Unit 8 Flashcards
What are balance sheets?
Balance sheets are a snapshot of a firms finances at a fixed point in time.
They show the value of all the business assets (the things that belong to the businesses including cash in the blank) and all its liabilities (the money invested in the business), and the source of that capital (eg loans shares or retained profits) so they show where the money’s come from as well as what is being done with it.
The net assets value (the total fixed and current assets minus total current and non current (long term) liabilities) is always the same as the total equity value, the total of all the money that is been put into the business.
What are assets?
Assets (like machinery and stock) provide a financial benefit to the business, so they’re given a monetary value on the balance sheet. Assets can be classified as non current assets (fixed assets) or current assets
Businesses can use capital to buy assets that will generate more revenue in the future, this is investment.
What are non current assets?
Non-current assets are assets that the business is likely to keep for more than a year like property, land, and production etc. The total non current assets value on the balance sheet is the combined value of all the business’ non current assets.
Non current assets often lose value over time, so they over time, so they are worth less every year. This is depreciation. Businesses should factor in depreciation to give a realistic value of their non current assets on the balance sheets.
What are current assets?
Current assets are assets that the business is likely to exchange for cash within the accounting year, before the next balance sheet is made. All the current assets are added together to give the total current assets value on the balance sheet..
Current assets include receivables (money owed to the business by other companies and individuals) and inventories (or stock)
What are current liabilities?
Current liabilities are debts which need to be paid off within a year. Hit include overdrafts taxes due to be paid, payables (money owed to creditors) and dividends due to be paid to shareholders.
Total current liabilities are deducted from total fixed and current assets to give the value of assets employed.
What are non current liabilities?
Non current liabilities are debts that the business will pay off over several years.
What is working caPital?
Working capital is the amount of cash (and assets that can be easily turned into cash) that the business has available to pay its day to day debts. The more working capital a business has, the more liquid (able to pay its short term debts) it is.
Working capital is the same as net current assets on the balance sheet. The amount left over when you subtract current liabilities.
Businesses cant survive if they don’t have enough working capital, as well as generating enough sales. The business must make sure it collects money quickly to get cash to pay back its liabilities.
Why do businesses need cash?
Businesses need just enough cash to pay off short term debts. They shouldn’t have too much cash, because spare cash is great at paying debts, but lousy at earning money for the business.
Businesses with a long term cash flow cycle need more cash, as they have to wait for money to come in.
To make money, the business needs current assets that make sales possible like machinery.
Inflation increases the cost of wages and buying/holding stock so firms need more cash when inflation is high.
When a business expands, it needs more cash to avoid overtrading. Overtrading means producing so much that the business cant afford to pay its suppliers until it gets paid by customers.
What is Capital expenditure?
Capital expenditure (fixed capital) means money used to buy non current assets (fixed assets). These are things used over and over again to produce goods or services.
Businesses need to capital expenditure to start up, to grow and to replace worn out equipment. They must set aside enough money to stop non current assets from wearing out, and then they can decide how much money to invest in growth. This is called allocating capital expenditure.
How businesses can control Debtors (receivables)?
A business needs to control its debtors (people who owe money to the firm). It is important that businesses make sure that their debtors pay them on time.
A company might sell millions of pounds worth goods, but if it doesn’t make sure that payment has been received, there will be no money coming in. That means that the business is no better off in terms of cash flow than if it had sold nothing at all.
The business has to still pay wages.
How businesses can control Stock (Inventories)?
A business needs to hold suitable volumes of stock (raw materials and unsold products) to allow and satisfy the demands of the market
A business holding too little stock will lose sales as it wont be able to supply enough goods to the market to meet demand.
A business with too much stock has money tied up stock instead of working for the company. It would be better to use the money to pay wages or debts or invest in new projects.
What is a realisable value?
Accounting conventions say that stock values must be realisible. The net realisible value is the amount the company could get by selling the stock right now in its current state (rather than after it’s been used to make a finished product.
The realisible value might be lower than the cost value *(the amount the business paid for the stock). Or the net realisible value might be higher than its original cost price, if demand for the materials has increased since the business bought them which happens in businesses like jewellery manufacturers.
How do assets depreciate (lose value over time)?
Most assets lose value over time, the longer the businesses has them, the less they are worth.
Assets lose their value over three main reasons which are: wear, tear and they may break down or they become old fashioned when new inventions come onto the market
Although most assets depreciate sometimes it can work the other way around and assets can increase in value like property.
What do balance sheets show?
Balance sheets show how much a business is worth. Balance sheets show the short term financial status of the company.
Suppliers are particularly interested in working capital and liquidity. They can look at the balance sheet to see how liquid the firms assets are, as well as how much working capital the firm has. The more liquid the assets, the better the firm will be at paying bills.
It also shows sources of capital, ideally long term loans and mortgages are used to finance the purchase of fixed assets. A well managed business wouldn’t borrow too much through short term overdrafts, because overdrafts are an expensive way of borrowing.
Benefits of comparing Balance sheets?
Comparing this years balance sheet to last years accounts let you pick out trends in company finances and evaluate the financial performance of the company.
A quick increase in non current assets indicates that the company has invested in property or machinery. This means that the company is investing in a growth strategy, which may increase its profit over the medium term.
increases in revenue also suggest an increase in profit.
Looking at several balance sheets also shows trends in how the business has raised its capital. It is risky to suddenly start borrowing a lot in case interest rates rise.
What do income statements show?
The income statement (also known as a profit and loss account) shows how much money has been coming into the company (revenue) and how much goes out (expenses).
Revenue is sales income from selling goods and services. This includes cash payments and sales on credit. Expenses include the cost of raw materials, production costs, marketing costs, wages etc.
These figure can be used in assessing financial performance.
What is gross profit?
Gross profit is revenue minus the cost of sales.
This shows the money being made being made from actually making and selling goods. If gross profit is low, managers need to look at ways of reducing the cost of making the product, or increasing the selling price.
