Unit 1, test 1 Flashcards
What needs to be included in a transaction question?
What items are impacted
Direction (increase or decrease)
Amount
The overall impact on classification (e.g Asset, liability, owner’s equity etc.)
Liquidity
The ability of the business to meet its short-term debts as they fall due
Stability
The ability of the business to meet its debts and continue operations in the long term.
How to calculate WCR
Current assets/ current liability :1
What is WCR
A liquidity indicator that measures the ratio of current assets to current liabilities to assess the firm’s ability to meet its short-term debts as they fall due
Consequences of low WCR
Businesses could struggle to meet their short-term debts
Consequences of high WCR
Excess CA that are idle or not being employed efficiently:
-> Cash shitting idle when it can be used to generate more revenues or make investments
-> Excess inventory could incur additional storage cost and increase the risk of inventory loss/damage
-> Longer it takes to collect AR, higher risk of not being able to collect debt -> bad debt expense
Strategies if WCR is too low
Improve cash flow from operations
Reduce drawings or capital contribution
Renegotiate ST debts to become LT debts
Strategies if WCR is too high
Reduce inventory levels
Reinvest excess cash in operations
Alternate investments
Owner withdraw cash
How to calculate debt ratio
Total liabilities / total assets x 100
What is debt ratio
Measure the proportion of the firm’s assets that are funded by external sources, providing an indication of the stability of the business
Strategies for improving debt ratio
Increase repayments
Seek a capital contribution from the owner to use in repaying a portion of the debt
Advertise to increase cash flow generation through sales
What is the role of accounting
A process of taking numbers (financial data) and turning them into reliable financial information and from there making decisions related to the performance of the business
Source documents
Documents that provide both the evidence that a transaction has occurred and the details of the transaction itself
Recording
Sorting, classifying and summarising the information contained in the source documents so that it is more usable
Reporting
The preparation of financial statements that communicate financial information to the owner
Advice
The provisions the owner of a range of options appropriate to their aims/objectives, and recommendations as to their suitability
What are the accounting assumptions?
Going concern assumption
Accounting entity assumption
Accrual basis assumption
Period assumption
Going concern assumption
The assumption that the business will continue operation in the future, and its records are kept on that basis
Accounting entity assumption
The assumption that the records of assets, liabilities and business activities of the entity are kept completely separate from those of the owner of the entity as well as from those of other entities
Accrual basis assumption
The assumption that revenues are recognised when earned and expenses are recognised with incurred.
Profit is calculated as revenue earned in a particular period less expenses incurred in that period.
Period assumption
The assumption that reports are prepared for a particular period of time, such as a month or year, in order to obtain comparability of results
Why is the period assumption significant?
Period assumption is significant in distinguishing between assets (benefits extend into future reporting period) and expenses (benefits totally consumed within one reporting period).
Relevance
Financial information must be capable of making a difference to the decisions made by users by helping them to form predictions and/or confirm or change previous evaluations
Materiality
The size or significance of financial information, determined by considering whether omitting or misstating it from the reports could influence decisions that users make
Faithful representation
Financial information should be a faithful representation of the real-world economic event it claims to represent: complete, free from material error and neutral (without bias)
Verifiability
Financial information should allow different knowledgeable and independent observers to reach a consensus that an event is faithfully represented.
Comparability
Financial information should be able to be compared with similar information about other entities and with similar information about the same entity for another period or another date
Understandability
Financial information should be understandable or comprehensible to users with a reasonable knowledge of business and economic activities and presented clearly and concisely
Timelessness
Financial information should be available to decision-makers in time and to be capable of influencing decisions
What are the qualitative characteristics
Relevance
Faithful representation
Timelessness
Understandability
Comparability
Verifiability
GST payable
GST owed by the business to the ATO when the amount of GST the business has received on its fees is greater than the GST it has paid to its suppliers
GST paid
GST paid by the business to suppliers on cash transaction
GST received
GST received from customers on cash transactions
GST receivable
GST owed to the business by the ATO when the amount of GST the business has paid to its suppliers is greater than the GST it has received on its fees
GST settlement
A payment made to the ATO by a small business to settle GST payable
GST refund
A cash receipt from the ATO to clear GST receivable
GST balance
Opening balance of GST
+ GST received from customers
- GST paid to suppliers
+ GST refund (to settle previous GST receivable)
- GST settlement (to settle previous GST payable)
= GST balance
Cash flows from operating activities
inflow and outflow examples
Cash flows related to day-to-day trading activities
Inflows: cash fees, GST received, interest received and receipts from accounts receivable
Outflows: wages, advertising, interest expenses
Cash flows from investing activities
Inflow and outflow examples
Cash flows related to the purchase and sale of non-current assets
Inflows: cash purchase from the sale of an NCA
Outflows: cash purchase of an NCA
Cash flows from financing activities
Inflow and outflow examples
Cash flows relating to changes in the financial structure of the firm
Inflows: capital contribution, loan received
Outflows: drawings and loan repayments
What is cash flow cover
A liquidity indicator that assesses the firm’s ability of the business operating cash flows to meet its short-term debts as they fall due
(calculates number of times average current liabilities can be met using net cash flows from operations)
Cash flow cover equation
Net cash flow from operations / average current liabilities
How should cash flow cover be assessed
Assessed against a standard or a benchmark
-Past performance (past periods)
-Budgeted / expected performance
-Competitors / Industry
Strategies to improve CFC
CFC is low (below 1 times)
- Improve cash flows by increasing effective advertising to drive cash flows
- Negotiate with the bank to extend repayment periods on existing loans (make CL to NCL)
- Organise a bank overdraft facility with the bank as there is a chance a negative balance might occur in the short term as the business tries to address the issue
Strategies when CFC is high
CFC is high (4 times and higher)
- Use excess cash to fund expansions of the business
- Use the excess cash to reduce its debts by paying down loans
- Use the excess cash to invest in upgrades to equipment to improve operations
