ACCOUNTING PRINCIPLES Flashcards
1
Q
What are the key financial statements that companies provide?
A
The key financial statements are:-
o Profit and loss accounts.
o Balance sheets.
o Cash flow statements.
2
Q
What is the difference between management and financial accounts?
A
- Management accounts are for the internal use of the management team.
- Financial accounts are the company accounts that are required by UK law.
3
Q
What is the difference between a profit and loss account and a balance
sheet?
A
- A profit and loss account shows the incomes and expenditures of a company and the resulting
profit or loss. - The balance sheet shows what a company owns (it’s assets) and what it owes (it’s liabilities) at
a given point in time.
4
Q
What is a cashflow statement?
A
- It is the summary of the actual or anticipated ingoing and outgoing of cash in a firm over the
accounting period. - It measures the short-term ability of a firm to pay off its bills.
5
Q
Explain your understanding of the following Terminology?
A
- Capital Allowances - Tax relief on certain items purchased for the business for example tools and
equipment. - Sinking Finds – Funds that are set aside for future expense or long-term debt.
- Insolvency – An inability to pay debts where liabilities exceed assets.
- Companies House – An agency that incorporates and dissolves limited companies within the United
Kingdom. - HMRC - Her Majesties Revenue and Customs.
6
Q
What are Liquidity ratios?
A
- Liquidity rations measure the ability of a company to pay off its current liabilities by converting its
current assets into cash. - Liquidity ratio calculation = current assets / current liabilities.
- The ratio is usually around 1.5 but it depends on the sector of activity.
- For example house builders often operate on 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 of insolvency.
7
Q
What are Profitability ratios?
A
- Profitability ratios measure the performance of a company in generating its profits.
- The 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.
8
Q
What are Financial Gearing Ratios?
A
- These 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.
9
Q
Why do chartered quantity surveyors need to understand and be able
to interpret company accounts?
A
- To aid in preparing their own business accounts.
- For assessing the financial strength of contractors and those tendering for contracts.
- For assessing competition.
10
Q
What is the purpose of a P & L?
A
- 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.
11
Q
What is the difference between debtors and creditors?
A
- 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 that 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 a debtor of the sub-consultant.
12
Q
What are Management Accounts?
A
- The accounts prepared by a company for internal management use.
- Accounts prepared for a lender, such as a bank to evaluate how you will be able to repay the
funding. - These accounts are not be audited externally.
13
Q
What is a Financial Statement?
A
- Forecasts of income and expenditure that can be used as an analytical tool to identify potential
shortfalls and surpluses.
14
Q
What is a Profit and Loss account?
A
- They demonstrate a companies sales, running costs and profit or loss over a financial period (usually 1
year). - They are used to show sales vs expense (invoicing vs time and disbursements).
- They can also be used to identify non-profitable work.
15
Q
What is a Balance Sheet?
A
- They shows 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.
16
Q
What is a Cash Flow forecast?
A
- A cash flow forecast summarises the amount of cash or cash equivalents entering and leaving a
company or project entity. - On construction projects they usually show as an ‘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.
17
Q
What is an S-Curve?
A
- S-Curve means ‘standard’ and refers to the shape of the expenditure profile when shown in
graphical form. - During the start of a project, the rate of expenditure is typically lower due to site setup and
lower value enabling works. - As the scheme progresses to the middle of the programme, the rate of expenditure will
typically increase as more expensive building components such as M&E and Structural Steel
Work are installed. - Towards the back end of the programme, the rate of expenditure will slow down which is
shown by the flattening of the S-Curve.
18
Q
How are these used by Surveyors?
A
- To track, analyse and assess business accounts and performance.
- For assessing the financial strength of contractors.
- To compare actual progress of the work against pre-contract predictions.
19
Q
What are Escrow Accounts?
A
- A sperate account owned by a third party, held on behalf of two other parties.
- 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.
20
Q
When have you used company accounts in your work?
A
- To assess the financial strength of contractors at Pre-Qualification Stage and tender stages.
21
Q
How do you analyse a company’s accounts?
A
- The client’s accountants will carry out the detailed analysis but I can look at the warning signs by
calculating ratios such as liquidity ratios, profitability ratios and gearing ratios. - I should always calculate the ratios myself as those included in the company accounts may have been
manipulated. - I should always use the group or consolidated accounts rather than the company accounts unless it is a
limited company.
22
Q
How do you carry out a credit check? Give an example.
A
- I use the Dun and Bradstreet website to which my company subscribes to access a company’s accounts.
- I considered both the group accounts and the company accounts.
- If the credit rating is low, I calculate some key ratios and pass on all the information to my client’s
accountants for them to analyse further.
23
Q
What are signs of insolvency in company accounts or credit checks?
A
- A low credit rating.
- A liquidity ratio below 0.75.
- A falling working capital ratio suggesting that the company has taken on more contracts than it can
finance. - A low return on equity.
- A highly geared company that is heavily reliant on loans.
- A falling cashflow statement.
24
Q
Why would you not recommend the appointment of a contractor with
a low credit rating?
A
- There may be an increased risk of the contractor not performing satisfactorily.
- It could present increased risk of the contractor failing to deploy sufficient resources and materials to
the project. - It could increase the risk of the contractor’s insolvency.
25
Q
What measures would you recommend if your client wanted to
appoint a contractor with a low credit rating?
A
- I would explore the option of requesting a performance bond that my client could call on if they Main
Contractor failed to perform. - I would also review the tender submission to ensure this is not excessively front loaded.
- When reviewing interim valuations, I would 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.
