5.29 Accounting Fundamentals

Question 1

What does the statement of financial position (balance sheet) show?

Answer 1

The net worth of the company

The difference be the assets and liabilities

Question 2

Cash-flow statement

Answer 2

Where cash was received from and what it was spent on

Question 3

Income statement

Answer 3

Records the revenue, costs and profit(loss) of a business over a given period of time

Question 4

Gross profit

Answer 4

Equal to sales revenue less cost of sales

Question 5

Sales revenue (or sales turnover)

Answer 5

The total value of sales made during the trading period = selling price * quantity sold

Question 6

Cost of sales (or cost of goods sold)

Answer 6

This is the direct cost of purchasing the goods that were sold during the financial year

Question 7

Net profit (operating profit)

Answer 7

Gross profit minus overhead expenses

Question 8

Profit after tax

Answer 8

Operating profit minus interest costs and operation tax

Question 9

Dividends

Answer 9

The share of the profits paid to shareholders as a return for investing in the company

Question 10

Retained profit

Answer 10

The profit left after all deductions, including dividends, have been made
This is a ‘ploughed back’ into the company as a source of finance

Question 11

What does The income statement show?

Answer 11

The gross and net profit of the company

Details of how the net profit is split up bw dividends and retained profits

Question 12

Low-quality profit

Answer 12

One-off profit that cannot easily be repeated or sustained

Question 13

High-quality profit

Answer 13

Profit that can be repeated and sustained

Question 14

Balance sheet

Answer 14

An accounting statement that records the values of a business’s assets, liabilities and shareholders’ equity at one point in time
The net worth of the company.
The difference bw the value of a company owns and what it owes

Question 15

Asset

Answer 15

An item of monetary value that is owned by a business

Question 16

Liability

Answer 16

A financial obligation of a business that it is required to pay in the future

Question 17

Shareholders’ equity

Answer 17

Share capital + retained earnings

Question 18

Share capital

Answer 18

The total value of capital raised from shareholders by the issue of shares

Question 19

Non-current assets

Answer 19

Assets to be kept and used by the business for more than one year. Used to be referred to as “fixed assets”

Question 20

Intangible assets

Answer 20

Items of value that don’t have a physical presence, such as patents and trademarks

Question 21

Current assets

Answer 21

Assets that are likely to be turned into cash before the next balance-sheet date

Question 22

Inventories

Answer 22

Stocks held by the business in the form of materials, work in progress and finished goods

Question 23

Accounts receivables (debtors)

Answer 23

The value of payments to be received from customers who have bought goods on credit.

Question 24

Current liabilities

Answer 24

Debts of the business that will usually have to be paid within 1 year

Question 25

Accounts payable (creditors)

Answer 25

Value of debts for goods bought on credit payable to suppliers.

Question 26

Non-current liabilities

Answer 26

Value of debts of the business that will be payable after more than one year

Question 27

Goodwill

Answer 27

Arises when a business is valued at or sold for more than the balance-sheet value of its assets

Question 28

Cash-flow statement

Answer 28

Record of the cash received by a business over a period of time and the cash outflows from the business

Question 29

Gross profit margin (%)

Answer 29

Gross profit/ Sales revenue x100

Question 30

Net profit margin (%)

Answer 30

Net profit/ sales revenue x 100

Question 31

Liquidity

Answer 31

The ability of a firm to pat its short-term debts

Question 32

Current ratio

Answer 32

Current assets/ current liabilities

Question 33

Acid-test ratio

Answer 33

Liquid assets/ current liabilities

Question 34

Liquid assets

Answer 34

Current assets - inventories(stocks) = liquid assets

Question 35

Window dressing

Answer 35

Presenting the company accounts in a favourable light - to flatter the business performance

Question 36

Users of accounting information

Answer 36

1. Business mangers
   + measure performance against targets, competitors, past periods
   + take decisions over new investments
   + control and monitor and operation of each department
   + set targets or budgets for the future
2. Banks
   + Decide whether to lend money to business
   + Assess whether to allow an increase in overdraft facilities
   + Decide whether to continue a loan
3. Creditors
   + See if business is secure and liquid enough to pay off its debts
   + Assess whether business is a good credit risk
   + Decide whether to press for early repayment of outstanding debts
4. Customers
   + Assess whether business is secure
   + Assured of future supplies
   + Security of spare parts and service facilities

Question 37

Users of accounting information

Answer 37

5. Gov
   + Calculate tax
   + Determine if business is likely to expand –> create more jobs –> help country’s economy
   + Danger of closing down ? –> econ probs
   + Confirm that business is staying in law in terms of accounting regulations
6. Investors
   + Value of business
   + Profitability, potential for growth
   + Compare bw companies
   + Sell off all part or hold their shares?
7. Workforce
   + Security of jobs and wages
   + Wage increase if profits are rising?
8. Local community
   + Business expansion or closure

Question 38

Methods to increase liquidity

Answer 38

1. Sell of fixed assets (land and property)
   - Might not raise their true value
   - Lease back methods will add to overheads -> recude proft margins
2. Sell off inventories for cash
   - Reduce gross profit margin if sold at a discount
   - Consumers doubt image of brand if sold cheaply
   - JIT might be difficult to adopt in some industries since inventories might be needed to meet changing customer demand levels
3. Increase loans to inject cash –> increase working capital
   - Increase in gearing ratio
   - Increase interest costs

Question 39

Methods of window dressing

Answer 39

• Selling assets –> more liquid –> more reliable in bank
• Reducing the amount of depreciation of fixed assets
• Ignoring the fact that some debtors won’t be able to repay their debts
• Giving stocks level higher value
• Delaying bills until the accounts are published

Question 40

Uses of income statements

Answer 40

• Used to measure and compare the performance of a business over time and with other firms
• Actual profit data can be compared with the expected profit levels of the business
• Bankers and creditors of the business can decide whether to lend money
• Prospective investors

Question 41

Three sections of an income statement

Answer 41

The trading account: Showing how gross profit has been made from the trading activities of the business
Profit and loss account: Calculates both the net profit and the profit after tax of the business
Appropriation account: Shows how the profits after tax of the business are distributed bw the owners

Question 42

Limitation of ratio analysis

Answer 42

• Incomplete analysis of a company’s financial position
• Need to be compared to others’ value
• Comparing w/ competitors should be done with caution. (Window dressed)
• Only show problems, not suggest potential solutions
• Only measure quantitative performance.

Question 43

Ways to increase profit margins

Answer 43

• Increase gross and net profit margin by reducing direct costs
• Increase gross and net profit margin by increasing price
• Increase net profit margin by reducing overhead costs