Level 1 - Accounting principles and procedures Flashcards
Why should you keep accounts?
Companies keep accounts for a number of reasons:
- To keep track of money coming and money going out so they know they can pay their bills and suppliers etc.
- So they can monitor profit and loss and company performance
- Use the information for future business planning
- Use the information to highlight any problem areas so they can be investigated and solved
- So they can submit annual financial statements to Companies House
In accordance with Company’s Act 1985 limited companies must provide their year-end accounts in accordance with a legal format.
What is the difference between Management and Company accounts?
Management accounts are used internally by the managers of the business
Financial accounts are company accounts required by law and audited by a Chartered Accountant.
What is meant by the terms Gross and Net?
In salary terms, Gross is the total salary and net is salary minus tax and all other deductions (the net cannot get any lower).
What is a balance sheet?
- A balance sheet is a statement showing a business’s financial position at a point in time.
- It shows a business’s assets and liabilities at a given date, usually at the end of a financial year.
Assets = things the business owns that you get a future benefit from e.g. physical assets like property and non-physical assets like brand and goodwill.
Current assets = assets to be used within 1 year
Non-current (fixed) assets = plant, machinery and equipment etc.
Liabilities = amounts a business owes due to past transactions e.g. wages and loans
What is a profit and loss account?
- A summary of a business’s income and expenditure transactions usually prepared on an annual basis.
- P&L Accounts demonstrate how the revenue is transformed into the net income - how the actual income the business receives transfers into profit for the year.
Revenue = income the business receives from its business activities e.g. money from things it sells
Expenses = outgoings that arise as the entity performs its business activities e.g. costs incurred in order to provide their service.
What is a cashflow statement?
- Cash flow shows the actual receipts and expenditure and includes VAT.
- Reviewing cash flow can identify potential shortfalls in cash balance i.e. where you may not have enough cash in the business to pay suppliers etc.
- Review cash flow helps ensure businesses can afford to pay suppliers and employees i.e. the cash coming in is enough to cover the cash going out.
- Struggling companies should review cash flow daily.
- Healthier companies should review cash flow weekly or monthly.
What is meant by depreciation in relation to an asset?
Depreciation is the systematic reduction in the recorded cost of a fixed asset. Examples of fixed assets that can be depreciated are furniture and IT equipment.
What is the difference between a Sole Trader, Partnership, Limited, and a LLP?
- Sole Trader
A person who is the exclusive owner of a business, entitled to keep all profits after tax has been paid but liable for all losses (unlimited liability). - Partnership
A business organization in which two or more individuals manage and operate the business. Both owners are equally and personally liable for the debts from the business. - Limited
In a limited company, the shareholders’ liability is limited to the capital they originally invested. If such company becomes insolvent, the shareholders personal assets remain protected. Shares in a private limited company are not offered to the general public (distinguishing it from a public limited company - plc.) - Limited Liability Partnership (LLP)
A limited liability partnership (LLP) is a partnership in which some or all partners have limited liabilities. It therefore exhibits elements of partnerships and corporations. In an LLP, one partner is not responsible or liable for another partner’s misconduct or negligence.
How would you assess a contractor’s financial accounts?
Request a copy of the contractor’s company accounts for the last 3 years which would include the Profit & Loss Statement, Balance Sheet and Cash Flow Statement.
I would then be able to assess:
- If the contractor had been profitable in the last few years.
- Calculate their liquidity ratio by looking at their assets vs their liabilities to see if they would be able to cover losses under a contract and stay solvent.
I would always caveat any advice given to a client on a contractor’s financial position and recommend that further advice is sought through financial reports and a qualified accountant.
What are ‘Mint’ and ‘Dun & Bradstreet’ reports?
D&B reports provide scores and ratings to help identify organisations that are likely to fail or pay late.
Financial Strength - derived from the net worth of the company by assessing the latest financial accounts.
Risk Indicator – the likelihood of an organisation obtaining legal relief from its creditors or ceasing operations within the next 12 months including any detrimental litigation events, possible fraudulent activity etc.
Delinquency Score - Predicts the likelihood that a business will pay its obligations late within the next 12 months.
E.g. are they paying their suppliers in time, if so, this demonstrates good and well managed cash flow
Limitations:
They are historic and look at past performance, whereas future performance is the key thing. As it may look profitable, but it may have been reducing profit steadily over the last few years which suggests it’s not actually healthy. I.e. you want to forecast future performance for security of investment etc.
What are the main types of ratio analysis used to assess a company’s financial strength?
• Liquidity – the ability of the company to pay its way (solvency). More companies fail due to cash flow than any other reason.
Current Ratio = Liquid assets / Liabilities
• Investment/shareholders – information to enable decisions to be made on the extent of the risk and the earning potential of a business investment.
Return on Investment (ROI) = (Gain – Cost) / Cost
• Gearing – information on the relationship between the exposure of the business to loans as opposed to share capital.
Net Gearing = Net Debt / Equity
• Profitability – how effective the company is at generating profits given sales and/or its capital assets.
Gross Margin = Gross profit / Net Sales
• Financial – the rate at which the company sells its stock and the efficiency with which it uses its assets.
Asset Turnover = Net Sales / Total Assets
Why do chartered surveyors in your pathway need to understand and be able to interpret company accounts?
- Companies business accounts.
- For assessing the financial strength of contractors and those tendering for contracts.
- For assessing competition.
What is insider trading?
The trading of a public company’s stock or other securities (such as bonds or stock options) by individuals with access to non-public information about the company.
What is the Construction Industry Scheme (CIS)?
- The Construction Industry Scheme (CIS) is a scheme created by HM Revenue & Customs (HMRC) for tax from contractors and subcontractors.
- The scheme is designed to minimize tax evasion within the construction industry.
- Contractors deduct tax from payments to subcontractors.
- All contractors and subcontractors must register with the scheme before work starts.
N1. Why is having an understanding of accountancy required as a Project Manager?
- To be able to understand the financial health of a project to protect the clients interests.
- To understand your own financial health.
- To be able to understand the financial health of a company.
N2. What is a balance sheet?
A Financial statement of the Company’s assets, liabilities and equity at a point in time.
N3. What does a balance sheet tell you?
It tells you how much the owes (assets) and owes (liabilities)
N4. What is a profit and loss account?
A financial statement comparing the income (revenue) and outgoings (expenditure) with adjustments for any liabilities etc. to identify the profit or loss a company has made over a specific period.
N5. What is included within a profit and loss account?
Income, expenditure, plus any adjustments for liabilities.
N6. Are profit and loss accounts current?
No, they are retrospective.
