Accounting Principles and Procedures (L1) Flashcards
(25 cards)
What is a Financial Statement?
Forecast of income and expenditure that can be used an an analytical tool to identify potential shortfalls and surpluses.
What are the key financial statements that companies provide?
Balance sheets
Cash flow statements
Profit and loss accounts
What is a Profit and Loss account (sometimes referred to a statement of comprehensive income)?
A Financial statement which confirms the income and expenditure of a company, resulting in in either a profit or a loss, over a financial period (usually 1 year).
They can also be used to identify non-profitable work.
For example:
* Total revenue = £100,000
* Cost of goods sold = £20,000
* Gross profit = £80,000
* Minus operating expenses (salaries, rent, utilities, depreciation) = -£30,000
* Operating profit = £50,000
* Minus interest expense = -£10,000
* Income before tax = £40,000
* Taxes = -£10,000
* Net income = £30,000
What is a Balance Sheet (sometimes referred to as a statement of financial position)?
Balance sheets shows what the company owns (assets) and what owes (liabilities), at any given point in time.
For example:
* Assets: fixed assets, intangible assets, bank, stock, debtors.
* Liabilities: creditors and loans
What is a Cash Flow statement?
Cashflow statement shows money coming in and going out of the business, over the accounting period.
Measures the short-term ability of a company to be off its bills.
What is a Cash Flow forecast?
A cash flow forecast shows the cash (or cash equivalents) entering and leaving the company.
On construction projects, these are usually illustrated as S curves – small outlay at the start, increase during the midway point of the project and taper towards the end of the project.
What is an S-Curve?
S curve means ‘standard curve’. It refers to the shape of the expenditure profile when shown on a graph.
Usually lower at the start (site set up and enabling works).
Towards the middle, rate of expenditure increases as higher capital costs are expended (M&E, steelworks and main elements of the project)
Towards the end, the curve tapers i.e. it slows down as the project approaches completion/ handover.
How are S curves these used by Surveyors?
To track, analyse and assess business accounts and performance.
To assess the financial strength of a contractor.
To compare actual progress on site against pre-contract predictions, which can also be used as a tool for assessing whether the contractor is on programme.
What are Management Accounts?
Management account are prepared by a company for internal management use.
They are accounts prepared for a lender (such as a bank) to evaluate how you will be able to repay the funding.
They are not audited externally.
What is the difference between management account and financial accounts?
Management accounts are used internally by the business, whereas financial accounts, which are the companies accounts must be issued to their shareholders, people who can go to the company’s general meetings, companies house and HMRC. This will include the balance sheet and profit and loss accounts. If further info is needed then GOV.UK website provides further information.
Explain your understanding of the following Terminology?
- Capital Allowances
- Sinking funds
- Insolvency
- Companies House
- HMRC
Capital allowances – tax relief on certain items, purchased by the business. For example, tools and equipment.
Sinking funds – money set aside by a business to cover any future expenses or long term debt.
Insolvency – where liabilities exceed assets and the inability to pay off those liabilities.
Companies house – an agency which incorporates and dissolves limited companies in the UK. It is available to the public and shows information such as the company’s number, directors, financial information.
HMRC – His Majesties revenue and customs
What are Liquidity ratios?
Measures the company’s ability to turn current assets into cash, to pay off current liabilities.
Calculation = current assets / current liabilities
Ratio of 0.75 may be an early indicator of insolvency.
What are Profitability ratios?
Measures a company’s performance to generate profit.
Calculation = turnover – (costs of sales/turnover)
Low margins may not mean poor management but a growth plan in place by the company.
What are Financial Gearing Ratios?
Measures the financial structure of a business.
= debt / equity to show proportion of debt the company is using against its equity.
Measures solvency of the company
Borrowing means interest and interest means lower profit.
A highly geared company means they reply heavily on borrowing.
Why do chartered quantity surveyors need to understand and be able
to interpret company accounts?
To help with the preparation of their financial accounts.
To check the financial strength of contractors and contractors tendering for a project.
For assessing competition.
What is the purpose of a P & L?
To monitor and measure the profit or loss of a company.
To compare with competitors
To compare with past performance and company budgets.
To forecast future performance.
Taxation purposes.
What is the difference between debtors and creditors?
Debtor is the party who owes money and creditor is the party who is owed the money.
For example, a debtor would be a client who owes you money for completing a service. Therefore, you would be the creditor.
You would be a debtor if you sub-consulted work and owed that sub-consultant money for their services.
What are Escrow Accounts?
A separate, third-party account, held on behalf of two other parties.
A bank account with defined contractual conditions for the release of funds, therefore, they can be used as a project bank account.
Mechanisms must be in place for the release of funds, such as payment certificates.
When have you used company accounts in your work?
No personal experience in conducting an assessment but on one project, for a new client, I passed the client’s details onto our finance department who completed a financial check to confirm their financial strength.
How do you analyse a company’s accounts?
For contractors, the client’s accountants usually complete a detailed analysis, but I could calculate ratios such as liquidity, profitability and gearing ratio’s, albeit, I have had no experience in undertaking these.
Liquidity ratio = current assets / current liabilities
Profitability ratio = turnover – (cost of sales / turnover)
Gearing ratio = total debt / total equity
How do you carry out a credit check? Give an example.
My company’s finance team will usually undertake the credit checks.
However, I could use the credit safe website which my company subscribes to access company’s accounts, consider both group and the company accounts. If the credit rating is low, ratios could be used. I would then pass this information onto the clients accountant to analyse further.
What are signs of insolvency in company accounts or credit checks?
- Low liquidity ratio – below 0.75.
- High gearing ratio – heavily reliant on loans
- Low credit rating.
- A falling cashflow statement
- A falling working capital ratio – suggesting the company has taken on more contracts than it can finance.
- A low return on equity.
Why would you not recommend the appointment of a contractor with a low credit rating?
- Performance risks – inability to pay supply chain, resulting in longer lead times / slower deliveries / reduced labour on site.
- Could present increased risk of the contractor failing to deploy sufficient resources and materials to the project.
- Could increase the risk of the contractor’s insolvency.
What measures would you recommend if your client wanted to
appoint a contractor with a low credit rating?
Firstly, advise them of the risks involved (performance and insolvency).
If they insisted, then:
- Explore the option of requesting a performance bond
- Review the tender return to check their tender is not excessively front loaded
- Complete usual obligations such as making sure application for payment are not being over claimed.
- A project bank account could also provide an additional level of assurance.
