1

LECTURE 2 - INTRODUCTIONLECTURE 2 - INTRODUCTION

General AccountingGeneral Accounting Cash flow Cash flow Profit and Loss StatementProfit and Loss Statement Balance SheetBalance Sheet

DepreciationDepreciation ConceptConcept Methods to account for depreciationMethods to account for depreciation Relation between depreciation and taxation Relation between depreciation and taxation

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CASH FLOW STATEMENTS

Statement of receipts and disbursementsStatement of receipts and disbursements Reflect actual movements of cash onlyReflect actual movements of cash only Time shifted from commitments and ordersTime shifted from commitments and orders Link to Profit and Loss and Balance Sheet documentsLink to Profit and Loss and Balance Sheet documents

Cash inflow - the amount of case received in a defined time Cash inflow - the amount of case received in a defined time period (week, month, quarter, year)period (week, month, quarter, year)

Cash outflow - the amount of case paid (disbursed) in a Cash outflow - the amount of case paid (disbursed) in a defined time period (week, month, quarter, year) - same defined time period (week, month, quarter, year) - same time period!time period!

Net Cash Flow - total cash inflow less total cash outflow

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PRODUCING A CASH FLOWPRODUCING A CASH FLOW

1.1. List all the cash inflows by amount and timeList all the cash inflows by amount and time

2.2. List all the cash outflows by amount and timeList all the cash outflows by amount and time

3.3. Select the time period and overall duration of the Select the time period and overall duration of the statementstatement

4.4. Arrange the inflows and outflows in time order and divide Arrange the inflows and outflows in time order and divide into time periodsinto time periods

5.5. Sum the cash inflows in each periodSum the cash inflows in each period

6.6. Sum the cash outflows in each periodSum the cash outflows in each period

7.7. Determine periodic Net Cash FlowDetermine periodic Net Cash Flow

8.8. Calculate the cumulative cash flow for each time periodCalculate the cumulative cash flow for each time period

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CASH FLOW FORECAST - CASH FLOW FORECAST - PROBLEMPROBLEM

Clear Air Ventilation SystemsClear Air Ventilation Systems

1.1. Produce a cash flow forecast for the first 6 months of Produce a cash flow forecast for the first 6 months of tradingtrading

5

TRADING RULES AND TRADING RULES AND REGULATIONSREGULATIONS

In the UK - Companies Act of 1985. In the UK - Companies Act of 1985.

This act specifies the minimum information that must be This act specifies the minimum information that must be included in the accounts that are filed at Companies included in the accounts that are filed at Companies

House. House.

SStatutory obligation to prepare tatutory obligation to prepare annual annual accounts accounts AAccounts must be 'true and fair' representationccounts must be 'true and fair' representation AAudited by an independent, practicing accountant.udited by an independent, practicing accountant.

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SOME ACCOUNTING SOME ACCOUNTING PRINCIPLESPRINCIPLES

Matching or Accruals PrincipleMatching or Accruals Principle

Revenues and Costs are recognised as they are earned Revenues and Costs are recognised as they are earned rather than as cash is received or paid.rather than as cash is received or paid.

Applies to all Limited CompaniesApplies to all Limited Companies

Now a statutory requirement (SSAP 2) resulting from Now a statutory requirement (SSAP 2) resulting from Companies Act 1985Companies Act 1985 Prudence Prudence

MaterialityMateriality

Only items that are financially significant need be Only items that are financially significant need be consideredconsidered

Accounts need to be practical in sizeAccounts need to be practical in size

Absurdity is not mandatoryAbsurdity is not mandatory

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GENERAL ACCOUNTINGGENERAL ACCOUNTING

Balancesheet

Balancesheet

Balancesheet

Profit and Loss Statement Profit and Loss Statement

March 31st2003

March 31st2004

March 31st2005

The purpose of accounting is to record the financial activity of an enterprise.

For Registered Organizations periodic formal reporting is mandatory.

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PROFIT AND LOSS STATEMENTPROFIT AND LOSS STATEMENT

How worth has changed over a period of timeHow worth has changed over a period of time The Profit and Loss Statement is a The Profit and Loss Statement is a dynamicdynamic measure of the measure of the

financial performance of the organization. It shows financial performance of the organization. It shows revenues and expenses for the period of time covered by revenues and expenses for the period of time covered by the statementthe statement

Fundamental profit and loss equation:Fundamental profit and loss equation:

Revenues - Expenses = Net Profit

Net Profit - Interest due - Taxation = Retained Profits

The Retained Profit is the measure of how much the activity The Retained Profit is the measure of how much the activity within the organization has contributed to the growth of the within the organization has contributed to the growth of the

Net Worth of the organization.Net Worth of the organization.

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PROFIT AND LOSS ACCOUNT

Income

Expenses

Net Profit

Interest & Tax

OWNERS MONEY

Sales RevenueTurnover

Trading Income

Direct Expenses:•Production

Labour•Materials

Indirect Expenses:•Sales Marketing•Development &

Engineering•Management

Interest on Capital Loans +

Taxation !

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PROFIT AND LOSS ILLUSTRATION

m.u.m.u.

(000,000)(000,000)Sales RevenueSales Revenue 25.525.5Cost of SalesCost of Sales 13.313.3Gross ProfitGross Profit 12.212.2OverheadsOverheads 6.06.0Net Profit (PBIT) Net Profit (PBIT) 6.26.2InterestInterest 2.42.4Profit Before Taxation (PBT)Profit Before Taxation (PBT) 3.83.8TaxationTaxation 1.61.6Profit After Taxation (PAT)Profit After Taxation (PAT) 2.22.2

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CASH FLOW FORECAST - CASH FLOW FORECAST - PROBLEMPROBLEM

Clear Air Ventilation SystemsClear Air Ventilation Systems

1.1. Produce a cash flow forecast for the first 6 months of Produce a cash flow forecast for the first 6 months of tradingtrading

2.2. Produce a Profit and Loss Statement for the first 6 months Produce a Profit and Loss Statement for the first 6 months tradingtrading

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GENERAL ACCOUNTINGGENERAL ACCOUNTING

Balancesheet

Balancesheet

Balancesheet

Profit and Loss Statement Profit and Loss Statement

March 31st2003

March 31st2004

March 31st2005

The purpose of accounting is to record the financial activity of an enterprise.

For Registered Organizations periodic formal reporting is mandatory.

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BALANCE SHEETBALANCE SHEET

Statement of worth of an organization at Statement of worth of an organization at a specific point in a specific point in timetime..

Sets out assets, liabilities and net worth of the organization Sets out assets, liabilities and net worth of the organization at that point in time.at that point in time.

The Balance Sheet is a The Balance Sheet is a static static measure of the financial measure of the financial performance of the organization. It is a snap-shot of the performance of the organization. It is a snap-shot of the financial condition of the organization.financial condition of the organization.

Fundamental accounting equation:Fundamental accounting equation:

Assets = Liabilities + Net WorthAssets = Liabilities + Net Worth

[Organizational perspective][Organizational perspective]

Net Worth = Assets - LiabilitiesNet Worth = Assets - Liabilities

[Shareholder’s perspective][Shareholder’s perspective]

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ASSETSASSETS

Fixed Assets Fixed Assets

““A fixed asset in an asset that is A fixed asset in an asset that is acquired for the purposes of acquired for the purposes of use within the business and is use within the business and is likely to be used by the likely to be used by the business for a considerable business for a considerable period of time”period of time”

i.e.: greater than a single i.e.: greater than a single accounting periodaccounting period

Current AssetsCurrent Assets

““A current asset is one which is A current asset is one which is either part of the operating either part of the operating cycle of the enterprise or is cycle of the enterprise or is likely to be realized in the likely to be realized in the form of cash within one form of cash within one accounting period”accounting period”

Fixed orFixed or Current Asset?Current Asset?

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FIXED AND CURRENT ASSETSFIXED AND CURRENT ASSETS

Fixed Assets Fixed Assets

““A fixed asset in an asset that is A fixed asset in an asset that is acquired for the purposes of use acquired for the purposes of use within the business and is likely within the business and is likely to be used by the business for a to be used by the business for a considerable period of time”considerable period of time”

i.e.: greater than a single i.e.: greater than a single accounting periodaccounting period

Current AssetsCurrent Assets

““A current asset is one which is A current asset is one which is either part of the operating cycle either part of the operating cycle of the enterprise or is likely to of the enterprise or is likely to be realized in the form of cash be realized in the form of cash within one accounting period”within one accounting period”

Fixed orFixed or Current Asset?Current Asset?Helicopter Helicopter producerproducer(e.g. Augusta)(e.g. Augusta)Stock item?Stock item?Current AssetCurrent AssetFinished goods Finished goods stockstock

Helicopter userHelicopter user(e.g. Oil Company)(e.g. Oil Company)

Used to move Used to move things for purposes things for purposes of tradingof trading

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BENEFITS FROM A FIXED ASSETBENEFITS FROM A FIXED ASSET

AccountingPeriod

0 1 2 3 4 5

Asset exists within the organization

Purchase

Fixed Asset

Benefit Gained

99/00 00/01 01/02 02/03 03/04 04/05

Disposal

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FIXED ASSETSFIXED ASSETS

Tangible fixed assetsTangible fixed assets Material ObjectsMaterial Objects Buildings, plant, equipment, computersBuildings, plant, equipment, computers

Financial fixed assetsFinancial fixed assets Titles to cashTitles to cash Investments in subsidiariesInvestments in subsidiaries

Intangible fixed assetsIntangible fixed assets Non-material things of valueNon-material things of value ??

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INTANGIBLE FIXED ASSETSINTANGIBLE FIXED ASSETS

PatentsPatents Brand-namesBrand-names

TrademarksTrademarks ImageImage

Kit Kat Black Magic Toffo

Smarties Dairy Box Walnut Whips

Quality Street Drifter Fox’s Glacier mints

Rolo Matchmakers Blue Riband

Lion Bar Caramac Rowntree’s Fruit Gums

Polo Golden Cup Tooty Frooties

Aero Mintola Lean Cuisine

Milky Bar Munchies Coffee

After Eight Yorkie Branston Pickle

Rowntree Nestle

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CURRENT ASSETSCURRENT ASSETS

Working Capital componentsWorking Capital components

Cash in hand and at bankCash in hand and at bank StockStock DebtorsDebtors

Financial componentsFinancial components

Short-term investmentsShort-term investments

ManufacturingProcess

Stocks

CASH

Creditors DebtorsPurchases Wages

Credit Purchases Credit Sales

Payment to Suppliers Payment by Customers

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LIQUIDITY OF BUSINESS LIQUIDITY OF BUSINESS ASSETSASSETS

Cash in Cash in Savings Short Debtors Stock Investments Motor Office Machinery Land Special

Hand Bank Account Term Vehicles Equip. & Plant

Deposits Buildings

Fixed AssetsFixed Capital

Current AssetsCirculating AssetsLiquid Capital

Totally LiquidAssets

Least LiquidAssets

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LIABILITIESLIABILITIES

Current liabilities – amounts falling due within the current Current liabilities – amounts falling due within the current financial yearfinancial year Basically short term debtsBasically short term debts

CreditorsCreditors

Long term liabilities – amounts falling due longer than the Long term liabilities – amounts falling due longer than the current financial yearcurrent financial year

Current Assets

Short termSource of

finance

Fixed Assets

Long termSource of

finance

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BALANCE SHEETBALANCE SHEET

Assets - LiabilitiesAssets - Liabilities Net WorthNet Worth

Fixed AssetsFixed AssetsTangible fixed assetsTangible fixed assetsFinancial fixed assetsFinancial fixed assets

Current AssetsCurrent AssetsCash in hand & at bankCash in hand & at bankStockStockDebtorsDebtors

Current LiabilitiesCurrent LiabilitiesCreditorsCreditors

Long term liabilitiesLong term liabilitiesNet AssetsNet Assets

Shareholders Shareholders fundsfunds

Retained profitRetained profit

Net AssetsNet Assets

=

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CASH FLOW FORECAST - CASH FLOW FORECAST - PROBLEMPROBLEM

Clear Air Ventilation SystemsClear Air Ventilation Systems

1.1. Produce a cash flow forecast for the first 6 months of Produce a cash flow forecast for the first 6 months of tradingtrading

2.2. Produce a Profit and Loss Statement for the first 6 months Produce a Profit and Loss Statement for the first 6 months tradingtrading

3.3. Produce a Balance Sheet as at the end of the first 6 Produce a Balance Sheet as at the end of the first 6 months tradingmonths trading