Accounting Principles

Question 1

What are the key financial statements that companies provide?

Answer 1

• Profit and loss accounts
• balance sheet
• Cash flow statement

Question 2

What is the difference between management and financial accounts?

Answer 2

• Financial are submitted to the HMRC for tax purposes
• Management accounts are used to help run the business

Question 3

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

Answer 3

• A profit and loss sheet shows the incoming and outgoings of the business, showing whether the business has made a profit or a loss
  A balance sheet shows a company’s assets and liabilities at a given time.

Question 4

What is a cash flow statement?

Answer 4

A cash flow statement shows the actual or forecast ingoings and outgoings of cash over the accounting period to demonstrate the short-term ability to pay bills.

Question 5

Explain your understanding of the following terminology -
Capital allowances
sinking funds
insolvency
companies house
HMRC

Answer 5

• Capital allowances tax relief available to business on certain items
• sinking funds - funds that are set aside for future expense or long term debt
• insolvency when a company cannot cover its debts
• companies house the registry of all incorporated in the UK
• HMRC His majesties revenue and customs

Question 6

What are liquidity ratios?

Answer 6

• Liquidity ratios measure the ability of a company to pay off its current liabilities
• Current assets are divided by liabilities
• 1.5 is a typical ratios
• a rate of 0.75 or lower can be a indicatory of insolvency

Question 7

What are profitability ratios?

Answer 7

Measure the ability of a company to create profit
the ratio is turnover - (cost of sales/ turnover)
Low margins can be due to various reasons such as a growth strategy

Question 8

What are financial gearing ratios?

Answer 8

These measure the company’s financial structure, which are crucial indicators for the external suppliers of debt and equity as well as for internal management.
-To help measure solvency
-Highly geared companies rely on borrowing
- The payment of interest reduces the profits

Question 9

Why do QS’s need to be able to understand company accounts?

Answer 9

• To aid in preparing their own accounts
• For assessing the financial strength of contractors and those tendering for contracts
  -For assessing competition

Question 10

What is the purpose of a Profit and loss

Answer 10

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

Question 11

What is the difference between debtors and creditors?

Answer 11

• Debtors owe money for a service
• creditors have provided a service requiring payment

Question 12

What are management accounts?

Answer 12

Management accounts are the business accounts used for plotting the business strategy, for internal use, unless shared with a potential lender

Question 13

What is a financial statement?

Answer 13

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

Question 14

What is a profit and loss account?

Answer 14

• They demonstrate the company’s sales, running costs and profit or loss over a financial period.
• They are used to show sales vs expense (invoicing vs time and disbursements)
• They can also be used to identify non-profitable work

Question 15

What is a balance sheet?

Answer 15

• 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 16

What is a cash flow forecast?

Answer 16

A cash flow forecast is a graph showing the expected outgoings over a period of time for a company or project.

It can be used for cost planning and to compare as the project progresses.

Typically there is a outlay of costs at the start for set up costs, with the rate of costs expending ramping up in the middle and tailing off towards the end.

Question 17

What are escrow accounts?

Answer 17

a separate account held by a third party on behalf of two parties that can be used as a project bank account. Agreed mechanisms, such as payment certificates, allow for the release of funds.

Question 18

When have you used your company accounts in your work?

Answer 18

• To assess the financial strength of contractors at the pre-qualification stage of a tender.

Question 19

How do you analyse a company accounts?

Answer 19

The clients accountants will carry out the detailed analysis, but I can look for warning signs by calculating ratios such as profitability or liquidity.

Unless it is a limited company, the accounts used should be the group or consolidated accounts.

Question 20

How do you carry out a credit check?

Answer 20

you can use the credit safe website to access a companies accounts
looking at the group and company accounts
If the credit rating is low I provide the information to the client for detailed analysis

Question 21

What are the signs of insolvency in company accounts?

Answer 21

• a low credit rating
• a liquidity rating below 0.75
• a falling working capital ratio
• a Low return on equity
• a highly geared company (high loan debt)
• a failing cashflow statement

Question 22

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

Answer 22

• They are likely to have underpriced the work to win the project, and may attempt to make up the costs during the project
  -The contractor could go insolvent during the works

Question 23

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

Answer 23

• request a performance bond
• I would look closely at the tender return for front loading of the costs
• at interim valuations, I will be careful to ensure the contractor is not over-claiming.
  -A project bank account may also provide a secure way of managing the monies.