M - Accounting Principles and Procedures

Question 1

What is the difference between Financial Accounting and Management Accounting?

Answer 1

Management Accounting

• Internal Use, for the management team
• Not required by law
• Can relate to a single aspect of the business

Financial Accounting

• Company Accounts, for shareholders
• Required by law
• Covers the entire business

Question 2

What are the key financial statements that all companies must provide?

Answer 2

1) Profit and Loss Statement
2) Balance Sheet Statement
3) Cash Flow Statement

Question 3

What is a Profit and Loss Statement?

Answer 3

• A summary of the businesses income and expenditure
• Usually prepared on an annual basis, shows the journey from one balance sheet to the next
• Used to show the businesses ability (or lack thereof) to generate profit by increasing revenue, reducing costs, or both

INCOME - COSTS = PROFIT / LOSS

Question 4

What is a Balance Sheet statement?

Answer 4

A snapshot of the businesses financial position / net worth at a given moment in time.

Demonstrates what the company OWNS & OWES

Used to assess the financial health of a business

Question 5

Why are balance sheets important?

Answer 5

Profit and Loss Statements can look great one year due to one off profits.

Balance sheets give a broader view of the companies health.

Question 6

What is a Cash Flow Statement?

Answer 6

Shows the income and expenditure of cash from various sources.

Compliments the Balance Sheet and P&L Statement.

Used to understand financial obligations of the next period.

Can identify when there may be difficulties in meeting liabilities (paying amounts due) - cash flow problems.
Early identification can enable strategies to be put in place to ease the burden.

Question 7

What is Insolvency?

Answer 7

The inability to pay debts

Question 8

What are the different types of insolvency?

Answer 8

1) Administration

2) Liquidation

Question 9

What is Administration?

Answer 9

• Company is operated by an Administrator
• Company affairs are frozen
• Options are sought to avoid Liquidation

Question 10

What is Liquidation?

Answer 10

• Winding up of a company, as it cannot pay its debts
• Company ceases trading
• Assets are sold in order to offset liabilities

Question 11

Where does the Client or Contractor fall in relation to receiving monies after liquidation?

Answer 11

Very low on the scale.

Both are considered unsecured creditors

Question 12

What are the consequences of insolvency on a construction project?

Answer 12

1) Increased Duration
2) Additional Cost
3) Reduced Quality
4) Solvency of subcontractors & suppliers

Question 13

What checks should be made pre-contract to avoid insolvency?

Answer 13

1) Check financial accounts - Ensure contractors are financially stable
2) Receive bank references, credit checks, annual accounts, previous references

Question 14

What are the steps if a Contractor goes insolvent?

Answer 14

1) Notify the Client - Advise on Contractual position and recommend action
2) Secure the site
3) Prepare detailed valuation of the completed works and an inventory of materials and equipment
4) Stop payment (not obliged to make any further payment)
5) Check contract for Bonds / Parent Company Guarantees
6) Contact the administrator or liquidator and client to understand their views for project completion
7) Contact key subcontractors / suppliers to commence discussions regarding continuation contracts
8) Record time spent and costs incurred in dealing with insolvency. Normal for additional fees to be charged.

Question 15

What is the difference between an internal audit and an external audit?

Answer 15

EXTERNAL AUDIT

• Independent examination of financial statements prepared by an organisation.
• Required by law and carried out by a registered firm of accountants

INTERNAL AUDIT

• An internal review of strengths, weaknesses and management risks.
• Not required by law

Question 16

What is an Internal Audit?

Answer 16

• Should be an independent and objective evaluation of an organisation’s internal controls to effectively manage risk within its appetite.
• Should identify and address areas of weakness
• Often identifies fraud
• Auditors should be independent and objective, internally assigned but free to carry out role

Question 17

What is an External Audit?

Answer 17

• Independent examination of financial statements prepared by an organisation.
• Determines whether financial statements give true and fair reflection of state of affairs and operations for that period.
• Not to detect fraud, but this may emerge
• Required by law

Question 18

Who can conduct an external audit?

Answer 18

A registered firm of accountants

Question 19

Who can conduct an internal audit?

Answer 19

Anyone in the firm

Question 20

What is the difference between bankruptcy and liquidation / administration

Answer 20

Only people can go bankrupt.

Companies go into administration / liquidation

Question 21

What is Gross Profit Margin?

Answer 21

It analyses the relationship between gross sales revenue and the direct cost of sales.

Gross profit = sales income (Revenue) - cost of sales (expenditure)

The gross profit margin is
Gross profit / total revenue x 100 = Gross Profit Margin %

Gross profit margin seeks to identify how efficiently a company is producing its product.

Question 22

What is Operating Profit Margin?

Answer 22

Operating profit margin focuses on indirect costs.

Operating profit is obtained by subtracting operating expenses from the gross profit.

The operating profit margin is then calculated by dividing the operating profit by the total revenue.

Operating costs include R&D, marketing, general and administrative expenses.

The operating profit shows a company’s ability to manage its indirect costs.
It shows how a company is investing in areas it expects will help to improve its brand.
A company may have a high gross margin but relatively low operating profit margin if indirect expenses like marketing / capital investments are high.

Question 23

What is Net Profit Margin?

Answer 23

Net profit margin takes into consideration the interest and taxes paid by a company.

Net profit is calculated by subtracting interest and taxes from operating profit.

The net profit margin is then calculated by dividing the net profit by the total revenue.

Net profit highlights a company’s ability to manage its interest and tax payments.

Question 24

Why are Gross, Operating and Net Profit Margins useful analysis tools?

Answer 24

Comparing gross, operating and net profit margins enable analysts to get a clear picture of a company’s operating strengths and weaknesses.

Market and business factors may affect each of the 3 margins differently.

• If direct sales expenses increase across the market, then a company will have lower gross margin that reflects higher cost of sales
• Companies will go through different cycles of growth that lead to higher operational and interest expenses. A company may invest more in marketing campaigns or capital investments that increase operating costs for a period which decreases operating profit margin.
• Companies may also raise capital through debt which can decrease their net profit margin when interest payments rise

Understanding these different variables and their effects on margin can be important for investors when analysing the worthiness of a corporate investment.