Need to remember

Question 1

Capital Terminology

Assets?

Equity?

Total capital?

Total capital?

Capital employed?

Working capital?

Answer 1

Assets = Liabilities + Equity

Equity = total owner investment + reserves = total capital

Total capital = Total assets – Total liabilities

Total capital = NCA + CA – CL – NCL

Capital employed = NCA + CA – CL

Working capital = CA – CL

Question 2

Performance ratios - their formulas and use? (5)

Answer 2

Gross profit

• (𝑮𝒓𝒐𝒔𝒔 𝒑𝒓𝒐𝒇𝒊𝒕)/𝑹𝒆𝒗𝒆𝒏𝒖𝒆 x 100%
• Effectively shows the percentage of revenue that’s generated from the main trade of the organisation.
  Very industry specific.

Operating profit margin

• (𝑶𝒑𝒆𝒓𝒂𝒕𝒊𝒏𝒈 𝒑𝒓𝒐𝒇𝒊𝒕)/𝑹𝒆𝒗𝒆𝒏𝒖𝒆 x 100%
• Shows a measure of profit that is generated per £1 of revenue that can contribute towards tax and finance costs. Very industry specific.

Return on capital employed (‘ROCE’)

• (𝑷𝒓𝒐𝒇𝒊𝒕 𝒃𝒆𝒇𝒐𝒓𝒆 𝒕𝒂𝒙 𝒂𝒏𝒅 𝒊𝒏𝒕𝒆𝒓𝒆𝒔𝒕)/(𝑻𝒐𝒕𝒂𝒍 𝒂𝒔𝒔𝒆𝒕𝒔 𝒍𝒆𝒔𝒔 𝒄𝒖𝒓𝒓𝒆𝒏𝒕 𝒍𝒊𝒂𝒃𝒊𝒍𝒊𝒕𝒊𝒆𝒔)

=

• (𝑶𝒑𝒆𝒓𝒂𝒕𝒊𝒏𝒈 𝒑𝒓𝒐𝒇𝒊𝒕)/(𝑪𝒂𝒑𝒊𝒕𝒂𝒍 𝒆𝒎𝒑𝒍𝒐𝒚𝒆𝒅) x 100%
• Indicates how efficiently and effectively a company has utilised its assets during a period in generating profit

Asset turnover

• 𝑹𝒆𝒗𝒆𝒏𝒖𝒆/(𝑪𝒂𝒑𝒊𝒕𝒂𝒍 𝒆𝒎𝒑𝒍𝒐𝒚𝒆𝒅)
• Expressed as a number of times per annum
• Effectively shows the sales revenue generated for every £1 of capital employed.
• Measure of the level of activity and productivity.

Non current asset turnover

• 𝑹𝒆𝒗𝒆𝒏𝒖𝒆/(𝑵𝒐𝒏 𝑪𝒖𝒓𝒓𝒆𝒏𝒕 𝑨𝒔𝒔𝒆𝒕𝒔)
• Expressed as a number of times per annum
• Effectively shows the sales revenue generated for every £1 of non current asset.
• Measure of the level of activity and productivity.

Question 3

Financial position/ liquidity - their formulas and use? (6)

Answer 3

Inventory turnover

• (𝑪𝒐𝒔𝒕 𝒐𝒇 𝒔𝒂𝒍𝒆𝒔)/(𝑨𝒗𝒆𝒓𝒂𝒈𝒆 𝒊𝒏𝒗𝒆𝒏𝒕𝒐𝒓𝒚)
• How many times inventory is turned over in a year

Inventory days

• (𝑨𝒗𝒆𝒓𝒂𝒈𝒆 𝒊𝒏𝒗𝒆𝒏𝒕𝒐𝒓𝒚)/(𝑪𝒐𝒔𝒕 𝒐𝒇 𝒔𝒂𝒍𝒆𝒔) 𝑿 𝟑𝟔𝟓
• How long on average inventory is stored before it is sold

Receivables’ days

• (𝑻𝒓𝒂𝒅𝒆 𝒓𝒆𝒄𝒆𝒊𝒗𝒂𝒃𝒍𝒆𝒔)/(𝑪𝒓𝒆𝒅𝒊𝒕 𝒔𝒂𝒍𝒆𝒔) 𝒙 𝟑𝟔𝟓
• How long it takes on average to collect receivables

Payables’ days

• (𝑻𝒓𝒂𝒅𝒆 𝒑𝒂𝒚𝒂𝒃𝒍𝒆𝒔)/(𝑪𝒓𝒆𝒅𝒊𝒕 𝒑𝒖𝒓𝒄𝒉𝒂𝒔𝒆𝒔) 𝒙 𝟑𝟔𝟓
• How long it takes on average to pay payables

Current ratio

• (𝑪𝒖𝒓𝒓𝒆𝒏𝒕 𝒂𝒔𝒔𝒆𝒕𝒔)/(𝑪𝒖𝒓𝒓𝒆𝒏𝒕 𝒍𝒊𝒂𝒃𝒊𝒍𝒊𝒕𝒊𝒆𝒔)
• Measure of extent current liabilities are covered by current assets

Quick ratio

• (𝑪𝒖𝒓𝒓𝒆𝒏𝒕 𝒂𝒔𝒔𝒆𝒕𝒔 𝒍𝒆𝒔𝒔 𝒊𝒏𝒗𝒆𝒏𝒕𝒐𝒓𝒚)/(𝑪𝒖𝒓𝒓𝒆𝒏𝒕 𝒍𝒊𝒂𝒃𝒊𝒍𝒊𝒕𝒊𝒆𝒔)
• Measure of ability to cover liabilities with most liquid current assets

Question 4

Investment ratio’s - their formulas and use? (5)

Answer 4

Capital Gearing

• (𝑳𝒐𝒏𝒈 𝒕𝒆𝒓𝒎 𝒍𝒐𝒂𝒏𝒔)/(𝑪𝒂𝒑𝒊𝒕𝒂𝒍 𝒆𝒎𝒑𝒍𝒐𝒚𝒆𝒅)
• Gearing or leverage is relationship between fixed interest capital (debt) and total capital (debt and equity).
• Measure of financial risk

Dividend Cover

• (𝑷𝒓𝒐𝒇𝒊𝒕 𝒂𝒇𝒕𝒆𝒓 𝒕𝒂𝒙)/(𝑬𝒒𝒖𝒊𝒕𝒚 𝒅𝒊𝒗𝒊𝒅𝒆𝒏𝒅)
• Measure of ability of company to pay current dividend

Interest Cover

• (𝑶𝒑𝒆𝒓𝒂𝒕𝒊𝒏𝒈 𝑷𝒓𝒐𝒇𝒊𝒕)/(𝑰𝒏𝒕𝒆𝒓𝒆𝒔𝒕 𝒄𝒐𝒔𝒕)
• Measure of ability of company to pay current interest

Earnings per share

• (𝑷𝒓𝒐𝒇𝒊𝒕 𝒂𝒇𝒕𝒆𝒓 𝒕𝒂𝒙)/(𝑵𝒐. 𝒐𝒇 𝒆𝒒𝒖𝒊𝒕𝒚 𝒔𝒉𝒂𝒓𝒆𝒔)
• Useful for shareholders to evaluate performance over time

Price Earnings Ratio

• (𝑴𝒂𝒓𝒌𝒆𝒕 𝒑𝒓𝒊𝒄𝒆 𝒐𝒇 𝒔𝒉𝒂𝒓𝒆)/𝑬𝑷𝑺
• Reflects risk – effectively number of years taken to cover the cost of buying a share

Question 5

HOW do we adjust for changes in working capital?

Increases in inventory or receivables: (3)

Increases in payables: (2)

Answer 5

Increases in inventory or receivables:

• Increase in inventory means more cash has been spent on buying inventory therefore the company has less cash
• Increase in receivables means more of the revenue in the PoL has not been collected therefore the company has less cash
• an increase in inventory or receivables must be subtracted from operating profit (cash OUTflow)

Increases in payables:

• Increase in payables means more of the purchases in the PoL have not been paid therefore the company has more cash
• an increase in payables is added to operating profit (cash INflow)

Question 6

Cash received from sale of non current assets(NCA)

Answer 6

P/L sale of NCA = sale proceeds - CV
Sale proceeds = CV + profit on sale (Deduct if loss on sale)

Question 7

Partnership loans

Answer 7

• Rather than injecting money into the partnership through a capital account a partner may make a loan to the partnership at an agreed rate of interest.
• This loan is shown in the balance sheet as a non current liability
  Dr Bank Cr Loan to partner (non current liability)
• and interest on the loan is allowed as a normal business expense in the income statement.
  Dr interest expense Cr Partners Current account

Question 8

The 5 main BOPE

Answer 8

• Sales Day Book (SDB)

     - Record credit sales and returned sales

• Purchase Day Book (PDB)

  - Record credit purchases and returns

• Cash Book (CB)

   - Recording bank receipts and payments

• Petty Cash Book (PCB)

    - Record petty cash transactions

• Journal Book (JB)

   - Record unusual and period end adjustments

Question 9

Potential bookkeeping errors(4/1,2,2,1)

Answer 9

• Errors of omission

  - Transaction not recorded (both or one side missing)

• Errors of commission

    - Correct theory but error by bookkeeper
    - Post repairs to rent, addition or transposition error

• Errors of principle

  - Dr or Cr to completely wrong account
  - Drawings to wages, repairs to non current asset additions

• Compensating errors

  - Two unrelated errors which balance each other out

Question 10

Bank reconciliations - process (4)

Answer 10

• Tick off items appearing in cash book and bank statement / transaction listing
• Perform the reconciliation

  - Reconcile the balance per the cash book to the balance per the bank statement
  - Adjust for any errors or omissions