Accounting principles & procedures Flashcards
What are the three types of financial statement you may come across relating to a company?
Profit and loss - a business’s total revenue, expenses, gains and losses arriving at net income for a specific accounting period
Cash flow - provides a view of a company’s overall liquidity
Balance sheet - what the company is worth from a book value perspective
What is an asset/liability?
Assets are quantifiable things - tangible or intangible
Liabilities - what the company owes to others
Equity = everything left when you subtract liabilities from assets
Examples of assets and liabilities
Examples of assets: Cash, inventory, building, furniture, and accounts receivable.
Examples of liabilities: Loans, accounts payable, sales tax payable, and debts.
What is the difference between financial and management accounts?
Financial accounts - are to be undertaken by an accountant and are audited. Must be submitted as financial statements each year.
Management accounts - are undertaken for internal purposes. Can be done by businesses as frequently or infrequently as the business feels necessary.
What do you understand by the term Generally Accepted Accounting Principles? (GAAP)
Standards that encompass the details, complexities, and legalities of business and corporate accounting. The Financial Accounting Standards Board (FASB) uses GAAP as the foundation for its comprehensive set of approved accounting methods and practices.
Company accounts must be prepared in this way if they are shared outside of the company.
How do companies know which reporting framework to comply with?
The FRC (Financial Reporting Council) sets UK and Ireland accounting standards.
The Companies Act 2006 demands that all UK businesses prepare their financial statements to accounting standards set by the UK (GAAP) or the international accounting standards community.
Which reporting framework do public limited companies have to comply with?
To ensure compliance, listed companies use UK GAAP, while non-listed companies use International Financial Reporting Standards (IFRS). If your company is listed on a stock exchange, it is required to follow International Financial Reporting Standards (IFRS) according to EU regulations.
How would you asses the financial strength of an entity e.g. for a valuation?
Analyse the balance sheet, income statement, cashflow statement.
Financial ratio analysis e.g. gross profit margin, debt-to-equity ratio, total asset turnover, return on equity.
Look at their covenant strength.
Can you tell me about a common financial measure?
Gross profit margin - a profitability ratio that measures what percentage of revenue is left after subtracting the cost of goods sold. The cost of goods sold refers to the direct cost of production and does not include operating expenses, interest, or taxes. In other worReds, gross profit margin is a measure of profitability, specifically for a product or item line, without accounting for overheads.
Gross Profit Margin = (Revenue - Cost of Sales) / Revenue * 100
Return on Equity - common financial measure
Return on equity, more commonly displayed as ROE, is a profitability ratio measured by dividing net profit over shareholders’ equity. It indicates how well the business can utilize equity investments to earn profit for investors.
ROE = Net Profit / (Beginning Equity + Ending Equity) / 2
What is the acid test?
Acid-test ratio (also known as quick ratio) is a measure of a company’s liquidity, which is its ability to pay its short-term obligations using only its most liquid assets. It is calculated by dividing the sum of a company’s cash, cash equivalents and marketable securities by its total current liabilities. The higher the acid-test ratio, the better.
What does an acid-test ratio of 1.5 1 mean?
An acid-test ratio of 1.5:1 means that the company has $1.50 of liquid assets available to cover every $1.00 of current liabilities. This ratio indicates that the company is in a good position to cover its short-term obligations as they come due.
What does an acid-test ratio of 1.0 mean?
An acid-test ratio of 1.0 means that a company has enough liquid assets to cover its current liabilities. This is considered a good sign that the company is in a healthy financial position.
What does it mean if acid-test ratio is below 1?
If the acid-test ratio is below 1, it means that a company does not have enough liquid assets (cash or equivalents) to cover its current liabilities. This suggests that the company is not in a financially sound position, as it cannot pay its short-term debts.
What is ROCE?
Return on capital employed – sometimes referred to as the ‘primary ratio’ – is a financial ratio that is used to measure the profitability of a company and the efficiency with which it uses its capital. Put simply, it measures how good a business is at generating profits from capital.
The higher your ROCE is, the better. This is because a higher ROCE indicates that a higher percentage of your company’s value may be returned to stakeholders as profit. So, what is a good return on capital employed? Although a “good ROCE” varies depending on the size of your company, in general, the ROCE should be double the current interest rates at the very least.
However, ROCE isn’t infallible. Because it’s based on the balance sheet and only looks at short-term achievements, it may not provide an accurate picture of a company’s future profitability. In addition, ROCE doesn’t consider the risk factors of different investments, which could lead to an inaccurate assessment of an investment’s long-term viability.
What is working capital ratio? (Current ratio)
“Working capital” is the money you need to support short-term operations. It is this focus on the short term that distinguishes working capital from longer-term investments in fixed assets or R&D.
Working capital is the difference between current assets and current liabilities.
The working capital ratio is calculated simply by dividing total current assets by total current liabilities. For that reason, it can also be called the current ratio. It is a measure of liquidity, meaning the business’s ability to meet its payment obligations as they fall due.
What is gearing ratio?
Gearing ratios are financial ratios that compare some form of owner’s equity (or capital) to debt, or funds borrowed by the company. Gearing is a measurement of the entity’s financial leverage, which demonstrates the degree to which a firm’s activities are funded by shareholders’ funds versus creditors’ funds.
Best known examples:
Debt-to-Equity Ratio= Total Equity / Total Debt
A higher gearing ratio indicates that a company has a higher degree of financial leverage and is more susceptible to downturns in the economy and the business cycle. This is because companies that have higher leverage have higher amounts of debt compared to shareholders’ equity. Entities with a high gearing ratio have higher amounts of debt to service, while companies with lower gearing ratio calculations have more equity to rely on for financing.
What is net assets per share? (NAVPS)
An expression for net asset value that represents the value per share of a mutual fund, an exchange-traded fund (ETF), or a closed-end fund. It is calculated by dividing the total net asset value of the fund or company by the number of shares outstanding. It is also known as book value per share.
Net Asset Value Per Share= Shares Outstanding / NAV
where:
NAV=Assets−Liabilities
Can you tell me what the role of an auditor is?
Auditors inspect organisations’ financial accounts to ensure they’re correct and comply with the law. Auditors review the accounts of companies and other organisations to ensure their financial records are correct and in line with the law.
Why are audited accounts needed?
Compliance with regulation
Many exempt organisations will voluntarily seek an audit to add an extra layer of confidence in their financial statements.
You may also consider having an audit if you are planning to sell your business, to help achieve the maximum sale price.
