Accounting Principles

Question 1

What are the key financial statements that companies provide?

Answer 1

1. Profit and loss accounts.
2. Balance sheets.
3. Cash flow statements.

Question 2

What is the difference between management accounts and financial accounts?

Answer 2

Management accounts are for the internal use of the management team

Financial accounts are the company accounts that are required by UK law (Company’s Act 2006).

Question 3

What is the difference between a profit and loss account & a balance sheet and what is the purpose of each?

Answer 3

Profit and Loss Accounts record revenue and expenses for each month to see whether the business is making a profit or operating on a loss.

This, in turn, will help a company to work out whether you they need to increase profit margins or lower expenses to ensure that your business is sustainable.

A balance sheet shows what a company owns (its assets) and what it owes (its liabilities) at any given point.

This can demonstrate the value of a company at any given point.

Question 4

What is a cash flow statement?

Answer 4

It is a measure of liquidity, a cash flow statement tracks in coming and out going cash on a day-to-day basis and tells a company their cash balance at any point in time to ensure they have enough funds to pay any bills.

Question 5

Explain your understanding of capital allowances, insolvency and sinking funds?

Answer 5

Capital Allowances - Tax relief for certain items purchased for the business, for example tools and equipment.

Sinking Funds - Sums that are set aside for future expenses or long term debt.

Insolvency - An inability to pay debts, where debts exceed assets.

Question 6

What are liquidity ratios?

Answer 6

Liquidity ratios = current assets / current liabilities

Liquidity ratios measure the ability of a company to pay off its current liabilities by converting its assets into cash.

The ratio is usually 1.5 although this depends on the sector the company is operating in. For example, house builders often operate with a liquidity ration of 3 because they hold high value assets in unsold houses.

A ratio of less than 0.75 can be an early indicator of insolvency.

Question 7

What are profitability ratios?

Answer 7

Profitability ratios measure the performance of a company in generating profits.

Trading profit ratio margin = turnover (cost of sales/ turnover).

Low margins may be due to a growth strategy from the company and do not result from bad management.

Question 8

What are financial gearing ratios?

Answer 8

These measure the financial structure of the company and are indicators for external supplier of debt as well as for internal management.

They help to measure solvency.

Highly ‘geared’ company’s relay on borrowing & the payment of interest reduces profit.

Question 9

What is the purpose of a Profit and Loss account?

Answer 9

To monitor and measure profit and loss

To compare against past performance and against company budgets.

For valuation purposes and to compare against competitors.

To assist in forecasting future performance

To calculate taxation.

Question 10

What is the difference between debtors and creditors?

Answer 10

Creditors are business entities that are owed money by another entity that they have extended credit to. For example, if you have provided services to a client and they owe payment of your fees, you become a creditor to the client.

Debtors are business entities that owe money to another respective company. For example, if you have used a sub-consultant and still owe them payment of their fees then you become debtors of a sub-consultant.

Question 11

What are management accounts?

Answer 11

These are accounts used for internal management use.

Accounts prepared for a lender, such as a bank, to evaluate how you’ll be able to repay the funding.

These accounts are not to be audited externally.

Question 12

What is a financial statement?

Answer 12

These are forecasts of income and expenditure that can be used as an analytical tool to identify shortfalls and surpluses.

Question 13

What is a profit & loss account?

Answer 13

They demonstrate a companies sales, running costs and resulting profit or loss over a period of time (usually 1 year).

They are used to compare sales vs expense.

They can also be used to identify works that are not profitable.

Question 14

What is a balance sheet?

Answer 14

It shows what the company owns in terms of assets and liabilities.

The balance sheet can demonstrate the value of the business at any given time.

Question 15

What is a cash flow forecast?

Answer 15

A cash flow forecast summarises the cash, or cash equivalents both entering and leaving a company or project entity.

On construction projects this is usually shown as an ‘S’ curve.

In terms of a project entity, there is usually a small financial outlay at the start, a steep increase outlay towards the midpoint and a taper towards the end.

Question 16

What are Escrow Accounts?

Answer 16

A separate account owned by a third party on behalf of two other parties.

It serves as a bank account with defined contractual conditions for the release of funds.

They can be used as a project bank account.

Mechanisms must be in place for the release of funds, such as payment certificates.

Question 17

When have you used accounts in your work?

Answer 17

To access the financial strength of contractors at pre-qualification stage or contract stage.

Question 18

How do you analyse a company’s accounts?

Answer 18

The client’s accounts will carryout a detailed analysis but I can look at the warning signs by calculating ratios including liquidity rations, profitability ratios and gearing ratios.

I should always calculate the ratios myself as those included within the company’s accounts may have been manipulated.

Question 19

How you carryout a credit check?

Answer 19

I use the ‘CreditSafe’ website, which my company subscribes to, providing access to company’s accounts.

I considered both the ‘group’s’ account and the relevant company’s account.

If the company’s credit rating is low, I calculate some ratios and pass on the information to my client’s accounts for them to further analyse.

Question 20

What are signs of insolvency in company accounts or credit checks?

Answer 20

1. Low credit score
2. Liquidity ration below 0.75
3. A falling working capital ratio - suggesting they may have taken on more work than can be financed.

Question 21

Why would you not recommend the appointment of a contractor with a low credit rating?

Answer 21

There may be an increased risk of the contractor carrying out works which were not satisfactory.

It could present a risk of the contractor failing to deploy sufficient resources and materials to the project.

Question 22

What measures would you recommend if your client wanted to appoint a contractor with a low credit rating?

Answer 22

I would explore the option of requesting a performance bond that my client could call on if the main contractor failed to perform.

I would review interim payment applications to ensure that these are accurate and not over-claimed.

A project bank account may also provide an additional level of assurance and should be considered.

Question 23

ACCOUNTING PRINCIPLES: What are a Director’s general duties under the Companies Act 2006?

Answer 23

1. Duty to act within powers - a Director of a company must only exercise powers that they have been granted.
2. Duty to promote the success of the company - a Director of a company must act in good faith to promote the success of the company for the benefit of its members as a whole.

3.Duty to exercise independent judgement - the director must exercise independent judgement.

4. Duty to exercise reasonable care, skill and diligence - the director must use care skill and diligence.
5. Duty to avoid conflicts of interest - The director must avoid a situation in which he has, or can have, a direct or indirect interest that conflicts.
6. Duty not to accept benefits from third parties - The director’s duty is not infringed if the acceptance of the benefit cannot reasonably be regarded as likely to give rise to a conflict of interest.
7. Duty to declare interest in proposed transaction or arrangement - The director must state if they are interested in a proposed transaction or arrangement with the company and state why.

Question 24

What is required within the Annual Accounts of a company under the Companies Act 2006?

Answer 24

1. Balance sheet: shows what a company owns (its assets) and what it owes (its liabilities) at any given point. This can demonstrate the value of a company at any given point.
2. Profit and Loss Statement (P&L): record revenue and expenses for each month to see whether the business is making a profit or operating on a loss.
3. Directors’ report: An overview of the company’s business activities, typically required for larger companies.
4. Auditor’s report: For large companies, this is a review by an external auditor confirming the accuracy of the accounts.

Question 25

ACCOUNTING PRINCIPLES AND PROCEDURES: You say in your SOE that you know ways of assessing your companies financial performance, what are these?

Answer 25

1. Gearing rations = total debt / total shareholders’ equity
   - These measure the financial structure of the company and are indicators for external supplier of debt as well as for internal management.
2. Comparing P&L sheets with previous years.