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5.5 Accounting fundamentals

5.5 Accounting fundamentals. Objectives. Why are financial accounts published ? Who wants to see the accounts and why ? What are the accounts ?. Why do companies publish accounts ?. Forced to !

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5.5 Accounting fundamentals

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  1. 5.5 Accountingfundamentals

  2. Objectives • Why are financialaccountspublished? • Whowantstoseetheaccounts and why? • What are theaccounts?

  3. Why do companiespublishaccounts? • Forcedto! • Itis a legal requirement of Ltd and PLC companiestopublishdetailed and audited (checked) informationregardingtheircompany. • Okay;letsrephrasethequestion.

  4. Whowantstoseethefinancialaccounts and why? • Copyoutthetitle. • Make a list of allthegroups of peoplethatwouldwanttoseethefinancialaccounts of a business and why……

  5. Whowantstoseethefinancialaccounts and why?

  6. Whowantstoseethefinancialaccounts and why?

  7. TheFinancialAccounts • There are threefinancialaccountsthatmustbeprovided: • IncomeStatement (previouslycalledprofit and lossaccount). • Balance Sheet (soontobecalledStatement of Financial Position). • Cash FlowStatement (noton syllabus and nottobeconfusedwith Cash FlowForecast, whichis).

  8. IncomeStatement

  9. IncomeStatement • Look at yourincomestatement! • Can youidentify; • Revenue • directcosts • indirectcosts • Interestpaid • Tax • dividends

  10. Activitiestounderstandaccounts • IncomeStatement • Youmayfinditusefultocopydownthekeydefinitionsonpages 535 and 536 • Activity 29.3 page 537

  11. IncomeStatement - Accruals • IncomeStatements record theprofitorlossmade in a 1 yearperiodto a certain date. • ACCRUALS isalsocalledthe MATCHING CONCEPT. • Costsshouldbechargedtotheperiod in whichtherevenuesthattheygenerate are made. • Eg. Stock isbought, butnotuseduntilthenextperiod. Towhichperiodshoulditscostbecharged? • Theperiod in whichitisused.

  12. IncomeStatement - Accruals • Example: • A companystarts a periodwith 250 units in stock. Itbuys 7,000 more unitsduringtheperiod. At theend of theperiodit has 300 units in a warehouse and 200 unitson a lorry. • Howmanyunitsshouldbechargedtotheperiod? • Activity 29.2 page 536

  13. The Balance Sheet

  14. The Balance Sheet • Balance Sheets record alltheassets, liabilities and equityheldby a company at a particular date. • Itscalledthe Balance Sheet as whatthecompanyowns (assets) mustequalwhatitowes (liabilities + equity). FA + CA = CL + LL + Eq

  15. Whatthecompanyowns (assets) mustequalwhatitowes (liabilities + equity)! • Thissoundsinsane! • However; • Ifthecompanymakes a profit • Theprofitbelongstothecompany. • However, thecompanybelongstotheshareholders. • Therefore, theprofitisownedbytheshareholders and, therefore, owedtothembythecompany.

  16. Lets do somemaths!!! • Fromthe balance sheet FA + CA = CL + LL + Eq • The chances are thatyour balance sheetis in a slightlydifferentorder. Maybe: FA+ CA –CL = LL + Eq Or FA + CA – CL - LL = Eq

  17. Activitiestounderstandaccounts • Balance Sheet • Thereis a list of keydefinitionson page 539. Ifyou do notknowany. Writethemdownnow! • Activity 29.4 page 540 • Activity 29.5 page 543

  18. Ratio Analysis • Ratio analysis = comparingonethingwithsomethingelse. • Ratio analysisenablesusto examine theaccounts of a business and extractadditionalinformation. • Enablesusto compare companies in thesamebusiness sector, but of differentsizes, eg. Walmart and Wong, Toyota and Great Wall, Petrobras and PetroPeru.

  19. Ratio Analysis – Profitability Ratios • GrossProfitMargin • Net ProfitMargin • Using page 544. • Copythe formulas foreachmargin and writeyourowndefinitionforeach. • CalculatetheGross and Net ProfitMarginforyouraccounts. • Activity 29.7 page 549 Qs 1 to 3 only.

  20. GPM= GrossProfit = Rev – DirectCosts RevRev • NPM= NP = Rev – DirectCosts - IndirectCosts RevRev

  21. Ratio Analysis – Liquidity • Recap: • Whyis cash important? • Whyisimportantnottohavetoomuch cash? • Whatisworking capital? • Howisworking capital calculated?

  22. Liquidity Ratios • Liquidity = theability of a companytopayits short-termdebts (currentliabilities). • Liquidity Ratios = ratio of currentassetstocurrentliabilities • Current Ratio = CurrentAssets / CurrentLiabilities • Thinkaboutitthisway … ifallyourcurrentliabilitiessaypayusnow! Can you? • The ideal levelforthecurrent ratio is 1.5 to 2. Althoughthiswillvarybetweenindustries. • CalculatetheCurrent Ratio foryourcompanyforeachyearyouhave data.

  23. Liquidity Ratios 2 • Inventoryisregarded as theleast ‘liquid’ of thecurrentassets. Thismeansitisthemostdifficulttoturninto cash. Itissometimes removed fromtheCurrent Ratio. • Acid-test (orquick) ratio= CA – Inventory CL • The ideal fortheacid-test ratio is 1 (sometextbookswrite 1 to 1.5). Althoughthiswillvarybetweenindustries. • CalculatetheAcid-test ratio foryourcompany.

  24. Liquidity Ratio Activities • Activity 29.6 page 548 • Activity 29.7 page 549. Youshouldalreadyhavecompleted 1 to 3.

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