Accounting Principles Flashcards
What are the key financial statements that companies provide?
- The key financial statements are:-
o Profit and loss accounts.
o Balance sheets.
o Cash flow statements.
What is a cashflow statement?
- It is the summary of the actual or anticipated ingoing and outgoing of cash in a firm over the accounting period.
- It measures the short-term ability of a firm to pay off its bills.
What is the difference between a profit and loss account and a balance sheet?
- A profit and loss account shows the incomes and expenditures of a company and the resulting profit or loss.
- The balance sheet shows what a company owns (it’s assets) and what it owes (it’s liabilities) at a given point in time.
What are Liquidity ratios?
- Liquidity rations measure the ability of a company to pay off its current liabilities by converting its current assets into cash.
- Liquidity ratio calculation = current assets / current liabilities.
- The ratio is usually around 1.5 but it depends on the sector of activity.
What are Profitability ratios?
- Profitability ratios measure the performance of a company in generating its profits.
- The trading profit margin ratio = turnover – (cost of sales / turnover).
- Low margins may be due to a growth strategy from the company and do not always result from bad management.
What are Financial Gearing Ratios?
- These measure the financial structure of the company which are crucial indicators for the external suppliers of debt and equity as well as for internal management.
- They help to measure solvency.
- Highly geared companies rely mainly on borrowing.
- The payment of interests reduces the profit.
Why do chartered quantity surveyors need to understand and be able to interpret company accounts?
- To aid in preparing their own business accounts.
- For assessing the financial strength of contractors and those tendering for contracts.
- For assessing competition.
What is the purpose of a P & L?
- To monitor and measure profit (or loss).
- To compare against past performance and against company budgets.
- For valuation purposes and to compare against competitors.
- To assist in forecasting with future performance.
- To calculate taxation.
How do you carry out a credit check? Give an example.
- I use the Credit Safe website to which my company subscribes to access a company’s accounts.
- I considered both the group accounts and the company accounts.
- If the credit rating is low, I calculate some key ratios and pass on all the information to my client’s accountants for them to analyse further.
How do you analyse a company’s accounts?
- The client’s accountants will carry out the detailed analysis but I can look at the warning signs by calculating ratios such as liquidity ratios, profitability ratios and gearing ratios.
- I should always calculate the ratios myself as those included in the company accounts may have been manipulated.
- I should always use the group or consolidated accounts rather than the company accounts unless it is a
limited company.
Why would you not recommend the appointment of a contractor with a low credit rating?
- There may be an increased risk of the contractor not performing satisfactorily.
- It could present increased risk of the contractor failing to deploy sufficient resources and materials to the project.
- It could increase the risk of the contractor’s insolvency.
What are signs of insolvency in company accounts or credit checks?
- A low credit rating.
- A liquidity ratio below 0.75.
- A falling working capital ratio suggesting that the company has taken on more contracts than it can finance.
- A low return on equity.
- A highly geared company that is heavily reliant on loans.
- A falling cashflow statement.
Please name the three different types of accounting ratios
Liquidity ratio
Profitability ratio
Gearing ratios - compares capital within the company against its debts. It measures the companies financial leverage and sets out what proportion of the firms activities are funded by shareholders vs its creditor funds
You understand the use of financial ratios and credit checks. How do you apply these tools to assess the financial health of contractors before awarding contracts?
