Accounting Principles Flashcards
Types of financial statements
Profit and loss
Balance sheet
Cash flow
What does each financial statement represent?
Profit and loss - incomes and expenditure
Cash flow - summary of actual and anticipated ingoings and outgoings
- ability to pay bills
Balance sheet - owns i.e assets and owes i.e liabilities
Identify keys terms
Capital allowance - tax relief of items purchased
Sinking fund - funds for future or long term debt
Insolvency - inability to pay debts meaning more liabilities than assets
Companies House - incorporates and dissolves limited companies
HMRC - His Majesty’s Revenue and Customs
Describe a liquidity ratio
Ability to pay off current liabilities by converting assets to cash
Assets v liabilities
1.5 usual ratio - house builders often 1.3
0.75 - indicates insolvent
What is a profitability ratio?
Measure in generating profit
Ratio = turnover - (loss of sales/turnover)
Low margin = Growth
What is financial gearing ratio?
Indicator for suppliers of debt and equity
Measures insolvency
High = rely on borrowing
Interest payments reduce profit
Why is it important to understand finances?
Prepare own accounts
Assess contractors
Assess competition
What is the purpose of Profit and Loss?
Monitor and measure profit and loss
Compare previous performance and budget
Valuation purpose
Forecast future
Compare to competition
Taxation
What are management accounts?
For internal use
For lenders to evaluate performance
Not audited
What is a debtor?
An entity that owes money
What is a creditor?
Owed money by other - i.e owed fee payment
What is a financial statement?
Forecasts income and expenditure to analyse shortfalls and surpluses
What is in a profit and loss account?
Sales, running costs, profit or loss
Sales v expense
Identity non-profitable work
What is on a balance sheet?
Value of everything owned = assets, liabilities
Value of business
What is in a cash flow forecast?
Cash in and out of the business
S curve - small outlay at the start
- i.e construction process
How do surveyors use financial accounts?
Track, analyse, assess the performance
Identify financial strengths
Compare progress v predictions
What is escrow accounts ?
Owned by third party, held one half of others
Conditions and mechanism to release funds
I.e Project bank account
When have you reviewed accounts?
Instructing contractors
Application process for new tenants
What did you do with accounts?
Viewed the ratios for liquidity, profitability, gearing
Calculated myself
How do you credit check an applicant?
Credit safe site
Group and company accounts
Low = calculate ratios and pass on info
Would you recommend an applicant with a low rating?
No - risk of performance
- risk of deployment of resources
- risk of insolvency
What are the signs of insolvency?
Low rating
Liquidity below 0.75
Working capital ratio falling
Low return on equity
Large borrowing
Falling cash flow
Advice to the client if they want a low rated contractor?
Performance bond if they fail to perform
Review tender
Review valuations
Set up project bank account
What is equity?
Value an owner has in the business
Total liabilities from total assets on B/S
What does the Companies Act 2006 stipulate?
All private limited companies and PLCs must file annual accounts on Companies House
What is a hurdle rate?
Minimum rate of return required on an investment
What are the UK quarter days?
25 March 24 June 29 Sept, 25 Dec
What is VAT?
Value added tax
Charged on top of goods and services
Some goods exempt - Royal Mail postage costs
Installation of a/c units = 0% since 1 April 22
What are liabilities?
Things people/businesses owe
Mortgage, car payments, loans
What are assets?
Resources businesses own or control
Car fleet, buildings
How to calculate Net worth?
Assets - liabilities = net worth
What is insolvency?
The inability to pay money owed on time
What are the types of insolvency?
Administration = court manage company
Liquidation = company assets sold to pay debts
Receivership = creditors appt receiver over the insolvent firms asssts
Company Voluntary agreement = agreement between company and creditors
What if a contractor goes bust?
Insure the site
Track materials
Withhold payment
Record time spent
Record value of works to date
What is the order of money after liquidation?
Fixed charge holders = bank
Liquidator fees and expenses
Preferential creditors = pensions, employees
Floating charge holders
Unsecured creditors = client
What is financial accounts?
Used externally for auditing
Required by law (companies house)
Types of Ratio analysis
Gross profit
Net profit
Capital expenditure
Revenue expenditure
Gearing
Liquidity
Types of tax
Vat
Stamp duty
Corporation
Land
Income
What are the generally accepted accounting principles?
Standards of details, complexities of legal accounting
What are management accounts?
Accounts shed light of business health and operational efficiency, not just numbers but holistic view
When should management accounts be prepared?
Monthly, quarterly - help to act swiftly to opportunities or threats
What are annual accounts for a private limited company?
Summary of financial activity of 12 month period. Prepared for HMRC and companies house. Incl balance sheet, profit and loss statement and cash flow statement
What is a balance sheet?
Statement giving insight to assets, liabilities and shareholders equity at a point in time. Owned v owed. Business health at a snapshot in time. Assets and liabilities shown.
On a balance sheet, what is an asset?
Owned or benefit from - fixed (long term = land, property), current (short term = petty cash, cash in the bank)
On a balance sheet, what is a liability?
Obligation for debt arising that needs to be repaid. Long term = money not due to be repaid in next year. Current = repaid in 1 year
What is a profit and loss statement?
Records performance over time. Revenues v expenses throughout year
What is a cash flow statement?
Cash movements in and out over the financial year. Money in and out during period of time
When is a statutory financial audit required?
Annual, independent inspection required by law unless exempt if below threshold. Legal requirement to be audited. Ensure accounts are correctly, prepared, accurate and in line with standards. Independent auditor and specialist.
Explain tax depreciation?
Where declining value of an asset is offset against a companies taxable profit
Recorded as an expensive in order to reduce the amount of taxable income
Applied to plant, tools, vehicles, computers, furniture and buildings
What are overheads?
Operating cost of the business that are incurred on an ongoing basis
Fixed or variable
Fixed - e.g rent, building insurance
Variable - e.g utility charges
What’s is an escrow account?
Contractual agreements used as financial instruments within a transaction
Asset/currency being transferred is held by intermediary third party
Currency being exchanged is held by third party until each party meets contractual obligations allowing money to be transferred
Mortgage lenders when completion buying/selling of real estate
What are Liquidity ratios?
Ability to pay debt obligations and assess its margin of safety by looking at e.g cash v short term debt s
Profitability ratios?
Ability to generate profits from sales operations and shareholding equity. Indicates how efficiently the company is generating profit
Gearing ratios?
Capital v debt.
Measure companies leverage and sets out proportion of the firms activities are funded by shareholders v creditor funds
Why does a business keep company accounts?
Record and measure profitability
Tax calculation
Legislation requires accurate records
Business growth identifies profitable operations
What is financial leverage?
Borrowed funds in form of debt
Enhance business operations and increase profitability
What a capital allowances?
Allow tax payers to gain tax relief by using their expenditure to be deducted from their taxable income
The expenditure used to lower taxpayer income is only allowed within certain categories: plant and machinery, integral parts of structure and buildings (lifts), research and development costs, patents
Current asset vs fixed assets
Current = converted to cash within one year, allow day to day operation of the business. E.g money owed for products or services
Fixed = cannot be converted within one year. Owns for long term e.g vehicles, machinery, land
Profit and loss accounts v balance sheet
P&L = income and expenditure
B/s = assets and liabilities and given point in time
Key financial statements?
Profit and loss
Cash flow
Balance sheet
What is a cash flow statement?
Actual and anticipated in/outgoings of cash over a period.
Operating, investing and financing activities
Measure short term ability to pay debts
Why understand accounts?
Own accounts
Contractors
Profitability and sustainability
Purpose of profit and loss?
Monitor and measure p/l
Compare performance vs past/competition
Forecast future
Calculate tax
Debtors v creditors
Creditor - coop owes another firm
Debtor - firm owes coop
What are financial statements?
Forecast of income and expenditure
Analytical tool
What are profit and loss accounts?
Sales and costs over a period of
Sales v expenses
What are balance sheets?
Shows value of everything the company owns, owes, and is owed
Value at given points
Summaries assets and liabilities
Signs of insolvency?
Low credit rating
Ration below 0.75
Falling working capital
How long to keep accounting records?
Private - 3 years
Public - 6 years
What is IFRS?
International Financial Reporting Standards
Common rules so statements are consistent, transparent and comparable worldwide
UK Standards?
UK GAAP - generally accepted accounting practice in the UK
Financial audit exemptions?
Small/micro businesses.
Qualify: turnover less than 10.2m
B/S not more than 5.1m
Average number of employees not more than 50
When do you use accounting principles?
Review applications
Service charge year end and budgets
What act governs the production of accounts?
Companies Act 2006
What is the role for an auditor?
Independent party confirming financial accounts are fair and true
What is insolvency?
Inability to pay debts due to
What is bankruptcy?
Legal declaration of inability or impairment of ability to pay creditors
What are statutory accounts?
Financial records prepared at the end of your company’s financial year.
Who must receive copies of statutory accounts?
All shareholders
People who can go to company’s general meetings
Companies House
HMRC
What are included in statutory accounts?
Balance sheet
Profit and loss accounts
Notes about accounts
Directors report
Auditor report depending on company size
What standards must statutory accounts meet?
Either:
International Financial Reporting Standards
New UK Generally Accepted Accounting Practice (GAAP)
