Financial Statements & How to Use Them I Flashcards
What should a bank do when an advance has been made by a company?
Strict monitoring and control are required to ensure that the business is performing as planned and that the level of risk stays the same as was originally deemed acceptable. Prompt action will be needed if there’s any deviation from the agreed budgets.
How is it determined if a company needs its accounts audited?
If they don’t need their accounts audited, what must they have instead?
- The requirement is determined by the level of the sales turnover in the financial year, which is decided by the govn.
- Companies with turnover of less than the threshold must have a Reporting Accountant’s Certificate.
Who develops the accounting standards in the UK?
What is the trend for financial reporting?
- UK accounting standards are developed by the Accounting Standards Board (ASB) and are conatined in the ‘Financial Reporting Standards’ (FRSs). The format and content of published accounts are governed by Financial Reporting Standard 3
- There is now a trend towards global standards of reporting. The IFRS Foundation is an independent not-for-profit private sector org working in the public interest. Its principal objectives include developing a single set of high quality, understandable, enforceable and globally accepted international financial reporting standards (IFRSs) through its standard setting body, the International Accounting Standards Board (IASB)
What do auditors do?
Confirm in their report, the auditor’s certificate, that they have carried out an audit and are satisfied that the final accounts ‘represent a fair and true view of the company’s position’ as stated in the profit and loss account, balance sheet, FRS 1 cash flow report and the Notes to the accounts. The accounts must include a statement confirming they’ve been prepared in accordance with relevant accounting standards.
What should one check/seek in an audited account?
- When the accounts were last audited
- Who the auditors are - are they respectable?
- 3 years worth of accounts to establish trends
- projected figures if the company is new
One should remember that a balance sheet is merely a snapshot of a company’s financial standing.
What is Cost of Sales = ?
What is Gross Profit = ?
What is Sales growth = ?
COS = COGS = Opening stock + purchases - closing stock
Gross profit = sales - COS
Sales Growth = (this years sales)*100 /(last years sales)
Note: Sales = turnover = revenue
How is Capital Expenditure calculated?
Capital Expenditure = (change in fixed assets) + Current years depreciation charge
What Financial Ratios are there?
- Capital Adequacy ratio
- Gearing ratio
- Interest Cover ratio
- Cash Cover ratio
One should look for trends in ratios rather than the number on their own. Before looking at the numbers one should develop expectations of what they should be based on the industry norm.
What is the point of looking at ratios in accounting?
Whilst they provide isloated indicators on the business’s performance, when compared with previous figures one can complete a trend analysis. They will then help determine a decision on a lending proposal.
One should always predict what the ratios should be based on industry norms, before calculating them for a given company.
What is the Capital Adequacy ratio?
Proprietors’ funds less intangibes
Total assests less intangibles
- Intangibles - those assets in the balance sheet which only have a value if the business can be sold as a going concern (a business that functions without the threat of liquidation in the forseeable future) e.g. goodwill.
- Proprietors’ funds - usually called capital & reserves/shareholders’ funds/shareholders equity in the balance sheet
It shoes how much money the owners have in the business - the higher this figure, the more protection there is for lenders should things go wrong as the capital and reserves must be used up before the bank is at risk. Genreally, a bank will not lend more money than what the proprietors have in the business - otherwise they’d have a greater stake in the business than the owners.
One seeks a figure in excess of 50%, where this isn’t the case, the gearing ratio should be scrutinised.
What is the Gearing ratio?
Medium and long term borrowings including preference shares
Proprietors’ stake
This is the relationship between capital and debt. A business which is highly geared has to maintain its profits in order to ensure that it can meet its commitments to its outside lenders.
One seeks a ratio of at least 1:1 and preferable lower, so that the proprietors’ stake at least covers medium to long term borrowings including preference shares. If it’s too low, then the business could be benefitting from extra borrowing.
What is the Interest Cover ratio?
Net profit before interest and tax
Interest paid
This shows the number of times the interest payments can be met out of current profits - measuring the ability of a company to meet its interest obligations. A detrioration in this ratio means the business has a reducing capacity to meet the interest it has to pay.
7-10 times cover is good, 1-3 times isn’t.
What is the Cash Cover ratio?
Cash cover = C_ash from operations before tax_
Cash finance costs
Cash finance costs = interest + expenses + CPLTD
Less than 1 is bad, 1.1-1.5 is okay.
What Liquidity Ratios are there?
- Working capital ratio/current ratio
- Liquid ratio/quick ratio/liquid asset ratio/acid test ratio
Liquidity is the availability of cash to meet the needs of the business.
What is the working capital ratio/current ratio?
Current Assets
Current Liabilities
How much current asset cover there is for each £1 unit of liability. Gives an indication of the ability of a business to pay its short term debts as they fall due without having to resort to selling any fixed assets.
The trend is more important than the ratio on its own. If the yearly ratio trend is consistent then there is unlikely to be anything untoward.
Businesses with liquid assets & stock can maintain a low ratio as they can generate cash quickly.
