1. 1 LECTURE 2 - INTRODUCTION General Accounting General Accounting Cash flow Cash flow Profit and Loss Statement Profit and Loss Statement Balance Sheet Balance Sheet Depreciation Depreciation Concept Concept Methods to account for depreciation Methods to account for depreciation Relation between depreciation and taxation Relation between depreciation and taxation

2. 2 CASH FLOW STATEMENTS Statement of receipts and disbursements Statement of receipts and disbursements Reflect actual movements of cash only Reflect actual movements of cash only Time shifted from commitments and orders Time shifted from commitments and orders Link to Profit and Loss and Balance Sheet documents Link to Profit and Loss and Balance Sheet documents Cash inflow - the amount of case received in a defined time period (week, month, quarter, year) Cash inflow - the amount of case received in a defined time period (week, month, quarter, year) Cash outflow - the amount of case paid (disbursed) in a defined time period (week, month, quarter, year) - same time period! Cash outflow - the amount of case paid (disbursed) in a defined time period (week, month, quarter, year) - same time period! Net Cash Flow - total cash inflow less total cash outflow

3. 3 PRODUCING A CASH FLOW 1. List all the cash inflows by amount and time 2. List all the cash outflows by amount and time 3. Select the time period and overall duration of the statement 4. Arrange the inflows and outflows in time order and divide into time periods 5. Sum the cash inflows in each period 6. Sum the cash outflows in each period 7. Determine periodic Net Cash Flow 8. Calculate the cumulative cash flow for each time period

4. 4 CASH FLOW FORECAST - PROBLEM Clear Air Ventilation Systems 1. Produce a cash flow forecast for the first 6 months of trading

5. 5 TRADING RULES AND REGULATIONS In the UK - Companies Act of 1985. This act specifies the minimum information that must be included in the accounts that are filed at Companies House. Statutory obligation to prepare annual accounts Statutory obligation to prepare annual accounts Accounts must be 'true and fair' representation Accounts must be 'true and fair' representation Audited by an independent, practicing accountant. Audited by an independent, practicing accountant.

6. 6 SOME ACCOUNTING PRINCIPLES Matching or Accruals Principle Matching or Accruals Principle Revenues and Costs are recognised as they are earned rather than as cash is received or paid. Revenues and Costs are recognised as they are earned rather than as cash is received or paid. Applies to all Limited Companies Applies to all Limited Companies Now a statutory requirement (SSAP 2) resulting from Companies Act 1985 Prudence Now a statutory requirement (SSAP 2) resulting from Companies Act 1985 Prudence Materiality Materiality Only items that are financially significant need be considered Only items that are financially significant need be considered Accounts need to be practical in size Accounts need to be practical in size Absurdity is not mandatory

7. 7 GENERAL ACCOUNTING Balance sheet Balance sheet Balance sheet Profit and Loss Statement March 31st 2003 March 31st 2004 March 31st 2005 The purpose of accounting is to record the financial activity of an enterprise. For Registered Organizations periodic formal reporting is mandatory.

8. 8 PROFIT AND LOSS STATEMENT How worth has changed over a period of time How worth has changed over a period of time The Profit and Loss Statement is a dynamic measure of the financial performance of the organization. It shows revenues and expenses for the period of time covered by the statement The Profit and Loss Statement is a dynamic measure of the financial performance of the organization. It shows revenues and expenses for the period of time covered by the 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 within the organization has contributed to the growth of the Net Worth of the organization.

9. 9 PROFIT AND LOSS ACCOUNT Income Expenses Net Profit Interest & Tax OWNERS MONEY Sales Revenue Turnover Trading Income Direct Expenses: Production Labour Materials Indirect Expenses: Sales Marketing Development & Engineering Management Interest on Capital Loans + Taxation !

10. 10 PROFIT AND LOSS ILLUSTRATION m.u. (000,000) (000,000) Sales Revenue25.5 Cost of Sales13.3 Gross Profit12.2 Overheads6.0 Net Profit (PBIT) 6.2 Interest2.4 Profit Before Taxation (PBT)3.8 Taxation1.6 Profit After Taxation (PAT)2.2

11. 11 CASH FLOW FORECAST - PROBLEM Clear Air Ventilation Systems 1. Produce a cash flow forecast for the first 6 months of trading 2. Produce a Profit and Loss Statement for the first 6 months trading

12. 12 GENERAL ACCOUNTING Balance sheet Balance sheet Balance sheet Profit and Loss Statement March 31st 2003 March 31st 2004 March 31st 2005 The purpose of accounting is to record the financial activity of an enterprise. For Registered Organizations periodic formal reporting is mandatory.

13. 13 BALANCE SHEET Statement of worth of an organization at a specific point in time. Statement of worth of an organization at a specific point in time. Sets out assets, liabilities and net worth of the organization at that point in time. Sets out assets, liabilities and net worth of the organization at that point in time. The Balance Sheet is a static measure of the financial performance of the organization. It is a snap-shot of the financial condition of the organization. The Balance Sheet is a static measure of the financial performance of the organization. It is a snap-shot of the financial condition of the organization. Fundamental accounting equation: Fundamental accounting equation: Assets = Liabilities + Net Worth [Organizational perspective] Net Worth = Assets - Liabilities [Shareholder’s perspective]

14. 14 ASSETS Fixed Assets “A fixed asset in an asset that is acquired for the purposes of use within the business and is likely to be used by the business for a considerable period of time” i.e.: greater than a single accounting period Current Assets “A current asset is one which is either part of the operating cycle of the enterprise or is likely to be realized in the form of cash within one accounting period” Fixed orCurrent Asset? Fixed or Current Asset?

15. 15 FIXED AND CURRENT ASSETS Fixed Assets “A fixed asset in an asset that is acquired for the purposes of use within the business and is likely to be used by the business for a considerable period of time” i.e.: greater than a single accounting period Current Assets “A current asset is one which is either part of the operating cycle of the enterprise or is likely to be realized in the form of cash within one accounting period” Fixed orCurrent Asset? Fixed or Current Asset? Helicopter producer (e.g. Augusta) Stock item? Current Asset Finished goods stock Helicopter user (e.g. Oil Company) Used to move things for purposes of trading

16. 16 BENEFITS FROM A FIXED ASSET Accounting Period 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

17. 17 FIXED ASSETS Tangible fixed assets Tangible fixed assets Material Objects Material Objects Buildings, plant, equipment, computers Buildings, plant, equipment, computers Financial fixed assets Financial fixed assets Titles to cash Titles to cash Investments in subsidiaries Investments in subsidiaries Intangible fixed assets Intangible fixed assets Non-material things of value Non-material things of value ?

18. 18 INTANGIBLE FIXED ASSETS Patents Patents Brand-names Brand-names Trademarks Image Kit KatBlack MagicToffo SmartiesDairy BoxWalnut Whips Quality StreetDrifterFox’s Glacier mints RoloMatchmakersBlue Riband Lion BarCaramacRowntree’s Fruit Gums PoloGolden CupTooty Frooties AeroMintolaLean Cuisine Milky BarMunchiesCoffee After EightYorkieBranston Pickle Rowntree Nestle

19. 19 CURRENT ASSETS Working Capital components Cash in hand and at bank Cash in hand and at bank Stock Stock Debtors Debtors Financial components Short-term investments Manufacturing Process Stocks CASH Creditors Debtors Purchases Wages Credit Purchases Credit Sales Payment to Suppliers Payment by Customers

20. 20 LIQUIDITY OF BUSINESS ASSETS Cash inCash inSavingsShortDebtorsStockInvestmentsMotorOfficeMachineryLandSpecial HandBankAccountTermVehiclesEquip.&Plant DepositsBuildings Fixed Assets Fixed Capital Current Assets Circulating Assets Liquid Capital Totally Liquid Assets Least Liquid Assets

21. 21 LIABILITIES Current liabilities – amounts falling due within the current financial year Current liabilities – amounts falling due within the current financial year Basically short term debts Basically short term debtsCreditors Long term liabilities – amounts falling due longer than the current financial year Long term liabilities – amounts falling due longer than the current financial year Current Assets Short term Source of finance Fixed Assets Long term Source of finance

22. 22 BALANCE SHEET Assets - Liabilities Net Worth Fixed Assets Tangible fixed assets Financial fixed assets Current Assets Cash in hand & at bank StockDebtors Current Liabilities Creditors Long term liabilities Net Assets Shareholders funds Retained profit Net Assets =

23. 23 CASH FLOW FORECAST - PROBLEM Clear Air Ventilation Systems 1. Produce a cash flow forecast for the first 6 months of trading 2. Produce a Profit and Loss Statement for the first 6 months trading 3. Produce a Balance Sheet as at the end of the first 6 months trading