Accounting principles and procedures

Question 1

What is meant by the terms Gross and Net?

Answer 1

In salary terms, Gross is the total salary and net is salary minus tax and all other deductions (the net cannot get any lower).

Question 2

What is a balance sheet?

Answer 2

• 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

Question 3

What is a profit and loss account?

Answer 3

• A summary of a business’s income and expenditure transactions usually prepared on an annual basis.
• PandL 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.

Question 4

What is a cashflow statement?

Answer 4

• 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.

Question 5

What is meant by depreciation in relation to an asset?

Answer 5

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.

Question 6

What is the difference between Management and Company accounts?

Answer 6

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.

Question 7

What is the difference between a Sole Trader, Partnership, Limited, and a LLP?

Answer 7

• 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.

Question 8

How would you assess a contractor’s financial accounts?

Answer 8

Request a copy of the contractor’s company accounts for the last 3 years which would include the Profit and 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.

Question 9

What are ‘Mint’ and ‘Dun and Bradstreet’ reports?

Answer 9

DandB 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.

Question 10

What are the main types of ratio analysis used to assess a company’s financial strength?

Answer 10

• 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

Question 11

Why do chartered surveyors in your pathway need to understand and be able to interpret company accounts?

Answer 11

• Companies business accounts.
• For assessing the financial strength of contractors and those tendering for contracts.
• For assessing competition.

Question 12

What is the Construction Industry Scheme (CIS)?

Answer 12

• The Construction Industry Scheme (CIS) is a scheme created by 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

Question 13

Why is having an understanding of accountancy required as a QS?

Answer 13

• 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.

Question 14

What are some examples of assets?

Answer 14

• Fee income from clients
• Plant equipment owned
• Rent income

Question 15

What are some examples of liabilities?

Answer 15

• Staff wages
• Rent payments for office premises
• Insurance

Question 16

How often do company accounts need to be logged and where?

Answer 16

• This is once a year and need to be published to the HMRC and companies house.
• This can be at any time of the year.

Question 17

What is the liquidity ratio?

Answer 17

Liquidity ratios are the ratios that measure the ability of a company to meet its short term debt obligations. These ratios measure the ability of a company to pay off its short-term liabilities when they fall due.

Question 18

What is the gearing ratio?

Answer 18

A gearing ratio is a type of financial ratio that compares company debt relative to different financial metrics, such as total equity.

Question 19

What is the profitability ratio?

Answer 19

Profitability ratios are a class of financial metrics that are used to assess a business’s ability to generate earnings relative to its revenue, operating costs, balance sheet assets, and shareholders’ equity over time, using data from a specific point in time.

Question 20

What is insider trading?

Answer 20

the illegal practice of trading on the stock exchange to one’s own advantage through having access to confidential information.

Question 21

What is the difference between liquidity, administration and insolvency?

Answer 21

• Liquidity is the process of selling all assets before dissolving the company completely.
• Insolvency means the company is unable to pay it’s debts.
• Administration aims to help the company repay debts in order to escape insolvency (if possible)

Question 22

What is capital expenditure?

Answer 22

Money spent by a business or organization on acquiring or maintaining fixed assets, such as land, buildings, and equipment.

Question 23

What is operational/revenue expenditure?

Answer 23

Revenue expenditure are those which relate to the trade of the business. In our example of a mobile catering trailer business, the stocks, fuel costs,staff wages, repair of catering equipment are the revenue expenditure.

Question 24

Why do chartered surveyors in your pathway need to understand and be able to interpret company accounts?

Answer 24

• For your own business accounts.
• For assessing the covenant strength of potential tenants and landlords.
• For assessing the financial strength of contractors and those tendering for contracts.
• For profits-method valuations (for leisure properties).
• For assessing competition.

Question 25

What is the difference between a statement of comprehensive income and a statement of financial position?

Answer 25

A statement of comprehensive income shows the income, expenditure and profit or loss of the company and the statement of financial position shows what a company owns (assets) and what it owes (liabilities) at a given point in time.