Understanding the Financials Ebrahim Mohamed. © Ebrahim Mohamed 2006 The Business Cycle Initial...

Understanding the Financials

Ebrahim Mohamed

© Ebrahim Mohamed 2006

The Business Cycle

Initial capitalDebt & Equity

Sales

Net Profit Assets

New Debt

Dividends


Overview of Financial Reporting

TheBusiness

ExternalEnvironment

Financial Accounting Process

Annual Financial Statements

Financial Transactions

The Balance Sheet A snapshot of thebusiness assets andliabilities

The Income StatementExplains change in wealth of an business over a period of time

The Cashflow Statement Explains the movement of liquid i.e., money resources over a periodof time


Published Financial Statements

• The Balance Sheet – a snapshot of the organisation’s 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


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


Key Components of Balance Sheet

• Assets, otherwise known as resources are things owned by the business that will have a probable future economic value


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



• 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



• 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


The Accounting Equation

• Assets = Liabilities + Equity

• Assets – Liabilities = Equity

• Assets – Equity = Liabilities


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


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)


The Trading Account

• Trading Account £

• Net Sales 120,000

• Less Cost of Goods

Sold (80,000)

Gross Profit 40,000


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


Cost of Goods Sold (COGS)

• COGS £Opening Stock 10,000

+ Purchases 5,000

Available for Sale 15,000- Closing Stock (4,500)

COGS 10,500


Gross Profit

£Net Sales 14,000

- COGSOpening Stock 10,000+ Purchases 5,000Available for Sale 15,000- Closing Stock (4,500)COGS (10,500)

Gross Profit 3,500


Gross Margin Ratio

• Gross Profit to Sales Ratio

•

• GP Margin% =

• GP Margin% = 25%

Gross Profit

Sales

£3,500

£14,000* 100


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)


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


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


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


Net Margin Ratio

• Net Profit to Sales Ratio

• .

• NP Margin% =

• NP Margin% = 12.5%

Net Profit

Sales

£15,000

£120,000* 100


Balance Sheet & Income Statement – Optimistic

Assets£150

Liabilities£100

Owners’Equity

£50

Assets£175

Liabilities£120

Owners’Equity

£55

Revenues£350

Expenses£340

Profit£10

Retained profit £5

Dividend £5

Balance Sheet31 December 2002


Profit & LossYear 2003


Assets£60

Liabilities£10

Owners’Equity

£50

Assets£90

Liabilities£80

Owners’Equity

£10

Revenues£300

Expenses£340

Loss£40

Loss carried forward £40

Dividend £0



Profit & LossYear 2003

Balance Sheet & Income Statement – Most Likely


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


Working Capital (Trading) Cycle

• Debtors – uncollected credit sales

• Creditors – unpaid credit purchases

• Liquidity – flow of cash resources

• Overtrading!


Cashflow projections

• Capital revenues and expenses• Revenues• Expenses• Contribution• Sensitivity Analysis• Assumptions

Understanding the Financials Ebrahim Mohamed. © Ebrahim Mohamed 2006 The Business Cycle Initial...

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