5.29 Accounting Fundamentals Flashcards
What does the statement of financial position (balance sheet) show?
The net worth of the company
The difference be the assets and liabilities
Cash-flow statement
Where cash was received from and what it was spent on
Income statement
Records the revenue, costs and profit(loss) of a business over a given period of time
Gross profit
Equal to sales revenue less cost of sales
Sales revenue (or sales turnover)
The total value of sales made during the trading period = selling price * quantity sold
Cost of sales (or cost of goods sold)
This is the direct cost of purchasing the goods that were sold during the financial year
Net profit (operating profit)
Gross profit minus overhead expenses
Profit after tax
Operating profit minus interest costs and operation tax
Dividends
The share of the profits paid to shareholders as a return for investing in the company
Retained profit
The profit left after all deductions, including dividends, have been made
This is a ‘ploughed back’ into the company as a source of finance
What does The income statement show?
The gross and net profit of the company
Details of how the net profit is split up bw dividends and retained profits
Low-quality profit
One-off profit that cannot easily be repeated or sustained
High-quality profit
Profit that can be repeated and sustained
Balance sheet
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
Asset
An item of monetary value that is owned by a business
Liability
A financial obligation of a business that it is required to pay in the future
Shareholders’ equity
Share capital + retained earnings
Share capital
The total value of capital raised from shareholders by the issue of shares
Non-current assets
Assets to be kept and used by the business for more than one year. Used to be referred to as “fixed assets”
Intangible assets
Items of value that don’t have a physical presence, such as patents and trademarks
Current assets
Assets that are likely to be turned into cash before the next balance-sheet date
Inventories
Stocks held by the business in the form of materials, work in progress and finished goods
Accounts receivables (debtors)
The value of payments to be received from customers who have bought goods on credit.
Current liabilities
Debts of the business that will usually have to be paid within 1 year
Accounts payable (creditors)
Value of debts for goods bought on credit payable to suppliers.
Non-current liabilities
Value of debts of the business that will be payable after more than one year
Goodwill
Arises when a business is valued at or sold for more than the balance-sheet value of its assets
Cash-flow statement
Record of the cash received by a business over a period of time and the cash outflows from the business
Gross profit margin (%)
Gross profit/ Sales revenue x100
Net profit margin (%)
Net profit/ sales revenue x 100
Liquidity
The ability of a firm to pat its short-term debts
Current ratio
Current assets/ current liabilities
Acid-test ratio
Liquid assets/ current liabilities
Liquid assets
Current assets - inventories(stocks) = liquid assets
Window dressing
Presenting the company accounts in a favourable light - to flatter the business performance
Users of accounting information
- 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 - Banks
+ Decide whether to lend money to business
+ Assess whether to allow an increase in overdraft facilities
+ Decide whether to continue a loan - 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 - Customers
+ Assess whether business is secure
+ Assured of future supplies
+ Security of spare parts and service facilities
Users of accounting information
- 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 - Investors
+ Value of business
+ Profitability, potential for growth
+ Compare bw companies
+ Sell off all part or hold their shares? - Workforce
+ Security of jobs and wages
+ Wage increase if profits are rising? - Local community
+ Business expansion or closure
Methods to increase liquidity
- Sell of fixed assets (land and property)
- Might not raise their true value
- Lease back methods will add to overheads -> recude proft margins - 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 - Increase loans to inject cash –> increase working capital
- Increase in gearing ratio
- Increase interest costs
Methods of window dressing
- 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
Uses of income statements
- 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
Three sections of an income statement
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
Limitation of ratio analysis
- 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.
Ways to increase profit margins
- 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
