BLP - Week 8 Debt finance and business accounting Flashcards
What are financial statements?
Reports prepared for each accounting period to summarize a business’s financial position, including a profit and loss account and a balance sheet.
Why are financial statements important?
They help track business performance year-over-year.
What is the difference between a profit and loss account and a balance sheet?
A profit and loss account records income and expenses to determine profit or loss, while a balance sheet records assets, liabilities, and capital at a specific date.
What is the principle of double-entry bookkeeping?
Every transaction affects two accounts equally: a debit in one account and a credit in another account.
What is a trial balance?
A list of all debit balances in one column and credit balances in another, with totals that should match.
What are the five types of ledger accounts (ALCIE)?
- Asset: What a business owns (e.g., cash, vehicles)
- Liability: What a business owes (e.g., loans, trade debts)
- Capital: Owner’s investment
- Income: Revenue earned (e.g., sales, services)
- Expense: Costs incurred (e.g., rent, wages)
What is the difference between fixed and current assets?
- Fixed assets: Used for long-term operations (e.g., buildings, machinery)
- Current assets: Cash or items convertible to cash within a year (e.g., stock, debtors)
What are the two types of liabilities?
- Current liabilities: Due within a year (e.g., trade creditors, overdrafts)
- Long-term liabilities: Due after a year (e.g., bank loans)
How is capital treated in business accounting?
Capital is treated separately. Capital includes initial investments and retained profits. Drawings reduce the owner’s capital account but are not expenses.
What are revenue and capital expenses?
- Revenue expenses: Day-to-day business spending (e.g., wages, utilities)
- Capital expenses: Long-term investment in assets (e.g., machinery purchase)
What is depreciation?
A method to spread the cost of a fixed asset over its useful life.
What are the methods of depreciation?
- Straight-line method: Equal depreciation each year
- Reducing balance method: Higher depreciation in early years
What are accruals and prepayments?
- Accruals: Expenses incurred but not yet paid
- Prepayments: Expenses paid in advance for future periods
How are bad debts and doubtful debts treated?
- Bad debts: Unrecoverable and written off
- Doubtful debts: Potentially uncollectible but not yet confirmed
What is the difference between partnership and sole trader accounts?
Partnerships have individual capital accounts for each partner, with profit divided based on agreements.
How does a company’s accounting differ from a sole trader’s?
Companies must prepare accounts for shareholders and regulators, pay corporation tax, and may distribute profit as dividends.
What is an accounting reference date (ARD)?
The date at which accounts are finalized each year.
What is the filing deadline for accounts after the ARD for private and public companies?
- 9 months for private companies
- 6 months for public companies
What are share capital and reserves?
- Called-up share capital: Amount shareholders must pay for shares
- Reserves: Capital exceeding the called-up share value
What is the difference between capital reserves and revenue reserves?
- Capital reserves: Not distributable (e.g., share premium, revaluation reserve)
- Revenue reserves: Distributable (e.g., retained earnings)
What is the share premium account?
Represents the extra amount paid by shareholders over the nominal value of shares.
It cannot be distributed as dividends.
What is a revaluation reserve?
- Created when assets are revalued at a higher price than their original cost.
- Represents an unrealized gain that cannot be distributed until the asset is sold.
What are retained earnings?
Profits not distributed as dividends but reinvested in the business.
How are dividends paid?
- Final dividends: Declared after year-end and require shareholder approval
- Interim dividends: Declared by directors during the year
- Dividends are distributions of profit, not business expenses.
What is Debt Finance?
Loan facilities and debt securities allowing borrowing under set terms.
What are the types of Debt Finance: Loan Facilities?
- Overdraft: On-demand facility with interest on overdrawn amounts
- Term Loan: Fixed-term loan with lump sum or installment repayments
- Revolving Credit Facility: Allows borrowing, repayment, and re-borrowing up to a limit
What are Debt/Equity Hybrids?
- Convertible Bonds: Bonds that can be converted into company shares
- Preference Shares: Equity with debt-like features, offering fixed dividends
What are the main Debt Finance documents?
- Term Sheet: Summarizes key loan terms
- Loan Agreement: Details terms like interest and repayment schedule
- Security Document: Governs collateral pledged for secured loans
What are debentures?
Covers all forms of company debt securities and details lender’s security over borrower’s assets.
What are important loan agreement terms?
- Representations & Warranties: Statements of fact about the borrower
- Undertakings: Promises by the borrower
- Events of Default: Triggers allowing lenders to demand repayment
What are the types of security in Debt Finance?
- Pledge: Creditor takes possession of asset until debt is repaid
- Lien: Creditor keeps possession until payment is made
- Mortgage: Ownership transferred to creditor but possession retained by borrower
- Charge: Lender gets an equitable proprietary interest
What is the difference between fixed and floating charges?
- Fixed Charge: Over stable assets; borrower cannot sell without lender’s permission
- Floating Charge: Over fluctuating assets; crystallizes into a fixed charge upon default
What are the disadvantages of floating charges?
- Lower priority in insolvency
- Can be overridden by preferential creditors
- Some assets reserved for unsecured creditors
What are guarantees in Debt Finance?
A commitment by a third party to pay if the borrower defaults.
What is the registration of charges?
- Most security must be registered within 21 days at Companies House.
- If not registered, the charge is void against liquidators and administrators.
What is the order of priority in insolvency?
- Fixed charge creditors
- Preferential creditors (e.g., wages, pensions)
- Floating charge creditors
- Unsecured creditors
- Shareholders
How do earlier charges affect priority among secured creditors?
Earlier fixed or floating charges take priority unless varied by agreement.
What is the effect of debt and equity finance on the balance sheet?
- Equity Finance: Increases net assets & share capital
- Debt Finance: Increases liabilities but does not change equity
What is the effect of issuing shares above nominal value?
- Increase in cash (assets)
- Nominal share value added to share capital
- Excess goes to share premium account
What is the gearing ratio formula?
(Long-term debt / Equity) × 100%.
What does high gearing indicate?
- Higher debt reliance
- Difficult borrowing
- Higher interest burden
What are the benefits of high gearing?
Increased profits and maintained earnings per share.
