have been put to use
<br></br>- The balance sheet also shows the capital structure of the business, i.e. the different sources of funds used by the business
<br></br>- the balance sheet can also be used to assess the solvency of the business
<br></br>- A business is solvent if it has enough liquid assets to pay its bills
<br></br>- The value of working capital will help to assess solvency of the business
<br></br>- the value of a business is roughly equivalent to the value of net assets in the business
<br></br>-This means that shareholders can use the balance sheet to see if their investment is growing</p>

Question 34

<p>Why would Managers and Directors be interested in the Statement of Financial Position?</p>

Answer 34

<p>- the balance sheet might be used by the management of a business e.g. it is important for senior managers to be aware of the firm;s financial position at any given point in time
<br></br>- It will need to monitor working capital levels to ensure that the business does not overspend
<br></br>- Also, if the business is considering raising some more finance, it will have consider the current capital structure before choosing a suitable source</p>

Question 35

<p>Why would Suppliers and Creditors be interested in Statement of Financial Position?</p>

Answer 35

<p>- Suppliers will be most interested in the solvency of the business
<br></br>- Suppliers are not likely to offer trade credit to a business that only has a limited amount of working capital</p>

Question 36

<p>Why would Others be interested in Statement of Financial Position?</p>

Answer 36

<p>- It is possible that employees might use the balance sheet to assess whether a business can afford a pay rise or whether their jobs are secure
<br></br>- The office for National Statistics (ONS) sheet to compile national statistics</p>