Understanding and Managing Finance This Presentation is in Self-Study Form To start the...

Understanding and Managing Finance

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Understanding and Managing Finance

Presentation 2

Self-Study Version

Objectives for This week

After studying this week’s work, you should: Know the three main types of financial

statements used in business. Know and be able to discuss the meaning of

some of the important terms used in these statements

Be able to work with simplified versions of these statements, taking account of transactions.

Menu2a Financial Statements: Terms & Principles

2b Examples of Financial Statements

2c Simple Example

2d Follow-Up Activities

Part 2a

Financial Statements

Some Terms & Principles

Financial Statements

Apart form day-to-day bookkeeping, there are three different types of ‘official’ financial statements which are used by an organisation:

The Cash-flow Statement is designed to answer the question “What happened to all the money?”

The Profit & Loss Account is designed to answer the question “How much money did we make (or lose)?”

The Balance Sheet is designed to answer the question “What is the current worth of the organisation?”

Financial Statements – Some Terms

The first ‘big idea’ is that there is a difference between cash and profit.

Cash is simply the money which flows into and out of the business

Profit is the amount that the business earns for itself at the end of some period of time by carrying out its normal trading activities.


The second ‘big idea’ is the notion of assets and claims.

Assets are what the business owns. This can be anything: money in the bank, stock held, buildings, cars, land etc. and also any monies owed to the business.

Claims are what the business owes. This can be bank loans extended to the business, unpaid bills, profits which can be claimed by the owner or shareholders


The third ‘big idea’ is the notion of debit and credit. This comes from the idea of ‘double entry bookkeeping’ . This is a system for recording financial transactions where each item is recorded twice, once as a debit and once as a credit.

Debits are always put on the left hand side of a bookkeeping system.

Credits are always put on the right hand side of a bookkeeping system

The Balance is what is left after the debit total has been subtracted from the credit total.


The terms ‘debit’ and ‘credit’ are also used in a slightly different way when talking about business transactions. Business mainly buy things on credit (as many people do using a credit card), then pay later.

Creditors are the people you owe money to. Note that these are part of the claims on your business.

Debtors are the people who owe you money.Note that these are part of the assets of your business.

Activity 2.1

Select the appropriate words to complete these statements:

If your business buys goods on credit, the person you buy from is called a creditor/debtor. The goods that you buy become part of your business assets/claims.

If your business sells goods on credit, the person you sell to is called a creditor/debtor. The money that is owed becomes part of your business assets/claims.

Answer

Activity 2.1 Solution

If your business buys goods on credit, the person you buy from is called a creditor. The goods that you buy become part of your business assets.

If your business sells goods on credit, the person you sell to is called a debtor. The money that is owed becomes part of your business assets.

NB if this last sentence tricked you, please re-read the final sentences in each paragraph carefully.

Part 2b

Examples of Financial Statements

Financial Statements – Some Examples

The examples which follow are simply to show you what Bookkeeping and the three Financial Statements ‘look like’. At this stage you should not expect to understand any more than the general idea of what it is that the statements are doing, and possibly look out for the terms which have been introduced.

Please note: these are not all from the same company!

Double Entry BookkeepingEXAMPLE:

Stock is bought for a cash payment of £600

EXAMPLE:

Stock is bought for a cash payment of £600

This is entered once as a credit

and once as a debit:

This is entered once as a credit

and once as a debit:

Net Cash-Flow from Operating Activities 300,000

Returns from investment and servicing of finance 100,000-

Taxation 30,000-

Capital Expenditure 150,000-

-----------

Subtotal 20,000

Equity Dividends paid 30,000-

-----------

Subtotal 10,000-

Management of liquid resource - disposal of investments 10,000+

Financing - additional long-term loan 50,000+

-----------

= Increase or Decrease in Cash over Period 50,000+

EXAMPLE OF A CASH FLOW STATEMENT

EXAMPLE OF A CASH FLOW STATEMENT

The Bottom Line: How much more/less cash have we than before?

Turnover (Sales) (Income) £ 100,000

Cost of Sales (Direct Costs)Materials £10,000

Transport £ 5,000

Labour £15,000

Total Cost of Sales £ 30,000 30%

Gross Profit (Gross Margin) £ 70,000 70%

Overheads (Indirect Costs)Administrative salaries £18,000

Advertising £ 5,000

Rent & Rates £ 4,000

Total Overheads £ 27,000 27%

Operating Profit (Net Margin) £ 43,000 43%Interest on loans £ 3,000

Profit before tax £ 40,000 40%Corporation tax due £10,000

Profit after tax & interest £ 30,000 30%Dividends payable £22,000

Retained Profit (Earned Surplus) £ 8,000 8%

EXAMPLE OF A PROFIT & LOSS ACCOUNT

EXAMPLE OF A PROFIT & LOSS ACCOUNT

The Bottom Line: How much actual profit have we made?

ASSETS CLAIMS

Fixed Assets Capital & ReservesLand £ 120,000 Share capital £ 100,000Buildings £ 150,000 Retained profit £ 120,000Fix & Fit £ 75,000 Total £ 220,000Total £ 345,000 L/T Liabilities

Loan £ 250,000Current Assets Total £ 250,000Stock £ 55,000 Current LiabilitiesDebtors £ 75,000 Creditors £ 22,000Bank £ 25,000 Tax & VAT £ 8,000Total £ 155,000 Total £ 30,000

________ ________£ 500,000 £ 500,000

EXAMPLE OF A BALANCE SHEET

EXAMPLE OF A BALANCE SHEET

The Bottom Line: How much is the organisation worth?

Activity 2.2

On which of the three main financial statements would you find: The assets of the Business The costs of running the Business The profit made by the business this year The profit retained by the company from previous years The amount the company has borrowed The amount paid out in dividends The interest paid on loans this year The amount of cash currently held in the Bank The amount of surplus Cash generated this year

Answer

Activity 2.2 - Solution

The assets of the Business Balance Sheet The costs of running the Business Profit & Loss The profit made by the business this year Profit & Loss The profit previously retained by the company Balance Sheet The amount the company has borrowed Balance Sheet The amount paid out in dividends Cash Flow The interest paid on loans this year Profit & Loss The amount of cash currently held in the Bank Balance Sheet The surplus Cash generated this year Cash Flow

Part 2c

Financial Statements -

A Simple Example

Financial Statements - Example

You decide to run a soft drinks business at a car boot sale to earn some extra money. You borrow £50 from a friend and you buy 200 cans of lemonade at 20p per can. It costs you £5 entry fee, and on the first day you sell 150 of your cans at 50p each.

Financial Statements – Activity 2.3


Some Questions How much did you start with? How much did you borrow? How much did you pay back? How much did you spend? How much were your takings? How much money have you now? What is the value of any unsold stock?

Answer

Financial Statements Activity 2.3 Solution


Some Questions How much did you start with? Nothing How much did you borrow? £50 How much did you pay back? Nothing How much did you spend? £45 (£40 Lemonade + £5 entry) How much were your takings? £75 How much money have you now? £80 What is the value of any unsold stock? £10 (50 x 20p)

Cash Flow Example


1. Produce a statement showing accounting for the Cash which your business has received and has been spent. You should start with an opening balance (what you had at the beginning of the day), record each item of cash as it comes in and goes out, and end with a closing balance (the cash you have at the end of the day).

What happened to all the money?

Opening Balance: £ 0

Loan from friend: £ 50+

Goods purchased: £ 40- (200 x 20p)

Entry Fee: £ 5-

Cash received: £ 75+ (150 x 50p)

Closing Balance: £ 80

This is an example of a Cash-flow Statement


On the second car boot sale that you attend, you purchase another 150 cans of lemonade at 20p per can. There is another £5 entry fee, and you sell 100 of your cans at 50p each. You decide that you will pay back £30 of the original £50 that you borrowed.

Construct a cash flow statement for the second day.

Answer

Activity 2.4 SolutionCash Flow Statement Day 2

Opening Balance: £ 80

Loan from friend: £ 30- (paid back)

Goods purchased: £ 30- (150 x 20p)

Entry Fee: £ 5-

Cash received: £ 50+ (100 x 50p)

Closing Balance: £ 65

Profit & Loss Example

You decide to run a soft drinks stand at a car boot sale to earn some extra money. You borrow £50 from a friend and you buy 200 cans of lemonade at 20p per can. It costs you £5 entry fee, and on the first day you sell 150 of your cans at 50p each.

2. Produce a statement showing accounting for any Profit your business has made. You should start with the takings, and subtract from this any expenses (outgoings). The final figure should give you the profit that has been made in the course of the day’s tradings.

How much money did we gain or lose?

Sales: £ 75 (150 x 50p)

Cost of Sales: -£ 30 (150 x 20p)

Entry Fee: -£ 5

Net Profit: £ 40

This is an example of a Profit & Loss Account

Notice here that we only account for what the sales have originally cost us.

Notice here that we only account for what the sales have originally cost us.



Construct a Profit & Loss Account for the second day.

Answer

Activity 2.5 SolutionProfit & Loss Account – Day 2

Sales: £ 50 (100 x 50p)

Cost of Sales: -£ 20 (100 x 20p)

Entry Fee: -£ 5

Net Profit: £ 25

Balance Sheet Example

You decide to run a soft drinks stand at a car boot sale to earn some extra money. You borrow £50 from a friend and you buy 200 cans of lemonade at 20p per can. It costs you £5 entry fee, and on the first day you sell 150 of your cans at 50p each.

3. Produce a statement of two halves, one side of which shows what the business owns (money, unsold stock etc.), and the other side showing what the business owes. You should try to ensure that you Balance one side with the other. The left hand side should show your assets, (what is owned); The right hand side should show the liabilities (what is owed). (NB Any profit made by your business is owed to you as a person!).

Do the Books Balance?

Assets:

Cash: £ 80

Stock: £ 10 (50 x 20p)

Total: £ 90

This is an example of a Balance Sheet

Liabilities (Claims):

Loan outstanding: £ 50

Retained profits: £ 40

Total: £ 90



Construct a Balance Sheet for the second day.

Answer

Activity 2.6 SolutionBalance Sheet Day 2

Assets:

Cash: £ 65

Stock: £ 20 (100 x 20p)

Total: £ 85

Can you see where all the figures are from?




Total: £ 85

Balance Sheet Day 2

Assets:

Cash: £ 65

Stock: £ 20 (100 x 20p)

Total: £ 85




Total: £ 85

CASH:

Final Line on the Cash Flow Statement

CASH:

Final Line on the Cash Flow Statement

ASSETS:Opening Stock: 50 cansStock Purchased + 150 cansStock Sold - 100 cansClosing Stock: 100 cans

ASSETS:Opening Stock: 50 cansStock Purchased + 150 cansStock Sold - 100 cansClosing Stock: 100 cans

Balance Sheet Day 2

Assets:

Cash: £ 65

Stock: £ 20 (100 x 20p)

Total: £ 85




Total: £ 85

LOAN:

Original Loan £50 Paid back -£30 Amount Owing £20

LOAN:

Original Loan £50 Paid back -£30 Amount Owing £20

PROFITS:Previous £40Today £25 (see P & L Account)Total £ 65

PROFITS:Previous £40Today £25 (see P & L Account)Total £ 65

Part 2d

Follow-Up Activities 1

Follow-up Work

Reading: M & A pp 24-top of p 29. Reading: M & A pp 24-top of p 29. Work through the text

and the activities. Challenge yourself by doing Exercises 2.1 and 2.2 on page 54. The solution is on page 587.

You should bring the result of these Exercises to the seminar.

In addition, read the details of the Activity which follows. You should bring to the Seminar the three statements for day 3 of the lemonade stall.

Seminar Preparation Activity

On the third car boot sale that you attend, you decide to pay your friend back entirely. In addition you purchase another 250 cans of lemonade at 20p per can. This time the entry fee is £10, but it rains and you only sell 50 of your cans at 50p each.

Construct a cash flow statement, profit & loss account and a balance sheet. for the third day.

Understanding and Managing Finance This Presentation is in Self-Study Form To start the...

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