Accounting Principles

Question 1

Wat are the key financial statements that companies provide?

Answer 1

1 - Profit & Loss Accounts
2 - Balance Sheets
3 - Cash Flow Statements

Question 2

What is the difference between management 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.

Question 3

What is the difference between a profit and loss account and a balance sheet?

Answer 3

A profit and loss account shows the incomes and expenditures of a company and the resulting profit and loss.
The balance sheet shows what a company owns (its assets) and what it owes (its liabilities) at a given point in time.

Question 4

What is a cashflow statement?

Answer 4

It is the summary of the actual anticipated ingoing and outgoing of cash in a firm over the accounting period. It measures the short term ability of the firm to pay off its bills.

Question 5

What are Capital Allowances?

Answer 5

Tax relief on certain items purchased for the business; for example, tools and equipment.

Question 6

What are sinking funds?

Answer 6

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

Question 7

What is insolvency?

Answer 7

An inability to pay debts where liabilities exceed assets.

Question 8

What is Companies House

Answer 8

An agency that incorporates and dissolves limited companies within the UK.

Question 9

What is HMRC?

Answer 9

His Majesties Revenue and Customs.

Question 10

What are liquidity ratios?

Answer 10

Liquidity ratios measure the ability of a company to pay off its current liabilities by converting its current assets into cash.
Liquidity ration calculation = Current Assets / Current Liabilities
The ratio is usually around 1.5 but depends on the sector of activity. House builders often operate a liquidity ratio over 3 because they retain high value assets in the form of unsold houses.
A liquidity ratio of less than 0.75 can be an early indicator or insolvency.

Question 11

What are profitability ratios?

Answer 11

Profitability ratios measure the performance of a company in generating its profits.
Trading Profit Margin Ratio = Turnover - (Cost of Sales - Turnover).
Low margins may be due to a growth strategy from the company and do not always result from bad management.

Question 12

What are Financial Gearing Ratios?

Answer 12

They measure the financial structure of the company which are crucial indicators for the external suppliers of debt and equity, as well as for internal management.
They help to measure solvency.
Highly geared companies rely mainly on borrowing.
The payment of interests reduces the profit.

Question 13

Why do Chartered Quantity Surveyors need to understand and be able to interpret company accounts?

Answer 13

1 - To aid in preparing their own business accounts.
2 - For assessing the financial strength of contractors and those tendering for contracts.
3 - For assessing competition.

Question 14

What is the purpose of a P&L?

Answer 14

1 - To monitor and measure profit (or loss).
2 - To compare against past performance and against company budgets.
3 - For valuation purposes and to compare against competitors.
4 - To assist in forecasting with future performance.
5 - To calculate taxation.

Question 15

What is the difference between debtors and creditors?

Answer 15

Creditors are business entities that are owed money by another entity that they have extended credit to.
Debtors are business entities that owe money to another respective company.

Question 16

What are Management Accounts?

Answer 16

Accounts prepared by a company or internal management use.
Accounts prepared for a lender (such a bank) to evaluate how you will be able to repay the funding.
These accounts are not to be audited externally.

Question 17

What is a Financial Statement?

Answer 17

Forecasts of income and expenditure that can be used as an analytical tool to identify potential shortfalls and surpluses.

Question 18

What is a profit and loss account?

Answer 18

They demonstrate a companies sales, running costs and profit (or loss) over a financial period (usually 1 year).
They show sales vs expenses and can be used to identify non-profitable work.

Question 19

What is a balance sheet?

Answer 19

They show the value of everything the company owns, made up of its assets and liabilities.
The balance sheet demonstrates the value of the business at any given point in time.

Question 20

What is a cashflow forecast?

Answer 20

It summarises the amount of cash or cash equivalents entering a company or project entity. On construction projects they are usually known as the “S” curve.
There is typically a small financial outlay at the start, a steep increase during the midway point and a taper towards the end.

Question 21

How are cashflow forecasts used by surveyors?

Answer 21

1 - To track, analyse and assess business accounts and performance.
2 - For assessing the financial strength of contractors.
3 - To compare actual progress of the work against pre-contract predictions.

Question 22

What are Escrow Accounts?

Answer 22

A separate account owned by a 3rd party, held on behalf of two other parties. It will usually have defined contractual conditions for the release of funds and can be used as a project bank account.
Mechanisms must be in place for the release of funds such as payment certificates.

Question 23

When have you used company accounts in your work?

Answer 23

When assessing the financial strength of contractors at pre-qualification stage and tender stages.

Question 24

How do you analyse a company’s accounts?

Answer 24

The client accountants will carry out the detailed analysis but I can look out for warning signs by calculating ratios, such as liquidity ratios, profitability ratios and gearing ratios.
When do this I should always calculate the ratios myself as those included in the company accounts may have been manipulated.
I should use the group (or consolidated) accounts rather than the company accounts unless it is a limited company.

Question 25

How do you carry out a credit check? Give an example.

Answer 25

I would use the Credit Safe website to access a companies accounts.
I would consider both the group accounts and the company accounts.
If the credit rating was low I would calculate some key ratios and pass on all the information to the clients accountants for them to analyse further.

Question 26

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

Answer 26

1 - A low credit rating.
2 - A liquidity rating of below 0.75.
3 - A falling working capital ratio, suggesting a company has taken more contracts than it can finance.
4 - A low return on equity.
5 - A highly geared company that is heavily reliant on loans.
6 - A falling cashflow statement.

Question 27

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

Answer 27

1 - There may be an increased risk of the contractor not performing satisfactorily.
2 - It could present increased risk of the contractor failing to deploy sufficient resources and materials to the project.
3 - It could increase the risk of a contractors’ insolvency.

Question 28

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

Answer 28

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 also review the tender submission to ensure that this has not been excessively front loaded.
When reviewing interim valuations, I would ensure that these are accurate and not over claimed.
A project bank account (such as an Escrow) may also provide an additional level of assurance and should be considered.