Understanding the Financials

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The Business Cycle

Initial capital
New Debt

Dividends

Debt & Equity

Net Profit

Assets

Sales

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Overview of Financial Reporting

The
Business

External
Environment

Financial Transactions

Financial Accounting Process

Annual Financial Statements

The Balance Sheet
A snapshot of the
business assets and
liabilities

The Income Statement

Explains change in
wealth of an business
over a period of time

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The Cashflow Statement

Explains the movement
of liquid i.e., money
resources over a period
of time

Published Financial Statements

The Balance Sheet a snapshot of the

organisations financial status at a given point in
time
Income Statement explains change in wealth of
an organisation over a period of time
Cashflow Forecast predicts the movement of
liquid i.e. money resources during business set-up

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Balance Sheet

Gives a financial state of affairs i.e., a

Snapshot at a given point in time
Informs reader of the organisations
financial status

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Key Components of Balance Sheet

Assets, otherwise known as resources are

things owned by the business that will
have a probable future economic value

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Classification of Assets

Fixed assets have over twelve months of future use

Current assets have less than twelve months of
future use
Tangible assets are physical such as land, buildings
and equipment
Intangible assets are non physical and examples
include goodwill, brands, patents and copyrights

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Key Components of Balance Sheet

Liabilities otherwise known as claims,

normally arise on behalf of suppliers of
goods, services and loans, but they may
include an obligation to provide a service
that has been paid for in advance

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Key Components of Balance Sheet

Equity is the ownership interest. This is

normally in the form of investment in shares
of a business
The Accounting concept of entity stipulates
that the owners of the business are a
separate legal entity from the business itself

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The Accounting Equation

Assets = Liabilities + Equity

Assets Liabilities = Equity
Assets Equity = Liabilities

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Working Capital

The amount of liquid (cash) resources a

business has to pay for its day to day
operation
Working Capital = Current Assets
Current Liabilities

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The Trading Account

Income Statement = Trading Account,

Profit & Loss Account and Appropriation
Account
First part of the Income Statement
Net Sales Cost of Goods Sold (COGS)

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The Trading Account

Trading Account

Net Sales
120,000
Less Cost of Goods
Sold
(80,000)
Gross Profit
40,000

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Cost of Goods Sold (COGS)

Opening Stock + Purchases Closing Stock

COGS
Opening Stock 15,000
+ Purchases
90,000
Available for Sale
105,000
- Closing Stock (25,000)
COGS
80,000

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Cost of Goods Sold (COGS)

COGS
Opening Stock
+ Purchases
Available for Sale
- Closing Stock
COGS

10,000
5,000
15,000
(4,500)
10,500

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Gross Profit

Net Sales
- COGS
Opening Stock
+ Purchases
Available for Sale
- Closing Stock
COGS

14,000
10,000
5,000
15,000
(4,500)
(10,500)

Gross Profit

3,500

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Gross Margin Ratio

Gross Profit to Sales Ratio

Gross Profit
Sales

GP Margin% =

3,500
14,000

* 100

GP Margin% = 25%

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The Profit & Loss Account

Income Statement = Trading Account, Profit

& Loss Account and Appropriation a/c
Second part of the Income Statement
Gross Profit Operating Expenses = Net
Profit (NP)

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The Profit & Loss Account

Income Statement

Net Sales
120,000
Less Cost of Goods
Sold
(80,000)
Gross Profit
40,000
-Operating Expenses
(25,000)
Net Profit
15,000

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The Appropriation Account

Income Statement = Trading Account and

Profit & Loss Account and Appropriation a/c
Third part of the Income Statement
Keeps track of profit (Payment of Dividends
and Transfer to Reserves)
Accumulated Profit & Loss reserve

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The Appropriation a/c

Income Statement
Net Sales

120,000

Less Cost of Goods

Sold
(80,000)
Gross Profit
40,000
-Operating Expenses (25,000)
Net Profit 15,000
-Dividends
(10,000)
Retained Profit 5,000

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Net Margin Ratio

Net Profit to Sales Ratio

Net Profit
.

Sales

NP Margin% =

15,000
120,000

NP Margin% = 12.5%

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* 100

Balance Sheet & Income Statement

Optimistic
Balance Sheet
31 December 2002

Assets
150

Profit & Loss

Year 2003

Balance Sheet
31 December 2003

Liabilities
100
Owners
Equity
50

Revenues Expenses
350
340

Assets
175

Liabilities
120

Owners
Equity
55
Profit
10
Dividend 5

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Retained profit 5

Balance Sheet & Income Statement Most

Likely
Balance Sheet
31 December 2002

Profit & Loss

Year 2003

Balance Sheet
31 December 2003

Liabilities
10
Assets
60

Owners
Equity
50

Revenues Expenses
300
340

Assets
90

Liabilities
80

Owners
Equity
10
Loss
40

Dividend 0

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Loss carried forward 40

Cashflow - Working Capital

Current Assets things that are owned by the business

that have a probable future economic value
<12 months duration
Liabilities otherwise known as claims, normally arise on
behalf of suppliers of goods, services and loans, but they
may include an obligation to provide a service that has
been paid for in advance
<12 months duration

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Working Capital (Trading) Cycle

Debtors uncollected credit sales

Creditors unpaid credit purchases
Liquidity flow of cash resources
Overtrading!

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Cashflow projections

Capital revenues and expenses

Revenues
Expenses
Contribution
Sensitivity Analysis
Assumptions

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