Accounting Principals & Procedures Flashcards
What is accounting?
Accounting is the collecting, analysing and communicating of financial information to make decisions and plans about business. There are 3 types of financial reporting:
1. Cash Flow Statement – shows cash movements (inflows and outflows) during reported period.
2. Profit and Loss Account – document showing how much profit or loss a business is making.
– live document / can be checked anytime.
3. Balance Sheet – Snap shot of the financial health and wealth of a business at a particular time.
Why is financial management in construction important?
- Investment goods industry, the products are wanted not for their own sake but on account of the goods and services, which they can create
- Amount to 7-8% of UK GDP and 3-10% of the world GDP.
- Dependence on government as a client, the government has the means to exercise very direct control over demand in the industry
Problems in the construction industry can affect the economy therefore good financial management is vital.
Why keep company accounts?
- To allow potential companies to see a companies financial standing
- Required by law for tax purposes
- For borrowing purposes
- To ensure the cash flow in a company is being managed correctly
What is a Cash Flow Statement and what would you see on one?
- Records the amount of cash entering and leaving a company.
- Useful to determine the short term viability of a business and its ability to pay bills (liquidity) by showing peaks & troughs in expenditure and helps outline future financial requirements.
Cash flow is determined by looking at three components by which cash enters and leaves a company: Core Operations, Investing and Financing.
Operations:
Cash inflows and outflows caused by core business operations. Changes made in cash, accounts receivable, depreciation, inventory and accounts payable are reflected in cash from operations.
Investing:
Changes in equipment, assets or investments relate to cash from investing. Usually cash changes from investing are a ‘cash-out’ item, because cash is used to buy new equipment, buildings etc.
Financing:
Changes in debt, loans or dividends are accounted for in cash from financing. Cash from financing are ‘cash-in’when capital is raised, and they are ‘cash-out’ when dividends are paid.
What is included in a cashflow?
- Net cash flow from operating activities – sum of cash receipts less sums paid e.g. salaries, interest on loans. Depreciation (loss of tangible asset value over time), deferred tax and amortization (loss of intangible asset value over time) are added / subtracted from the net income figure from P&LA.
- Returns on investments and servicing of finance – cash that the business receives as interest and dividends from investments e.g. repayment of debt.
- Taxation – tax payment at the end of the accounting year – 50% from previous and 50% from current.
- Capital Expenditure – cash payment used to acquire fixed assets (buildings, machinery) and receipts from disposal of others.
- Equity Dividends Paid – payment to equity holders to period shown
- Management of Liquid Resources – cash payment / receipts from acquisition / disposal of readily disposable investments.
- Financing – concerned with the long term financing from borrowings and shares.
- Increase / decrease in cash over a period – money in hand and bank deposits.
Why do we use cash flow?
- Ensures cash resources of the firm are fully utilized
- Ensures there is sufficient cash available to meet anticipated demand
- Provides a reliable guide to lending institutions when negotiating and repaying loans
- It provides an accurate tool for control
What is a profit & loss statement and what would you see on one?
A profit and loss statement indicates how much profit or loss a company has accrued over a period of time. This statement shows the company and its investors the profit or loss during a certain period.
How much income the company is generating (from selling goods and services)
The expenses are subtracted from the sales to calculate how much profit (where income exceeds expenses) is being generated.
- It shows how much profit / loss a company has made over a period of time;
- Shows investors / managers how profitable a company is;
- Profit / loss for the period = total revenue (inflow of assets / reduction of liabilities) – expenses incurred in generating the revenue;
- Includes:
o Turnover / Revenue (sales);
o Gross profit (before tax);
o Net profit (after tax);
o Operating expenses (wages & salaries + rent + energy bills + repairs + insurance + advertising
+ telephone & postage + interest on loans + depreciation);
o Taxation;
o Dividends.
What is a balance sheet and what would you find on it?
It is a snap shot of the financial position of a business at a particular time.
A balance sheet is a business’s financial statement summarizing its incoming and outgoings. It is used to assess the value of a business for possible investors or creditors, to analyze the performance of a business and identifying its weaknesses and for reporting purposes for business’s accounts.
Balance sheet
- Assets
- Liabilities
- Equity
It sets out the assets and owners against those assets (assets = liabilities + shareholders’ equity).
Businesses need to use assets to generate wealth – assets are the things that a business owns.
The business obtains the finance for these assets from two main sources:
1) Internally (inside the business) from capital raised from the business owners (shareholders in the case of a company);
2) Externally (liabilities) – for example, in the form of loans, and other forms of repayable finance.
You would also find the following:
- Current assets: cash, inventory, accounts receivable – converted to cash within 12 months);
- Fixed assets: property, plant, equipment less depreciation – cannot be easily converted;
- Current liabilities: accounts payable, accrued expenses – owed within 12 months;
- Long-term liabilities: loans, pension obligations – owed in over 12 months;
- Equity: company shares, retained earnings (earnings retained by company).
A balance sheet always balances because an asset has a certain market value, the liabilities against the asset are what is owed by the business. The difference is the equity (what is actually owned).
Difference between assets and liabilities = equity
How would a profit & loss statement relate to a balance sheet?
- The net profit (or loss) shown on a P&L statement is added to the capital on a Balance Sheet;
- However, profit & loss statement summarises a company’s financial activities over a period, a balance sheet shows a company’s financial position at a precise date;
- For analysis purposes, it is best to have both a profit & loss statement and the balance sheet together.
What do you look for when analysing consultant fee proposals?
- Total fee and how it was calculated;
- Level of resources; seniority, experience and allocation;
- Fee drawdown;
- Agreement of client Terms & Conditions;
- Agreement of client payment terms / period;
- Agreement of Scope of Services;
- Exclusions;
- Assumptions e.g. programme.
How are these fee proposals calculated and what other methods are there?
- Fees are usually based on either a percentage of the construction cost or a lump sum. o % fee of AECOM PM ranges from 1% to 2% (lower % if construction value is high); o Total % fee of consultants on project ranges from 10% to 15%.
- Other / smaller specialist consultants provide advice based on day rate fees.
How do you review the financial viability of tenderers?
- Review financial reports; level of profitability, liquidity and solvency.
- In the PQQ / RfP, ask tenderers:
o Insurances they have in place (Professional Indemnity / Public Indemnity / Employers Liability) and their liability limits;
o Confirm they’ve met all obligations to pay creditors and staff during the last year;
o Do they have any claims pending against them from within the last 3 years;
o To sign a permission form to ask their bank for a reference. - Due diligence – e.g. credit check (Dun & Bradstreet)
What would you see in a company account report for AECOM?
- Introduction
o Chairman’s statement;
o Summary of financial performance;
o Overview of market conditions; - Organisational structure & offices – sectors / countries;
- Strategy for 2020 – Business Recovery / Expansion / Training / Sustainability targets;
- Overview of Services – Project Management / Cost Management / Engineering Services / Value and Risk Management;
- Overview of Regional Developments – Scotland / Northern England / Southern England / Greater London / Wales;
- Financial Statements
o Balance Sheet;
o Profit & Loss Statement.
Why is it important for companies to hold accurate accounts?
- Legally required for inclusion in their annual financial report – legal requirement;
- To submit to tax authorities;
- To plan future investment / strategies;
- To submit to clients in bids upon request.
What is an asset?
Resources of the business that are expected to have some future monetary value.
What is a liability?
An obligation to provide cash or other benefit to another party.
What is bad debt?
Where it is reasonably certain that a debt will not be paid and the creditor writes off this debt.
What types of profit are there?
- Gross profit = Net sales – Cost of goods sold;
- Operating Profit = Gross Profit – Total operating expenses;
- Net profit = Operating Profit – taxes & interest.
Define ‘Gross’
Amount of money (profit) before deductions
Define ‘Net’
Remaining money (profit) after all deductions have been made - amount available for shareholders. Net profit can be stated as after taxes & interest.
Define ‘Revenue’
The value of goods and services sold.
Would a good balance sheet indicate that a company like AECOM is worth investing in?
Not necessarily as consultants don’t manufacture anything so fixed assets are low; they rely on the brain power of individuals which is shown as ‘goodwill’; not the most accurate indicator of skills.
What is ‘Goodwill’?
- It is the non-capital value of a business (reputation, staff skills) and is typically calculated on future revenue and profit.
What are possible reasons for business failure in construction?
- Low working capital requirements
- Sensitive to economic cycles
- Characteristics of construction contracts
- Insolvency
