Company Accounts
AS Business Studies
Content
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Capital and revenue expenditure
Cash flow forecasting
Improving cash flow
Control of working capital
Cash flow vs. profit
Sources of finance:
– Internal
– External
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Profit and loss
Balance Sheets
Depreciation
Window dressing
Capital and Revenue Expenditure
• Capital expenditure – spending on items that can be
used time and time again in the production process
(fixed assets)
• Revenue expenditure – meets current day-to-day
expenses e.g purchase of raw materials and the
payment of wages
Cash Flow Forecast & Cash Flow Statements
• A Forecast is a prediction of what may happen in the
future
• A cash Flow Forecast is therefore a prediction of the
inflows and outflows of cash in the future
• Businesses use past figures and experiences to
predict forecasts
• A Cash Flow statement differs from a forecast. It
detailed what has happened in the business, i.e. the
money that has flowed in and out of the business
Cash Flow Forecast
• Opening balance
• Total incomes
– Sale of goods
– Rental income
• Total expenditures
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Materials
Energy costs
Wages
Transport
Cash Flow Forecast cont…
• Total incomes – total expenditures (outflows) = net
cash flow
• Opening balance + net cash flow = Closing balance
• Closing balance is then carried forward as the
opening balance for the next month
Uses of cash flow forecasts
• To anticipate potential shortages of cash
• To examine and possibly adjust the timings of
receipts and payments, in order to avoid problems
• To arrange financial support where problems are
forecast
Problems with cash flow
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Inaccurate market research
Changing tastes
Competitors
Economic changes
Uncertainty
Cause of cash flow problems
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Seasonal demand
Overtrading
Over-investment in fixed assets
Credit sales
Poor stock management
Unforeseen change
Types of cash flow problems
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Long term structural problems
Cyclical features
Internal problems / inefficiencies
External changes
Working capital problems
Ways of improving cash flow
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Improve planning
More thorough market research
Diversifying the product portfolio
Improved decision making
Contingency funds
Use of sources of finance to avoid short term
working capital problems
Cash flow vs. profit
• Cash flow is most important in the short term as it is
the businesses ability to pay their bills
• Profit is more important in the long term
• Businesses can be profitable and still experience
cash flow problems
Working Capital
• Working capital measures the amount of money the
business has to pay day-to-day expenses
• Working capital = current assets – current liabilities
• Businesses need to be aware of their working
capital and ensure that they have enough cash to
survive
Control of working capital
• Stock and debtor control – arranging appropriate
credit terms
• Liquidity – need to manage assets to ensure that
the business has sufficient liquidity (ease of
converting assets to cash)
• Stock needs to be valued correctly
• Need to ensure are not holding excess stocks or
excess cash
Sources of Finance
• These are how businesses get money to finance
growth, to overcome working capital / cash flow
problems etc
• Internal sources – from inside the business
• External sources – from outside the business
• Internal sources:
– No external body to pay
– Generally no time limit
Internal Sources - Retained Profit
• Cheap and flexible
• Technically profit is shareholders so they need convincing
its used effectively
• Usually okay infrequently
• Idea retained profit used to generate future profits and
therefore used for purchase of fixed assets
• Opportunity cost needs to be assessed
Internal Sources - Sale of Assets
• This can allow business to develop more profitable
ventures
• If in crisis can sell fixed assets but will lead to a
decrease in profitability in long term
• In principle the sale of these assets should allow a
firm to increase its level of profit
Internal Sources - Sale and Leaseback
• This allows the organisation to receive a cash
payment – improving short term cash flow
• But have to rent the asset which may reduce profit
long term
• If cash used to buy more profitable assets the cost
of rental is covered
External sources of finance – long term –
Share Capital
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Share capital
Limited companies can issue shares
Share holders receive dividends
Shares can be
– Preference shares – fixed % dividend
– Ordinary shares – risk capital / equity
Loan capital
• Providers of loans = creditors
• Four main types of loan capital:
– Debentures – long term loan to the business at an agreed fixed %
of interest repayable on a stated date. Up to 25 years.
– Mortgages – used to purchase property. Up to 25 years
– Long term loans – provided by specialist organisations
– Government assistance – selective and takes form of grants
generally
External sources of finance – medium
term
• Bank loans
• Leasing
• Hire purchase
External sources of finance – short term
• Bank overdrafts – agreed limit, stated time period
• Trade credit – suppliers allow time period before
money is due
• Debt factoring – business receives immediate
payment for credit sales
Sources of Finance - Choice
• Businesses need to consider a number of factors
when deciding what sources of finance to use
• External sources of finance are more expensive as
you need to pay interest
• To use retained profits you need to get agreement
from shareholders
• The source of finance chosen also depends on the
time period and what you need the finance for
Profit and Loss Account
• This is a financial statement that shows a businesses
revenues, expenses and profit / loss over a period of time
• Gross profit = Sales – cost of sales
• Net profit = Gross profit – overheads
• Retained profit = Net profit – tax – dividends
• Trading account – shows the income earned by the
business over a trading period
• Appropriation account – the uses of net profit after taxation
Interpreting Profit and Loss Accounts
• The following groups are interested in a businesses
profit and loss accounts:
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Shareholders
Managers
Employees
Inland revenue / government
Balance Sheets
• Balance sheets are financial statements that record the assets and
liabilities of a business at a specific point in time
• Assets – items owned by a business
• Fixed assets – items owned by a business expected to be retained
for at least one year e.g. buildings
• Current assets – items that are expected to be turned into cash in the
next year e.g. cash, stock
• Liabilities – monies owed by a business
• Current liabilities – debts owed by the business payable within a year
e.g. creditors
• Long term liabilities – debts owed by the business which wont be
repaid within the next year e.g. bank loan
Balance Sheets - Rules
1. Assets = Liabilities
2. Total Assets = Fixed assets + current assets
3. Liabilities = Share capital + borrowings + other
creditors + reserves
Depreciation
• The decrease in value of assets over time
• This is shown as an expense on the profit and loss
account
• Fixed assets will be depreciated in value on the
balance sheet
• Two methods:
– Straight line
– Reducing
Window dressing
• These improve the appearance of a companies balance
sheet
• Can borrow money for a short period of time to improve
cash position just before date of balance sheet
• Use sale and leaseback
• Include intangible assets e.g. goodwill / brands on balance
sheet
• Capitalise expenditure – including things as assets that
could be classified as expenses
Summary
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Capital and revenue expenditure – capital spend on fixed assets, revenue on day to
day expenses
Cash flow forecasting – a prediction of cash inflows – cash outflows
Improving cash flow – cash flow can be improved by better planning, sources of
finance, revision of credit terms and better market research
Working capital – current assets – current liabilities, need to ensure have sufficient
cash to operate
Cash flow vs. profit – Cash flow - short term and profit long term
Sources of finance – these are ways businesses can get money
– Internal – from inside the business e.g. retained profits, sale of assets
– External – from outside the business e.g. loans, mortgages
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Profit and loss – shows revenues, expenses and profit / loss over a period of time
Balance Sheets – record assets and liabilities on a specific day
Depreciation – the reduction in value of fixed assets over time
Window dressing – techniques used to improve appearance of accounts
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