Financial Statements & How to Use Them II Flashcards
Are the following a source or use of funds?
- Increase in assets
- Decrease in assets
- Increase in liabilities
- Decrease in liabilities
- Increase in assets - use of funds as profits are bing tied up in stock or debtors
- Decrease in assets - source of funds as previosuly tied up stocks or debtors are released
- Increase in liabilities - source
- Decrease in liabilities - use of funds
What does EBITDA and CPLTD stand for?
- Earnings Before Interest, Tax, Depreciation and Amoirtisation - used in cash flow reports alongside EBIT (often called operating profit), EBITA and operating cash flow.
- Current Portion of Long Term Debt
Cash from Operations = ?
Cash from Operations = EBITDA
- (+ change) in Stock
- (+ change) in Debtors
+ (+ change) in Creditors
Where the change is taken from the previous year. What proportion of CfO is EBITDA, (Stock and Debtors) and Creditors? This is the amount available for payments of tax, interestm repayment of loans due, dividends and capital expendature.
How is the ‘Amount of Corporation Tax Paid in Cash’ calculated?
Cash corporation tax paid =
Opening corporation tax (owed) on 1st April 20XX
+ Corporation tax declared per the profit and loss account in year 20XX+1
- Closing corporation tax (owed) on 31st March 20XX+1
How is Total Cash Finance Costs calculated?
Total cash finance costs =
Interest expenses (from the profit and loss account - i.e. interest on short term loans)
+ Current portion of long term debt (CPLTD) from previous year (as debts is paid in the following year)
- Total cash finance costs can then be compared to the cash from operations and after tax to establish if the business generated sufficient cash to repay its interest-bearing debt.
How is Capital Expenditure calculated?
Captial Expenditure =
(Net Tangible Fixed Assets (NTFA) for end of year reported) - (What NTFA should be)
Where (What NTFA should be) =
Opening Tanglible Fixed Assets (i.e. at amount at end of previous year)
- Depreciation for current year
- Capital expenditure consists of a
- Maintenance part - what a business requires to pay out in replacing its fixed assets in order to keep things running smoothly without having to spend sizeable amounts in repairs or maintenance costs
- Discretionary part - management may decide/wish to do something to directly influence part of a strategic plan e.g. open another shop
How is dividends paid in cash calculated?
Dividends paid in cash =
Dividends outsanding in current liabilities at the start of the year (i.e. end of prev. year)
+ Dividends declared in the profit and loss account for the current year
- Dividends outstanding in current liabilites at the end of the year
What is the trading capital requirement?
Why is a term loan better than an overdraft for long term debt?
Trading capital Requirement = stock + debtors - creditors
Long term debt is better to be structured in a term loan, which allows one to analyse how it’s being paid off and when it’ll be paid off.
What does overtrading arise from?
Overtrading occurs when a business has insufficient finance for working capital to sustain its level of trading. Three serious managerial mistakes:
- Initial under-capitalisation - the business has not raised enough capital/shareholders’ funds to finance the anticipated level of trading
- Over expansion - the business expands to such a degree that the capital base is insufficient to support the new level of acitvity
- Poor utilisation of working capital resources - this may occur when planned profits and cash flow forecasts are not met and finite capacity is used up to replace lost profits instead of being used as planned to invest in working capital
What are the signs of overtrading?
- A progressive fall in the debtors/creditors ratios: this can be one of the earliest signs and happens when creditors increase more rapidly or fall more slowly the debtors
- Despite no increase in turnover there are frequent requests to increase bank borrowing; increasing creditors and stock may be the reason
- A fall in the working capital ratio this can indicate an increase in business without a corresponding increase in working capital
- In the early stages, gross profit may be maintained but there is a steady decline in net profit due to increasing expenses. In the later stages gross profit profit will also fall
What are the signs of overtrading in the bank account?
- Increased incidence of irregular positions; requests to exceed the limit in anticipation of monies that are certain to come in
- A reduction in the level of fluctuations between the max and the min balances on a monthly bases
- Regular requests to assist with wages
- Monthly accounts being paid progressively later in the month
- Cheques to suppliers in round amounts, suggesting payments to appease them
How may a business avoid overtrading?
- Scale back the level of trading - i.e. live within its means
- Injection of captial - this can be new share capital, a long term loan, or injection of capital by a new partner - the drawbacks to this option can be a dilution of control of the business or higher interest costs
- Maintain tight control of working capital
- Lease of assets rather than outright purchase
- Buy fixed assets on hire purchase - this is the same impact as leasing but they end up owning the asset
- Reduce drawings from the business or don’t pay a dividend
- Cut costs or improve efficiency
What does Cash Flow Monitoring involve?
- Preparation of a cash budget - if the cash flow is already completed, can the customer convince you that the figures are not only accurate but also realistic and acheivable
- Relating items of income to expenditure - so much depends on the income forecast being generated. Therefore you must be satisfied that the basic assumptions of income and expenditure are realistic. How does the customer justify the assumptions. Are the terms of trade normal? ;- How long a period of credit will the business take from its suppliers? Do the figures show payment being made within the timescale agreed? Similarly what collection period is used in the cash flow for the business’s debtors? Are these terms of trade in line with the industry norm?
- Making comparisons between forecasted and actual figures - if variances from projected figures are identified at an early stage, this enables you to work with your customer to address the situation and agree and adopt appropriate remedial action to avoid it becoming a bigger problem
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Interpretation of a cash budget - leads us naturally to the key cash generating areas of the balance sheet - the working capital:-
- Stock control - stock is least liquid asset, can be expensive to store/insure/secure etc., but too little stock can disrupt trade and lose sales
- Debtor control - the business needs to establish the period of credit it’s prepared to offer together with the limit for each customer. Debtors are often the largest single asset in the business and thus need careful management. An aged list will illustrate whether debtors are being invoiced and collected promptly to avoid potential bad debts.
- Trade creditors - the buying policy of raw material must be efficient wrt period of credit, type, quality and quantity of materials bought. Can get an aged list of creditors
What is cash flow, and how do accountants report it?
Cash flow is the difference between the money receieved and the money paid out. Accountants change it in two ways:
- They use accrural accounting (rather than cash accounting which recognises transactions only when the money is received) which shows income and profit as it is earned at the time of sale, rather than when the money is actually received; a company’s debtors may pay up after an agreed period of credit like 2-3 months.
- They categorise cash outflows into current expenses and capital expenses (amount spent to improve longterm assets e.g. equipment). Current expenses are deducted when calc’ing profits but capital expenses aren’t. Instead capital expenses are depreciated over a number of years and an annual depreciation charge made against the profits. Thus profits include some cash flows but not others and are reduced by depreciation charges which aren’t cash flows at all!
Explain earnings, amortisation and depreciation.
- Earnings are profits
- Amortisation is the name for depreciating intangible assets - the accounting practice of writing down the value of intangible assets over a number of years. An annual charge is made to profits. One has to check that it should be included in the calc of EBITDA etc. somtimes it isn’t.
- Depreciation is the accountant’s method of spreading the cost of an asset over a number of years, usually its useful life. It’s a non-cash item. The cash went out as capital expendature when the asset was first purchased and the depreciation charge is the method employed to recognise this cost over a number of trading cycles.
Amortisation and depreciation trasnfers value, or the part that’s being written off, from the balance sheet to the profit and loss account where it reduces taxable income.
