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Accounting Workbook

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7/23/2019 Accounting Workbook

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Accounting

Workbook 

Developed by Matt Davies

Aston Business School

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Contents

Part 1: Study Material1.1 What is accounting !

1." #nderstanding accounting in$or%ation and

 &argon ' ( 1)

Part ": *+ercises

".1 ,esco key $inancial ratios 1- ( 1"." Cash v pro$it "/ ( "0

".0 Manage%ent accounting "! ( "

Part 0: Solutions to *+ercises0.1 Cash v pro$it " ( 01

0." Manage%ent accounting 0" ( 0'

Part !: 2e$erence %aterial!.1 ,esco $inancial state%ents 0 ( !1

Part ': 3lossary o$ ter%s3lossary o$ ter%s !0 ( '-

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Part 1:

Study Material

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1. What is accounting

‘Accounting’ can be defined as the process of measuring, analysing and reporting financial

information about a business to enable to the user of that information to make better judgements and

decisions.

There are two main branches to accounting: ‘financial accounting’ and ‘management accounting’.

‘Financial accounting’ is the process of generating and reporting financial information to eternal

users such as shareholders, the bank, suppliers, customers, and so on. ‘!anagement accounting’ on

the other hand is the process of generating and reporting financial information to management to

assist them in running the business.

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". #nderstanding Accounting 4n$or%ation and 5argon

The "alance #heet, $ncome #tatement %or &rofit and 'oss Account( and )ash Flow #tatement are

traditionally regarded as the three key financial statements for a business.

As the diagram below illustrates, the "alance #heet represents the financial position of a business at

a single point in time, which for the company’s annual published accounts is as at the company’s

financial year*end.

The $ncome #tatement and )ash Flow #tatement, on the other hand, report the financial

 performance of a business during a period of time, for eample for the year*ended +st -ecember, or 

for a specific month or for the year*to*date for a company’s internal management accounts. The

$ncome #tatement reports the business’ performance in terms of generating sales reenue in ecess

of epenses for a period, whereas the )ash Flow #tatement reports the business’ performance in

generating cash flows for a period.

/e will now eplore the content and format of these three statements in more detail.

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".1. ,he Balance Sheet

First the "alance #heet which, as we hae already established, reports the financial position of a

 business at a snapshot in time.

$t contains information on three key items:

Assets: which in simple terms are items of alue to the business

which the business either owns or controls %for eample

ia a long*term lease contract(.

'iabilities: which are the amounts the business owes.

01uity: which include the amounts paid into the business by the

shareholders for the purchase of ordinary shares plus the amounts that

the business has retained on the shareholders’ behalf %for eample, all profits earned by the business during its eistence that hae not been

 paid out to shareholders as diidends, which are known as ‘retained

earnings’(.

To understand a "alance #heet re1uires an understanding of the relationship between these three

items:

Assets 6 7iabilities 8 *9uity

$n other words, the financial alue of the assets in the "alance #heet must e1ual the sum of thealue of the business’ liabilities plus the e1uity.

&ut simply, the assets represent ’what has been done with the money’ and the liabilities plus e1uity

represent ‘where the money came from’.

To illustrate, imagine you wanted to buy a factory %an ‘asset’( to start up a business that would cost

2m. The purchase of this asset would need to be financed either through borrowing money from a

 bank or through your own money. 'et’s assume the business borrowed 2344,444 and you inested

2544,444 of your own cash. The business’ "alance #heet would then be as follows:

Assets 6 'iabilities 7 01uity

2m 6 2344,444 7 2544,444

 

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Another way of arranging the "alance #heet relationship is to say:

Assets ( 7iabilities 6 *9uity

This is not fundamentally different of course, but the "alance #heet this time balances to ‘8et

Assets’ %sometimes called ‘8et /orth’(.

9eturning to our preious eample, the business’ 8et Assets can be found as follows:

 8et Assets 6 Assets 'iabilities 6 2m * 24.3m 6 24.5m

/e will now look at the three categories of information contained in a "alance #heet in more detail.

".1.1. Assets

Assets are subdiided into two types: 8on )urrent %Fied( Assets and )urrent Assets.

".1.1.1. on Current ;<i+ed= Assets

 8on )urrent Assets are those assets that are used in the business on a continuing basis and are not

intended for resale. 8on )urrent Assets can be tangible %e.g. land and buildings, plant and

machinery, computer e1uipment and motor ehicles( or intangible %e.g. goodwill, copyrights and

 patents(. $ntangible 8on )urrent Assets are generally only recognised when they are purchased bya business, since the measurement of the alue of such assets in the "alance #heet would otherwise

 be highly subjectie.

An eample of an $ntangible 8on )urrent Asset is ‘goodwill’. ;oodwill effectiely represents the

difference between the alue of a company as a whole and the sum of the alue of its separately

identifiable net assets. <nly goodwill arising from an ac1uisition can be included on a company’s

"alance #heet. For eample, if a company paid 25=m to ac1uire a company with separate net assets

alued at 24m, then this would gie rise to goodwill of 2=m to be included on the "alance #heet.

This goodwill will relate to a number of factors such as the company’s reputation, customer loyalty,

home*grown brands, the skills of its workforce, and so on, none of which are incorporated on the

ac1uired company’s "alance #heet. ‘>ome*grown goodwill’, howeer, cannot be included on the

"alance #heet. This leads to an important conclusion: the "alance #heet does not measure the true

alue of a business?

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All 8on )urrent Assets %ecept for land, inestments and goodwill( must be either depreciated %if

Tangible( or amortised %if $ntangible( oer their useful economic lies. For eample, we buy a

machine for 244,444 with a 4*year economic life. Assuming the ‘straight*line’ depreciation

method is used, whereby an e1ual charge for depreciation is made each year, then the depreciation

charge will be 24,444 per annum. $n the "alance #heet, 8on )urrent Assets are recorded after

deducting the accumulated deprecation charged to date %which gies what is called the ‘net book

alue’ of the 8on )urrent Asset(.

@sing the machine introduced aboe to illustrate, after years the machine will be recorded in the

"alance #heet at:

244,444 24,444 6 2B4,444

".1.1.". Current Assets

)urrent Assets are those assets that are ‘used*up’ or ‘turned oer’ regularly and fre1uently in the

course of business. $n other words, while 8on )urrent Assets represent the long*term assets, these

are the short*term assets of a business. )urrent Assets include inentories %raw materials, work in

 progress and finished goods(, receiables %the amounts owed by customers for goods receied but

not paid for at the year*end( and cash. %$nentories are sometimes called ‘#tock’ and 9eceiables

are sometimes called ‘-ebtors’(.

".1.". 7iabilities

'iabilities are subdiided into two types: )urrent 'iabilities and 8on )urrent 'iabilities.

".1.".1. Current 7iabilities

)urrent 'iabilities are those obligations of the business that are due for payment within 5 months

of the "alance #heet date.

)urrent 'iabilities include: Accounts &ayable %the amounts owed to suppliers for goods and

serices receied before the year*end, for which inoices hae been receied but not paid(, @npaid

/ages and #alaries %if employees hae not been paid by the year*end for all of the work

 performed(, Accruals %amounts owed to suppliers for which inoices hae not been receied at the

time the time the financial statements are prepared( and @npaid Taes. %Accounts &ayable is

sometimes called ‘Trade )reditors’(.

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".1.".". on Current 7iabilities

 8on )urrent 'iabilities are those obligations of the business that are due for payment in more than

5 months after the "alance #heet date.

0amples of long*term liabilities include loans and other forms of long*term borrowing %including

amounts owed under long*term lease arrangements(.

".1.0. *9uity ;Capital and 2eserves=

This section of the "alance #heet records the shareholders’ inestment in the company. The main

items to be found in the 01uity section of a "alance #heet are as follows:

<rdinary #hare )apital: the ‘nominal alue’ of ordinary shares issued by the

company.

#hare &remium Account: the surplus cash raised when ordinary shares

are issued at a price which is aboe their nominal alue.

9etained 0arnings: the total accumulated profits earned by

the business that hae not been paid out as diidends

%i.e. total retained earnings to date(.

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".1.'. 4nterpreting a Balance Sheet

The interpretation of a "alance #heet focuses on three key aspects of a business’ financial position:

".1.'.1. ,he %i+ o$ on Current Assets and >Working Capital? invest%ent

First, we are interested in whether a business has inested in the right mi of long*term and short*

term assets. This is reealed by a comparison of the leel of 8on )urrent Assets compared with

the ‘8et )urrent Assets’ of the business %which is also known as ‘/orking )apital’(. 8et )urrent

Assets is the difference between )urrent Assets and )urrent 'iabilities.

The total leel of 8on )urrent Assets plus /orking )apital is referred to as the business’ ‘)apital

0mployed’.

".1.'.". 7i9uidity

#econd, we are also interested in the business’ ability to meet its short*term obligations when they

fall due for payment. This is reealed by the comparison of )urrent Assets to )urrent 'iabilities.

As a general rule, we are generally relaed about a business’ li1uidity if it has more )urrent Assets

than )urrent 'iabilities.

".1.'.0. Stability

Finally, we are also interested in the business’ long*term stability or solency. This is reealed by

the comparison of the amount of ‘-ebt’ %borrowings and other fied*income sources of finance(

ersus the 01uity that is used to finance the business. The greater the reliance on -ebt finance, thegreater the risk that the business will be unable to meet its obligations to pay interest and repay the

debt at maturity.

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".". ,he 4nco%e State%ent ;Pro$it and 7oss Account=

The $ncome #tatement reports the financial performance of a business during a period of time

through comparing income %eg reenue( with epenses.

$ncome and epenses are recorded in the $ncome #tatement according to the ‘matching’ concept.

This means, on the one hand, that income is included in the period in which it is ‘earned’ and not

necessarily when cash is receied. $ncome is earned according to when the economic actiity that

gies rise to income is performed. For eample, this might be the date goods are collected by the

customer %for retailers(, the date goods are deliered %manufacturing companies( or the date the

serice is performed %for serice proiders(.

0penses, on the other hand, are included in the period in which they are ‘consumed’ in earning

income %not necessarily when cash is paid(. #ome eamples of how the matching concept is

applied %for a company with a +st

 -ecember 544C year*end( for determining epenses are proided below:

. An electricity bill for 2B=,444 for the +*months to +st Danuary 5443 is receied in February

5443. >ow much of this bill should be recorded as epense for the 544C year*end $ncome

#tatementE

Answer: 5+rds of the period coered by the bill falls into the year*ended + st -ecember 544C so

5+rds of the bill should be recorded as an epense in the $ncome #tatement: 2+4,444. $n the

"alance #heet, an accrual of 2+4,444 will be included within )urrent 'iabilities.

5. <n st Duly 544C, an amount of 254,444 is paid to coer the cost of insurance cost for the period st Duly 544C to +4th Dune 5443. >ow much of this payment should be recorded as an

epense in the 544C year*end $ncome #tatementE

Answer: 5ths of the period coered by this payment falls into the year*ended +st -ecember

544C so 5ths of the payment should be recorded as an epense in the $ncome #tatement:

24,444. $n the "alance #heet, a prepayment of 24,444 will be included within )urrent Assets.

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".".1. ,he 4nco%e State%ent <or%at

2

9eenues G

)ost of #ales %G(

;ross &rofit G

#elling and Administratie 0penses %G(

<perating $ncome G

$nterest %G(

&rofit "efore Ta G

Ta %G(

 8et &rofit After Ta G

".".". De$initions o$ 4nco%e State%ent 4te%s

9eenues The sales reenue earned by the business in the period.

)ost of #ales The cost of making the goods that were sold during the

 period.

;ross &rofit The difference between sales reenue and cost of  

sales.

#elling and Administratie0penses #elling and administratie costs incurred in the period.

<perating &rofit The profit generated by the operations of the business before

deducting interest and ta

$nterest The interest epense %net of interest receiable( for the period.

Ta The amount of income ta %corporation ta( payable in relation to the

 profit earned in the period.

 8et &rofit The profit generated by the business after all epenses hae been

deducted. <nce the diidend paid for the year has been deducted, the

surplus retained profits for the year are added to the retained earnings

resere in the "alance #heet.

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".0. ,he Cash <lo@ State%ent

The )ash Flow #tatement reports the cash performance of a business during a period of time. $t

ultimately proides an eplanation of the moement in the business’ cash position from the start tothe end of a period, by analysing cash flows across three main categories:

* cash flow proided from %or used in( operating actiities

* cash flow proided from %or used in( inesting actiities

* cash flow proided from %or used in( financing actiities

The )ash Flow #tatement complements the "alance #heet and $ncome #tatement by proiding

information that helps in the assessment of a business’ cash management. /hilst profit is an

important measure of business performance, clearly it is also important, and perhaps arguably een

more important, that the business is able to generate sufficient cash to meet the necessary payments

re1uired to sustain and deelop the business, and proide returns such as interest and diidends tothose who proide the finance.

The )ash Flow #tatement proides a comparison of the profit performance to the cash performance

of the business for the period. Therefore, before eamining the format of a )ash Flow #tatement in

more detail, it is important to consider the reasons why profit performance does not necessarily

e1ual cash flow performance for a period. The reasons include the following:

* sales reenue included in the $ncome #tatement includes sales made on credit which

may not hae been receied in cash by the year*end. This would be reflected in an

increase in 9eceiables in the "alance #heet.

* epenses included in the $ncome #tatement can include items not paid for in cash by the

year*end. This would be reflected by an increase in &ayables in the "alance #heet.

* the cost of buying %or manufacturing( $nentories is only treated an epense %‘)ost of

#ales’( in the $ncome #tatement in the period in which the $nentories are sold

* depreciation charged in the $ncome #tatement is a non*cash epense

* cash spent on inestments in new 8on )urrent Assets %‘capital ependiture’( is not

recorded an epense in the $ncome #tatement

* cash flows with respect to obtaining new finance %such as new issues of common stock

or new borrowings( or repaying eisting finance %such as the repurchase of stock or the

repayment of borrowings( are not recorded in the $ncome #tatement

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".0.1. ,he Cash <lo@ State%ent <or%at

2et Cash Provided by ;#sed 4n= perating Activities:

<perating profit G

-epreciationamortisationimpairment G

-ecrease %increase( in working capital G%G(

Cash generated by operating activities be$ore i%pacts o$

$inance costs and ta+es

)ash payments for financial epenses %G(

)ash payments for corporation ta %G(

et cash provided by operating activities

et Cash Provided by ;#sed 4n= 4nvesting Activities:)apital ependitures and inestments %G(

)ash proceeds from disposals G

et cash provided by ;used in= investing activities ;=

et Cash Provided by ;#sed 4n= <inancing Activities:

&roceeds from issuing common stock G

-iidends paid %G(

&roceeds from issuing long*term debt G

9epayment of long*term debt %G(

$ncrease %decrease( in short term debt G%G(

et cash provided by ;used in= $inancing activities

4ncrease ;Decrease= in Cash

Cash at Start o$ ear

Cash at *nd o$ ear

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".0.". *+planation o$ ey Cash <lo@ State%ent 4te%s

et Cash Provided By ;#sed 4n= perating Activities

A key source of cash to a business is the amount generated from the operation of the business. The

net cash proided by the operating actiities is found by taking the operating profit and conerting

this into the amount of cash generated in the period by making a number of adjustments:

* charges made in the $ncome #tatement for depreciation, amortisation and impairment are

added back to net income since these are non*cash epenses

* moements in working capital. For eample, an increase in $nentories oer the period

has a negatie cash impact, as does an increase in 9eceiables. An increase in &ayables

oer the period, on the other hand, has a positie cash impact.

After these adjustments are made the actual cash payments made for finance costs %interest( and

income taes are then deducted to gie typically a net cash inflow to the business proided by the

operating actiities for the period.

et Cash Provided By ;#sed 4n= 4nvesting Activities

The net section of the )ash Flow #tatement deals with cash flows associated with inesting

actiities, and therefore shows:

* the amount of cash spent on 8on )urrent Assets %eg ‘capital ependiture’ such as the purchase of new machinery and e1uipment, or the amount of cash spent on inestments

such as purchasing shares in a new joint enture(

* the amount of cash receied from the disposal of 8on )urrent Assets %eg machinery and

e1uipment, or the sale of shares in a company that has been treated as a long term

inestment(.

The net effect of these two items typically gies rise to a net outflow of cash used in inesting

actiities.

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et Cash Provided By ;#sed 4n= <inancing Activities

The third section of the )ash Flow #tatement deals with cash flows associated with financing

actiities, and therefore shows:

* the amount of cash receied from the sale of new common stock %ie ordinary shares(

* the cash paid to common shareholders in the form of a diidend %ie the ordinary

diidend(

* the amount of cash receied from new long*term debt %eg a new long*term bank loan(

* the amount of cash used to repay long*term debt

* the moement in short*term debt. An increase in short*term debt proides an inflow of

cash, whilst a reduction in short*term debt re1uires an outflow of cash.

The net effect of these items could either be an inflow or outflow of cash, depending upon the

financing re1uirements of the business in the light of the net amount of cash proided by the

operations and the net amount of cash used in inesting actiities.

2econciliation o$ Cash at Start to *nd o$ Period

The final section of the )ash Flow #tatement reconciles the opening to the closing cash balance,taking into account the moement in cash for the period.

$n other words: the net cash moement for the period %being the sum of cash flows related to

operating, inesting and financing actiities( is added to the opening balance to gie the closing

cash balance.

A simplified )ash Flow #tatement is proided below to illustrate:

2m

et cash provided by operating activities 1//et cash used in investing activities ;1"/=

et cash provided by $inancing activities !/

4ncrease ;Decrease= in Cash "/

Cash at Start o$ ear '

Cash at *nd o$ ear "'

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Part ":

*+ercises

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2.1. Tesco Key Financial Ratios Exercise

Calculate key ratios for Tesco for 2009. The solutions to this exerciseare provided within the elearning course. (Tesco’s financial

statements are summarised on pages 37 – 38).

"// "//-

1. 2eturn on Capital *%ployed

<perating profit

Total assets less current liabilities

1!./E

5CH

%5+3B7+44*45+(

". 2eturn on Sales

<perating profit 9eenue

'.E

5CH

BC5H3

0. 3ross Margin E

;ross profit 9eenue

.E

++4

BC5H3

!. Sales 2evenue on Capital *%ployed

9eenue

Total assets less current liabilities

F".0-

BC5H3

%5+3B7+44*45+(

'. Sales 2evenue on on Current Assets

9eenue 8on current assets

F1.-

BC5H3

5+3B

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). Current ratio

)urrent assets )urrent liabilities

"// "//-

/.)1

+44

45+

. Guick ratio

)urrent assets less inentories

)urrent liabilities

/.0-

%+44*5B+4(

45+

-. 3earing ratio

-ebt -ebt 7 01uity

!/.!E

%543B7=HC5(

%543B7=HC57

H45(

. 4nterest cover

<perating profit

 8et finance epense

!!.0

5CH

%5=4*3C(

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2.2 Cash Versus Profit Exercise

Part A Profit Statement

On 1st April 2009, a manufacturing business started trading. The business has the following

manufacturing costs per unit:

2

!aterials 4

'abour 3

!anufacturing oerheads 5

Total unit cost 54

In addition, excluding depreciation, the company incurs selling, general and administrative

overheads of £4,000 per month. In addition, the company will invest £120,000 in machinery and

equipment which is expected to have a 5-year economic life, with a zero residual value. The

depreciation on this machinery and equipment will be treated as an operating expense and not added

to the cost of production.

The company has a selling price of £30 per unit.

The company expects to make and sell the following during its first 6 months of trading:

&roduction 1uantity #ales 1uantity

April 444 =44

!ay 444 44

Dune 444 C44

Duly 444 344

August 444 H44

#eptember 444 444

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Required

a) Using the table below, calculate the amount of profit generated by the business during the first 6months of trading.

April

F///

May

F///

5une

F///

5uly

F///

August

F///

Septe%ber

F///

,otal

F///

Sales 2evenue

Cost o$ Sales

3ross Pro$it

SH 3 I A

Depreciation

,otal

e+penses

Pro$it

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Part B Cash Flow Forecast

You are provided with the following further information relating to the cash flows for this business:

1. On 1st

 April 2009, the owners of the business invested £100,000 in the business.2. Materials, salaries and manufacturing overheads are paid in the month in which they are incurred.

The company will maintain no surplus stock of raw materials.

3. ‘S, G and A’ overheads are paid one month in arrears.

4. Customers will be given 2 months’ credit.

5. The machinery and equipment was paid for in April.

Required

Using the information above and the table below, calculate the amount of cash generated by the

business for the first 6 months of trading.

April

F///

May

F///

5une

F///

5uly

F///

August

F///

Septe%ber

F///

,otal

F///

Cash 2eceipts:

<wners’ inestment

From customers

,otal receipts

Cash Pay%ents:

!aterials

'abour 

!anufacturing

oerheads

#, ; and A

)apital ependiture

,otal pay%ents

SurplusJde$icit

pening balance

Closing balance

b) What improvements would you recommend to improve the cash performance of this business?

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Part C Cash Flow Statement

Required

Using the table below, reconcile the operating profit for the business to its cash flow for the first 6

months of trading:

F///

Pro$it

Add: depreciation

8 or K change in inventory ;1=

8 or K change in receivables ;"=8 or K change in payables ;0=

7ess: capital e+penditure

Add: o@ners? invest%ent

6 Change in cash over period

Workings:

1. Change in inventory = total cost of goods manufactured less total cost of goods sold in

period, plus cost of opening inventory. (In this case opening inventory is zero).

Total cost of goods manufactured ………..

Total cost of goods sold ………..

Increase in inventory ………..

2. Change in receivables = total sales revenue less total cash received from customers in

period, plus opening receivables. (In this case opening receivables is zero).

Total sales revenue ………..

Total cash received from customers ………..

Increase in receivables ………..

3. Change in payables = total cost of goods and services received less total amounts paid to

suppliers, plus opening payables. (In this case opening payables is zero).

Total cost of goods/services received ………..

Total amounts paid to suppliers ………..

Increase in payables ………..

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2.3 Management Accounting: Exercises

1. Cost Volume Profit Analysis

A manufacturing business has the following variable costs of production (per unit):

F

-irect materials "/

-irect labour  1"

Iariable oerheads -

!/

The business’ selling price is £65 per unit. Next year the business expects to incur £8m of fixed

production overheads and £7.5m of fixed selling, general and administrative costs.

Required

a) Assuming the business is expecting to sell 750,000 units next year, what is the budgeted

profit for next year?

F///

#ales alue

Iariable costs

Contribution

Fied production costs

#, ; and A

Pro$it

b) What is the business’ break-even point?

c) How many units would the business need to sell in order to achieve its target profit of £5m?

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2. Discontinuing a Product Line

A manufacturing business has three product lines: A, B and C. Financial information relating toeach product is provided below:

A

F///

B

F///

C

F///

,otal

F///

#ales alue =,444 3,444 5,444 =,444

Iariable costs %+,444( %,=44( %,C44( %,544(

Contribution "H/// 1H'// 0// 0H-//

&roduct*line specific

oerheads

%44( %+44( %5=4( %,=4(

#hare of general

 business oerheads

%=44( %344( %544( %,=44(

Pro$it // !// ;1'/= 1H1'/

Required

a) Advise management on whether Product C should be discontinued.

b) What further information might be relevant to a decision whether or not to discontinue a

particular product line?

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3. Product Profitability Analysis

A manufacturing business produces two products: Alpha and Beta.

The company uses absorption (full) costing and absorbs production overheads on a direct labour

hour basis.  Direct labour is paid £10 per hour.

The company expects to make and sell 100,000 units of Alpha and 30,000 units of Beta. Further

financial information relating to the two products is provided below:

Alpha

F

Beta

F#ales priceunit 54 34

-irect material costsunit +4 5=

-irect labour costsunit =4 54

The company expects to incur £2,240,000 of production overheads per annum.

Required

a) Calculate the business’ production overhead absorption rate per labour hour:

b) Using the table below, and your answer to a) above, calculate the budgeted profit per unit of

each product:

Alpha

F

Beta

F

Sales priceJunit

-irect material costunit

-irect labour costunit

&roduction oerheadunit

,otal product costJunit

Pro$it per unit

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c) Further analysis of the company’s production overheads has revealed the overhead can be

analysed across three different costs, with the following cost drivers and activity levels for

each product:

verhead F Cost driver Alpha Beta

#et up costs 44,444 8umber of  

set ups

544 set ups

 per annum

B44 set ups

 per annum

!achine related costs ,544,444 !achine

hours

44,444

machine

hours per 

annum

4,444

machine

hours per 

annum&roduction planning costs BB4,444 8umber of  

 production

orders

344

 production

orders per 

annum

+,44

 production

orders per 

annum

Total "H"!/H///

Required

Using the above information and the table below, recalculate the budgeted profit per unit of

each product using the principles of Activity Based Costing (ABC):

Alpha

F

Beta

F

Sales priceJunit 1"/.// -/.//

-irect material costunit %+4.44( %5=.44(

-irect labour costunit %=4.44( %54.44(

Pri%e costJunit ;-/.//= ;!'.//=

verhead analysis:

#et up costsunit

!achine costsunit

&roduction planning

Production overheadJunit

,otal product costJunit

Pro$it per unit

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Part 0:

Solutions to *+ercises

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3.1 Cash Versus Profit Exercise

Part A Profit Statement Solution

April

F///

May

F///

5une

F///

5uly

F///

August

F///

Septe%ber

F///

,otal

F///

Sales 2evenue 1' 1- "1 "! " 0/ 10'

Cost o$ Sales %4( %5( %B( %( %3( %54( %H4(

3ross Pro$it ' ) - 1/ !'

SH 3 I A %B( %B( %B( %B( %B( %B( %5B(

Depreciation %5( %5( %5( %5( %5( %5( %5(

,otal

e+penses

;)= ;)= ;)= ;)= ;)= ;)= ;0)=

Pro$it ;1= K 1 " 0 !

Workings:

1. Sales revenue = sales quantity x sales price

2. Cost of sales = sales quantity x unit cost

3. Depreciation = £120,000 / 5 years = £24,000 per annum = £2,000 per month

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Part B Cash Flow Forecast Solution

a)

April

F///

May

F///

5une

F///

5uly

F///

August

F///

Septe%ber

F///

,otal

F///

Cash 2eceipts:

<wners’ inestment 44 1//

From customers = 3 5 5B -

,otal receipts 1// K 1' 1- "1 "! 1-

Cash Pay%ents:

!aterials %4( %4( %4( %4( %4( %4( ;)/=

'abour %3( %3( %3( %3( %3( %3( ;!-=

!anufacturing

oerheads

%5( %5( %5( %5( %5( %5( ;1"=

#, ; and A %B( %B( %B( %B( %B( ;"/=

)apital ependiture %54( ;1"/=,otal pay%ents ;1!/= ;"!= ;"!= ;"!= ;"!= ;"!= ;")/=

SurplusJde$icit ;!/= ;"!= ;= ;)= ;0= K ;-"=

pening balance K ;!/= ;)!= ;0= ;= ;-"= K

Closing balance ;!/= ;)!= ;0= ;= ;-"= ;-"= ;-"=

b) What improvements would you recommend to improve the cash performance of this business?

* negotiate better credit terms with suppliers

* negotiate better credit terms with customers

* improve management of inventory of finished production

* spread capital expenditure (eg by leasing)

* obtain more finance (eg from owners or via bank loan)

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Part C Cash Flow Statement Solution

F///

Pro$it

Add: depreciation 1"

8 or K change in inventory ;1= ;0/=

8 or K change in receivables ;"= ;'=

8 or K change in payables ;0= !

7ess: capital e+penditure ;1"/=

Add: o@ners? invest%ent 1//

6 Change in cash over period ;-"=

4. Change in inventory = total cost of goods manufactured less total cost of goods sold in

period, plus cost of opening inventory. (In this case opening inventory is zero).

Total cost of goods manufactured (6000 x £20) £120,000

Total cost of goods sold (4500 x £20) £90,000Increase in inventory £30,000

 An increase in inventory has a negative effect on cash flow.

5. Change in receivables = total sales revenue less total cash received from customers in

period, plus opening receivables. (In this case opening receivables is zero).

Total sales revenue £135,000

Total cash received from customers £78,000

Increase in receivables £57,000

 An increase in receivables has a negative effect on cash flow.

6. Change in payables = total cost of goods and services received less total amounts paid to

suppliers, plus opening payables. (In this case opening payables is zero).

Total cost of goods/services received (60,000 + 12,000 + 24,000) £96,000

Total amounts paid to suppliers (60,000 + 12,000 + 20,000) £92,000

Increase in payables £4,000

 An increase in payables has a positive effect on cash flow.

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3.2 Managing Financial Performance: Solutions

1. Cost Volume Profit Analysis

d) Assuming the business is expecting to sell 750,000 units next year, what is the budgeted

profit for next year?

F///

#ales alue B3,C=4

Iariable costs %+4,444(

Contribution 1-H'/Fied production costs %3,444(

#, ; and A %C,=44(

Pro$it 0H"'/

e) What is the business’ break-even point?

 Break-even point = Fixed costs / contribution per unit

= £15,500,000 / £25 per unit

= 620,000 units

f) How many units would the business need to sell in order to achieve its target profit of £5m?

Units to achieve target profit = Fixed costs + target profit / contribution per unit

= (£15,500,000 + £5,000,000) / £25 per unit

= 820,000 units

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2. Discontinuing a Product Line

A manufacturing business has three product lines: A, B and C. Financial information relating toeach product is provided below:

A

F///

B

F///

C

F///

,otal

F///

#ales alue =,444 3,444 5,444 =,444

Iariable costs %+,444( %,=44( %,C44( %,544(

Contribution "H/// 1H'// 0// 0H-//

&roduct*line specific

oerheads

%44( %+44( %5=4( %,=4(

#hare of general

 business oerheads

%=44( %344( %544( %,=44(

Pro$it // !// ;1'/= 1H1'/

Required

c) Advise management on whether Product C should be discontinued.

 Product C makes a positive contribution towards shared general business overheads of

 £50,000 (contribution less product line specific overheads). Therefore, there does not seem to

 be any financial justification why Product C should be discontinued.

d) What further information might be relevant to a decision whether or not to discontinue a

particular product line?

 Further information relevant to product line discontinuation decisions might include:

 a. whether sales of each product are complementary

 b. whether there are alternative (potentially more profitable) uses for the capacity

used by Product C 

 c. long-term performance potential for each product

 d. relative amount of capital employed required to support each product

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3. Product Profitability Analysis

A manufacturing business produces two products: Alpha and Beta.

The company uses absorption (full) costing and absorbs production overheads on a direct labour

hour basis.  Direct labour is paid £10 per hour.

The company expects to make and sell 100,000 units of Alpha and 30,000 units of Beta. Further

financial information relating to the two products is provided below:

Alpha

F

Beta

F

#ales priceunit 54 34

-irect material costsunit +4 5=

-irect labour costsunit =4 54

The company expects to incur £2,240,000 of production overheads per annum.

Required

d) Calculate the business’ production overhead absorption rate per labour hour:

Total production overhead = £2,240,000

Total direct labour hours per annum = (100,000 x 5) + (30,000 x 2) = 560,000

 Production overhead per labour hour = £2,240,000 / 560,000 hours = £4 per hour

e) Using the table below, and your answer to a) above, calculate the budgeted profit per unit of

each product:

Alpha

F

Beta

F

Sales priceJunit 1"/ -/

-irect material costunit %+4( %5=(

-irect labour costunit %=4( %54(

&roduction oerheadunit %54( %3(

,otal product costJunit ;1//= ;'0=

Pro$it per unit "/ "

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f) ABC analysis

Alpha

F

Beta

F

Sales priceJunit 1"/.// -/.//

-irect material costunit %+4.44( %5=.44(

-irect labour costunit %=4.44( %54.44(

Pri%e costJunit ;-/.//= ;!'.//=

verhead analysis:#et up costsunit %5.44( %+.++(

!achine costsunit %C.=4( %=.44(

&roduction planning %4.34( %5.44(

Production overheadJunit ;1/.0/= ;!/.00=

,otal product costJunit ;/.0/= ;-'.00=

Pro$it per unit "./ ;'.00=

Workings:

verhead F Cost driver rate verhead

allocated to

Alpha

verhead

allocated to

Beta

#et up costs 44,444 2,444 per set up F" per unit

%2,444 544

44,444 units(

F10.00 per unit

%2,444 B44

+4,444 units(

!achine related costs ,544,444 2C.=4 per  

machine hour 

F.'/ per unit

%2C.=4

44,444

44,444 units(

F1' per unit

%2C.=4 4,444

+4,444 units(

&roduction planning

costs

BB4,444 244 per  

 production order 

F/.-/ per unit

%244 344

44,444 units(

F1" per unit

%244 +,44

+4,444 units(

Total "H"!/H///

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Part !:

2e$erence Material

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!.1 ,esco <inancial State%ents

Su%%ary Consolidated 4nco%e State%ents

otes "//

F%

"//-

F%

2evenue '!H0" !H"-

)ost of sales %=4,4H( %B+,3(

3ross pro$it !H"1- 0H)0/

Administratie epenses %,5B3( %,45C(

&rofit arising on property related items 5+ 33

perating pro$it 0H"/) "H1

#hare of post*ta profits of joint entures and associates 4 C=

Finance costs 5 %BC3( %5=4(

Finance income 5 3C

Pro$it be$ore ta+ "H'! "H-/0

Taation %C33( %C+(

Pro$it $or the year "H1)) "H10/

<ut of which:

3roup share "H1)1 "H1"!

!inority interests + =

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Su%%ary Consolidated Balance Sheets

otes "//

F%

"//-

F%

Assets

on current assets

$ntangible assets B B,45C 5,++

&roperty, plant and e1uipment 5+,=5 H,C3C

$nestment property ,=+H ,5

$nestments in joint entures and associates 5 5 +4=

'oans and adances = ,BC4 *

<ther non current assets ,C=3 +5B

on current assets ;A= 0"H//- "0H-)!

Current assets$nentories 5,H 5,B+4

Trade receiables ,CH3 ,+

<ther current assets C ,4H CC

)ash +,=4H ,C33

Current assets ;B= 1!H/!' )H0//

Current liabilities

Trade and other payables %3,=55( %C,5CC(

-ebt %B,4=H( %5,43B(

<ther current liabilities 3 %=,B=H( %H45(Current liabilities ;C= ;1-H/!/= ;1/H")0=

et current liabilities ;D 6 B ( C = %+,HH=( %+,H+(

on current liabilities

&ost*employment benefit obligations H %,B3B( %3+3(

-ebt %5,+H( %=,HC5(

&roisions 4 %C+( %35=(

<ther non current liabilities %+34( %+B(

on current liabilities ;<= ;1'H/1-= ;H=

et assets ;3 6 * ( <= 5,HH= ,H45

*9uity

#hare capital +H= +H+

#hare premium account B,+3 B,=

<ther reseres B4 B4

9etained earnings C,3= ,3C

Shareholders? e9uity ( parent co%pany 1"H0- 11H-1'

!inority interests + =C 3C

*9uity ;L 6 3= 1"H' 11H/"

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*+planatory otes:

1. <inance costsJinco%e

&rimarily relates to interest payable and receiable, but also includes echange gainslosses and

diidends from inestments.

". 4nco%e $ro% J 4nvest%ent in &oint ventures and associates

‘Associates’ are companies in which Tesco has a significant but not controlling interest %typically a

shareholding between 54J and BHJ(. Doint entures are companies which Tesco jointly controls

with one or more other organisations.

The income statement includes Tesco’s share of the after ta profits of associates and joint entures

immediately below the line ‘<perating &rofit’. $n the balance sheet, ‘inestment in joint entures

and associates’ is shown as a separate item under non current assets.

0. Minority interests

!inority interests relate to those companies %known as ‘subsidiaries’( in which Tesco has a

controlling interest %typically a shareholding of more than =4J( but does not own all 44J of the

shares. $n such circumstances, outside shareholders %‘minority shareholders’( hae a claim on the

net income and net assets of that subsidiary company. The total outside shareholders’ share of thenet income and net assets of Tesco subsidiaries are shown separately on the income statement and

 balance sheet.

!. 4ntangible assets

&rimarily relates to goodwill on ac1uisitions, but also includes items such as deelopment costs and

 pharmacy and software licences.

'. 7oans and advances

9elates to loans made by Tesco &ersonal Finance, the company’s wholly owned financial serices

 business.

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). ther non current assets

$ncludes deriatie financial instruments, deferred ta assets and ‘other inestments’.

. ther current assets

$ncludes loans and adances %Tesco &ersonal Finance(, deriatie financial instruments, current ta

assets and short term inestments.

-. ther current liabilities

$ncludes deriatie financial instruments, customer deposits %Tesco &ersonal Finance(, current ta

liabilities and short term proisions.

. PostKretire%ent bene$it obligations

9efers to the total net deficit on the ;roup’s defined benefit pension plans.

1/. Provisions

These are obligations that eist at the year*end where there is some uncertainty as to the amount or

timing of the releant payments. &rimarily relates to deferred ta and property proisions.

11. ther non current liabilities

&rimarily deriatie financial instruments.

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Tesco Summary Consolidated Cash Flow Statements

"//

F%

"//-

F%*, CASL P24D*D B P*2A,43 AC,44,4*S

Pro$it be$ore ta+ "H'! "H-/0

 8et finance costs +5 +

#hare of post*ta profits of joint entures and associates %4( %C=(

perating pro$it 0H"/) "H1

Add: depreciation, amortisation and impairment ,C H35

'ess: increase in working capital %=35( %HB(

Add'ess: <ther items ,3C =54

Cash generated $ro% operations !H- !H/

'ess: interest paid %=5( %B4(

'ess: corporation ta paid %B=( %+B(

et cash $ro% operating activities ;A= 0H)/ 0H0!0

*, CASL P24D*D B ;#S*D 4= 4*S,43 AC,44,4*S

)apital ependiture %B,C4C( %+,44(

$nestments %eg in subsidiaries and joint entures( %5,C34( %5(

-isposals ,+=B ,4=

<ther =H 5

et cash provided by ;used in= investing activities ;B= ;'H!= ;"H'!=

*, CASL P24D*D B ;#S*D 4= <4AC43 AC,44,4*S

#hare purchases net of proceeds from share issues %+=( %5(

-iidends paid %33( %CHB(

$ncrease in borrowings C,+3C H,+++

9epayment of borrowings %5,C++( %C,=H+(

$ncrease %decrease( in finance lease obligations %3( 3C

et cash provided by ;used in= $inancing activities ;C= 0H)1' !1"

4ncrease J decrease in cash ;D 6 A 8 B 8 C= 1H)/1 -/1

Cash at start o$ year ;*= 1H-- 1H/!"

 8et effect of foreign currency translation on cash reclassifications %F( 1"/ ;''=

Cash at end o$ year ;3 6 D 8 * 8 <= 0H'/ 1H--

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Part ':

3lossary o$ ,er%s

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37SSA2 < ACC#,43 AD <4AC* ,*2M473

A

Absorption ;$ull= costingThe total cost of an actiity, product or serice based on direct costs and an estimate of oerheads.

Accounting

The process of identifying, measuring and communicating economic information to permit

informed decisions by users of the information.

Accounting standards

9ules and guidance which should be followed by preparers of financial statements. $nternational

accounting standards %$nternational Financial 9eporting #tandards( are issued by the $nternational

Accounting #tandards "oard %$A#"(.

Accounts payable

!oney owed to suppliers.

Accounts receivable!oney owed by customers.

Accrual

An epense that has not been paid for at the end of the accounting period, typically where the

supplier inoice has not been receied by the time the financial statements are prepared.

Acid test ratio

#ee 1uick ratio.

Ac9uisition

The act of one company buying another and taking a controlling interest in it.

Activity Based Costing ;ABC=

A method of costing products or serices, under which oerheads are charged according to the way

in which the product or serice consumes the business’ resources.A%ortisation

-epreciation of intangible fied %non current( assets.

Analyst

#omeone who researches inestments in shares %e1uity analysts( or debt %fied income analysts(.

AP2 

Annual percentage rate. The rate of interest, calculated by a set formula, to gie a ‘true’ rate of 

interest on a loan. All companies offering loans to the public are obliged to 1uote the A&9 on the

loans or credit they are offering.

Arbitrage

The act of eploiting price differences of the same security by simultaneously selling the oerpriced

security and buying the under*priced security.

Asset

A resource that a business owns or controls to produce goods and proide serices that will generate

reenue for the business. There are tangible assets, such as money owed to the business by

customers, money with bankers and cash in hand, inentory, land and buildings, and intangible

assets, such as patents and goodwill.

Asset $inance

>ire purchase and lease arrangements that allow a company to use an asset without haing to pay

for it ‘up front’ in full.

Audit

The independent eamination of a company’s financial statements and epression of opinion as towhether the financial statements gie a ‘true and fair iew’.

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B

Bad debt

Accounts receiable that is likely to remain uncollectible and will be written off. )ompanies should

make an allowance for bad debts since it is unlikely that all of the debtors will pay them in full.

Balance sheet

A financial statement that measures the financial position of an organisation at a single moment in

time. The balance sheet e1uation is Assets 6 'iabilities 7 01uity.

Bear

An inestor who beliees share prices will fall.

Beta

The measure of systematic risk of a financial security %eg a share(, as used in the )apital Asset

&ricing !odel %)A&!(. $t measures the coariance of the security’s return with the market

 portfolio return.

Bill o$ e+change

A bill of echange is a written document in which you re1uire your customer to pay a specified

amount by a specified date.Bond

A certificate confirming that the owner of the bond has lent money to a specified borrower which

will be repaid at a fied date and at a fied rate of interest. @sually issued by companies and

goernments as a means of raising finance.

Book value

The balance sheet alue of an item.

Botto% line ;,he=

The final figure on a profit and loss account that represents the profits attributable to shareholders.

Broker

Assists in the buying and selling of financial securities %eg shares( by acting as a ‘go*between’,

thereby reducing search and information costs.Business plan

-ocument prepared by management that summarises the operational and financial objecties of a

 business and the detailed plans and budgets showing how the objecties are to be realised. $t is

different from an inestment proposal in that the business plan is considered an internal document.

BreakKeven analysis

The leel of sales necessary for a company to coer all its fied and ariable costs for a gien

 period of time, ie so that the business will not operate at a loss. Aboe break*een sales, a company

will be profitable.

Budget

The financial representation of a plan for a defined period of time, usually a year.

BullAn inestor who beliees share prices will rise.

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C

Call option

A contract that gies the purchaser the right but not the obligation to buy a fied 1uantity of a

commodity, financial instrument or some other underlying asset at a gie price at or before a

specific date.

Capital

The owners’ claim on the assets of the business. Also called ‘capital and reseres’ and ‘e1uity’.

Capital allo@ance

A ta allowance which takes account of depreciation of certain types of business assets such as

machinery, e1uipment, ehicles etc.

Capital Asset Pricing Model ;CAPM=

A theory of asset pricing which assumes that financial assets, in e1uilibrium, will be priced so as to

 produce returns that will compensate inestors for systematic risk as measured by the beta.

Capital e%ployed

The long term finance that has been used by a business. )alculated from a balance sheet as longterm liabilities plus e1uity, or total assets less current liabilities.

Capital e+penditure

The amount inested in constructing, purchasing or improing long*term ie fied assets.

Capital %arket

A market through those raising finance can do so by selling financial inestments to inestors %such

as shares and bonds(.

CashK$lo@ $orecast

A projection of the timing and amount of a business’s inflow and outflow of cash measured oer a

specific period of time, typically on a monthly basis.

Cash $lo@ state%ent

A statement that shows the sources and uses of cash for a period.Collateral

#ee security.

Co%%ercial paper

An unsecured loan note promising the lender a sum of money to be paid in a few days. The aerage

maturity is B4 days.

Co%%it%ent

A cost that has not yet been incurred but that must be incurred in the future as a result of some

contractual or other obligation. An eample is future lease payments due under a long term lease

contract.

Co%%it%ent $ee

A fee payable to a bank in return for the bank’s commitment to lend money.Co%%on stock 

#ee ordinary shares.

Consolidated accounts

A set of financial statements that combine the financial performance and financial position of a

group of companies under common control. Also called ‘group accounts’.

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Contingent liability

A possible obligation that arises from past eents and whose eistence will be confirmed only by

the occurrence of one or more uncertain future eents not wholly within the entity’s control or, a

 present obligation that arises from past eents or transactions but is not recognised on the balance

sheet because:

  payment is not probableK or 

  the amount cannot be measured reliably

)ontingent liabilities are not recorded on the balance sheet, but details are disclosed in a note to the

accounts.

Contribution

#ales reenue less ariable costs.

Corporate 3overnance

The systems and controls for running a company.

Cost o$ capital

The rate of return re1uired by inestors in a company to compensate them for the time alue ofmoney effect on their inestment.

Cost o$ sales

The cost to a business of manufacturing or purchasing the goods sold during a period, or the cost of

 proiding serices sold during a period.

Credit

The process whereby an organisation proides goods or serices to customers, but then allows a

certain amount of time for them to pay for it.

Credit period

The time allowed to customers to pay for goods or serices receied.

Credit rating

An assessment of the 1uality of debt from a lender’s perspectie in terms of the likelihood ofinterest and capital not being paid and the etent to which the lender is protected in the eent of

default. )redit rating agencies are paid fees by companies, goernments, etc that wish to attract

lenders. )redit rating agencies include #tandard and &oor, !oody’s and Fitch.

Creditors

<rganisations or people to whom the organisation owes money. Also called ‘accounts payable’.

Creditor days

The financial ratio used to assess how 1uickly an organisation pays its creditors. %Also called

‘payables days’(.

Covenant

A contractual condition attached to a loan agreement that is designed to proide some protection to

the lender.Current assets

Assets of a business that are turned oer or used up fre1uently in the running of the business. #hort

term assets that are either cash or are epected to conert into cash typically within one year.

0amples include stock %inentory(, debtors %accounts receiable( and cash.

Current liabilities

Amounts owed by the organisation that will hae to be paid within one year. These include trade

creditors %accounts payable(, accruals, unpaid taes and short*term bank loans and oerdrafts.

Current ratio

9atio of current assets to current liabilities.

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D

Debenture

A long*term loan eidenced by a trust deed. @sually secured against assets.

Debt

$n terms of financing a business there is a distinction between debt and e1uity. -ebt is money

 borrowed from a bank or other institution which is subject to interest paid at a specified rate. The

total amount borrowed must be repaid either on a specified date or on demand.

Debt to e9uity ratio

A comparison of debt to e1uity in a business’s capital structure.

Debtors

<rganisations or people who owe the business money. Also called accounts receiable.

Debtor days

Also known as the Laerage collection periodL this is the financial ratio which shows how 1uickly

organisation is able to collect what it is owed. %Also known as ‘receiables days’(.

De$ault$f the terms of an inestment agreementloan are broken, then the business is in default.

Depreciation

A measure of the amount of a fied asset %non current asset( that has been consumed during a

 period.

Derivative

A financial asset, the performance of which is based on %deried from( the behaiour of an

underlying asset.

Direct cost

A cost incurred in the operation of a business that can be easily and accurately attributed to the cost

of purchasing or manufacturing a product, or proiding a serice.

Discount $actorThe rate applied to a future cash flow to conert into its alue in today’s terms to take account of the

time alue of money effect.

Discount rate

The rate of return used to discount future cash flows to adjust for the time alue of money effect.

Dividend

A cash or share payment to shareholders made out of the company’s accumulated retained profits to

date.

Dividend yield

The ratio of the amount of diidend receied from a share relatie to its current market alue.

Due diligence

-etailed inestigations carried out by lawyers, public accountants and others on a business’smarket, competitors, management, track record, financial and legal status. -ue diligence is done

 prior to the closing of a transaction, such as a property transfer, corporate merger, share issue or

loan agreement.

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*

*arnings per share ;*PS=

The ratio of profits aailable to ordinary shareholders earned for a period related to the number of

ordinary shares in issue.

*B4,DA

0arnings before interest, ta, depreciation and amortisation.

*cono%ic Pro$it ;*P=

Another name for 0conomic Ialue Added. #ee below.

*cono%ic alue Added ;*A=

A measure of business performance which is calculated as the net operating profits after ta

%8<&AT( less a charge which reflects the cost of using capital in the business.

*$$iciency

The business’ ability to generate sales reenue from the resources it uses.

*9uity

<rdinary shareholders’ inestment in a company, being the total of the inested capital and theaccumulation of retained profits during the life of the business.

*urobond

A bond issued by a company where the finance is raised on an international basis. The bond is

issued in a currency that is different from the currency in the country in which the company raising

the finance is located.

*+it

The realisation of an inestment by way of sale or echange for some sort of marketable

commodity.

*+it route

!ethod by which an inestor intends to, or has realised an inestment. This could range from a

trade sale by the directors through to flotation on the stock echange.*+pected return

The total amount of money %return( an inestor anticipates receiing from an inestment.

*+penditure

)osts incurred by a project or business.

*+pense

The amount of cost recorded in the profit and loss account %income statement( for a period

representing the amount of cost consumed in the generation of income in the period.

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<

<actoring

The purchase by a factor of a company’s outstanding sales inoices at a discount to proide

immediate cash.

<inance

$n simple terms, all matters relating to money. Also refers to the study how businesses raise finance

and how they select appropriate inestments.

<inance lease

A lease which inoles substantially all of the risks and rewards of ownership being transferred the

lessee. For assets used under finance lease arrangements, the asset and liability are included on the

lessee’s balance sheet.

<inancial accounting

The process of identifying, measuring and communicating economic information to permit

informed decisions by eternal users %such as shareholders, the bank and suppliers(.

<inancial %anage%entA subject area concerned with decisions that impact on the financial resources of an organisation,

 particularly financing and inesting decisions.

<i+ed assets

Assets that are ac1uired with the intention of being used in the business on a continuing basis

%usually with a life eceeding one year( and that are not intended for resale. %Also called ‘non

current assets’(.

<i+ed costs

)ost of doing business, which does not change with the olume of business. 0amples might be

rent for business premises, insurance payments, heat and light.

<lotation

The launching or financing of a business through the trading of its shares on a stock echange.<or@ard

A contract between two parties to undertake an echange at an agreed future date at a price agreed

now. #imilar to futures but not traded ia an echange and can be tailored to specific re1uirements.

<ree Cash <lo@

The amount of cash generated by a business that is aailable %ie ‘free’( to proide as return to the

 proiders of finance to the business %ie debtholders and shareholders(. )alculated as net operating

 profit after ta, plus depreciation, less capital ependiture and inestments in working capital.

<und Manage%ent

$nestment of and administering of a 1uantity of money %eg pension fund, insurance fund( on behalf 

of the fund’s owners.

<utureA contract between two parties to undertake an echange at an agreed future date at a price agreed

now. @nlike forwards, trading is ia an echange with restrictions such as siMe, duration and timing

of contracts.

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3

3AAP

;enerally accepted accounting practice.

3earing

The ratio of debt to total debt plus e1uity of a company. $n general, the higher the gearing, the

higher the percentage of annual profits which must be used to pay interest and the greater the

ulnerability of the company to eents such as a rise in interest rates or a fall in sales. %Also called

‘leerage’(.

3oing long

"uying a financial security %eg share( in the hope that its price will rise.

3ood@ill

The difference between the amount one company pays to ac1uire the shares of another and the fair 

alue of the company’s assets that hae been ac1uired. Ac1uired goodwill is recorded on the

 balance sheet as an intangible fied asset %non current asset(.

3ross pro$it#ales reenue less cost of sales. 9epresents the profit earned by a business from trading, prior to

the deduction of selling, general and administratie oerhead epenses.

3ross pro$it %argin

The gross profit epressed as a percentage of sales reenue for a period.

3uarantee

A promise by a guarantor to repay a loan or part of a loan on behalf of the borrower if the borrower

cannot.

3uarantor

A person who accepts responsibility for the repayment of a financial obligation should the original

 borrower default on the terms of repayment or fail to repay the obligation altogether.

L

Ledge <und

A collectie inestment ehicle that operates free from regulation, allowing it to act in ways not

aailable to other fund managers %eg borrowing to inest and short selling(.

Lire purchase

!ethod of financing the purchase of assets. @nder a hire purchase agreement, the business pays an

initial deposit with the remainder of the balance and interest being paid oer a period of time. At the

end of the period, the asset is owned by the business.

Lostile takeover

The takeoer of a company against the wishes of the incumbent management or board.

4

4nco%e

Ialue generated by the business in a period eg from sales reenue or interest receiable. %@nder @#

and $nternational Accounting, income is another name for profit(.

4nco%e state%ent

#ee profit and loss account.

4ncre%ental budget

An approach to budgeting, where the budget prepared for the current year is based on last year’s

 budget with some adjustment for epected changes such as planned growth and the anticipated leel

of inflation.

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4nitial public o$$ering ;4P=

The initial offer and sale of a company’s shares on a public market such as a stock echange.

4nsolvency

The situation where an organisation is unable to meet its liabilities. Technical insolency arises if

the organisationLs balance sheet reeals total assets are less than total liabilities.

4ntangible assets

Assets that do not hae a physical substance %such as brands, goodwill and debtors(.

4nterest

A charge for the use of money supplied by a lender.

4nterest cover

The ratio of profit before interest and ta to the net interest payable for a period.

4nternal 2ate o$ 2eturn ;422=

The discount rate for an inestment that produces a Mero net present alue,

4nternational accounting ;$inancial reporting= standardsTransnational accounting rules deeloped by the $nternational Accounting #tandards "oard.

4nventory

#ee stock.

4nvest%ent appraisal

The financial ealuation of capital ependiture and other long*term inestment decisions.

4nvest%ent Bank 

"anks that carry out a ariety of financial serices, but usually ecluding high street banking.

#erices include adice on mergers and ac1uisitions and share issues as well as trading actiities.

4nvest%ent grade debt

-ebt with a sufficiently high credit rating to be considered safe for inestors.

4nvestors&roiders of capital for the long term, as distinct from lenders of short*term capital. $nestors hae

rights which short term lenders do not enjoy and accept risks which short term lenders are not

eposed to.

4nvoice discounting

A ariation of factoring.

5

5oint venture

The cooperation of two or more indiiduals or businesses in a specific business enterprise rather

than a continuing relationship. $t can be simply an agreement between two parties as to who does

what and gets what or it can be an entirely new company set up for the specific purpose of pursuingthe joint business.

5unk bonds

"onds with a low credit rating. 9ated below inestment grade bonds and therefore represent high

risk, high return inestments.

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ey per$or%ance indicators ;P4?s=

The key financial and non financial measures that are used to track the etent to which a business is

on course to achiee its objecties.

7

7ease

An arrangement whereby the legal owner of an asset %the lessor( grants the use of the asset to

another party %the lessee( for a specified period of time in return for regular rental payments. The

asset is returned to the lessor at the end of the lease period.

7etter o$ credit

A guarantee gien by a bank on behalf of an importer to pay an eporter, on presentation of

specified documents that represent the supply of goods within a specific time. @sed in international

trade, it permits two parties to echange ownership and possession of goods and the money to payfor them.

7everage

The amount of debt used to finance the business’ assets. %#ee ‘gearing’(.

7iability

An obligation to pay an amount or perform a serice to a third party.

7i%ited liability

The obligations of the owners of shares in a company with respect to the liabilities of the company

are limited to the amount they hae committed for the purchase of their shares.

7ine o$ credit

An agreement negotiated between a borrower and a lender that establishes a maimum amount

against which a borrower may draw. The liability of the borrower at any point is only the amountdrawn against that maimum. The agreement also sets out other conditions, such as how and when

money borrowed against the line of credit is to be repaid.

7i9uidity

The ability of a business to meet its short term obligations, or the ease with which an inestment

can be sold and conerted into cash.

7i9uidation

The sale of all of a company’s assets, for distribution to creditors and shareholders in order of 

 priority. This may be as a result of the failure of the company or by agreement amongst

shareholders.

7isting

/hen a company trades its shares on a stock market, it is said to be ‘listed’.7oan capital

Form of debt which has to be repaid at a specified time in the future %as distinct from a bank 

oerdraft which may be called in at short notice(.

7ong ter% liabilities

Amounts owed by the organisation that will hae to be paid in more than one year after the balance

sheet date. These include long term loans and long term proisions for liabilities and charges. Also

called ‘non current liabilities’.

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M

Manage%ent accounting

The process of identifying, measuring and communicating economic information to permit

informed decisions by managers, to assist them in running the organisation.

Manage%ent buyKin ;MB4=

Funds proided to enable a manager or group of managers from outside a company to buy into it.

Manage%ent buyKout ;MB=

Funds proided to enable operating management to ac1uire the eisting product line or business that

they currently manage.

Marginal ;variable= costing

The additional cost of an actiity, product or serice.

Market capitalisation

The total market alue of a company’s ordinary shares.

Matching

The accounting concept that re1uires that for measuring profits, income earned in the period should be matched against the epenses that hae been consumed in earning the income.

Materiality

The relatie significance of an item %or error or omission( to the readers’ iew of the financial

statements.

Maturity

The duration of a liability such as a loan before it must be repaid.

Merger

The formation of one company from two or more preiously eisting companies.

MeNNanine $inance

A financing instrument that has elements of both e1uity and debt, eg debt with rights to conert to

e1uity or a share in the profits.

et assets

The difference between the balance sheet alue of assets and liabilities. !ust e1ual the e1uity

%capital and reseres( of the business. %Also known as ‘net worth’(.

et book value ;B=

The cost less accumulated depreciation of fied %non current( assets.

et operating pro$it a$ter ta+ ;PA,=

A measure of finance performance which is calculated as net operating profits less a deduction for

the amount of ta payable on those profits.

et present value ;P=A method of inestment appraisal based on the present alue of the cash flows associated with the

inestment opportunity.

et pro$it

The profit of a business after deducting all of the epenses. %@nder @# and $nternational

Accounting, also called ‘net income’(.

on current assets

#ee fied assets.

on current liabilities

#ee long term liabilities.

onKe+ecutive director

A part*time director who shares all the legal responsibilities of eecutie directors on the board of acompany, but who does not get inoled in the day*to*day running of the company.

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perating lease

A short term lease arrangement which does not transfer substantially all of the risks and rewards of

ownership to the lessee.

perating loan

A loan intended for short*term financing to support cash flow or coer day*to*day operating

epenses. 'oans of this type are part of the line of credit.

perating pro$it

The profit achieed by a business during a period before deducting any financing costs. ;enerally

taken to mean the profit before interest and ta as disclosed in the profit and loss account %income

statement(.

ption

A contract giing one party the right but not the obligation to buy or sell a financial instrument,

commodity or some other underlying asset at a gien price at or before a specific date.

rdinary shares

The e1uity capital of a company. The holders of ordinary shares are the legal owners of thecompany and are therefore entitled to all of the residual profits of the company after other claims

hae been met. %@nder @# and $nternational Accounting, ordinary shares are referred to as

‘common stock’(.

verdra$t

An amount of money that a business with a bank account is temporarily allowed to borrow from a

 bank at an interest rate and oer an agreed period of time.

verheads

)osts incurred in the operation of a business that cannot be easily and accurately attributed to the

cost of purchasing or manufacturing a product, or proiding a serice. %Also called ‘indirect costs’(.

vertrading

The situation arising when a business is operating at a leel of actiity which cannot be supported by the amount of finance aailable to the business.

P

Payables

#ee accounts payable.

Payback 

A method of inestment appraisal that measures how 1uickly the initial amount inested is epected

to be repaid by cash flows generated by the inestment.

Phased budget

A budget that has been analysed into months taking into account of anticipated changes in actiity

oer the course of the year.Pre$erence shares

'ike ordinary shares %common stock(, they represent ownership in a business. >oweer, these

shares are usually non*oting and hae a fied diidend rate. $n the eent of li1uidation, preferred

shareholders rank ahead of ordinary shareholders but behind creditors for claims against the assets

of the business.

Prepay%ent

Arises where the amount paid eceeds the amount of epense consumed in a period. )lassified

within debtors %receiables( on the balance sheet.

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Present value

The alue in today’s terms of a future cash flow, when adjusted %ie discounted( to take account of

the effect of the time alue of money.

Price earnings ratio

The ratio of the market alue of a share the earnings per share. &roides an indication of the stock

market’s confidence in the future earnings potential of the business.

Pri%ary %arket

A market in which financial assets %‘securities’( are initially issued.

Private e9uity

#ee enture capital.

Pro$itability

The business’ ability to generate profits.

Pro$it and loss account

A financial statement presenting the reenue, epenses and profits %or losses( of an organisation

during a specified period of time. Also called an ‘income statement’.Provisions

There are two types of proisions in accounting. First, there are proisions made against assets to

reflect a reduction in the amount epected to be recoered %eg proision for bad debts(. #econd,

there are proisions for liabilities and charges, which are potential liabilities where there is some

uncertainty as to the amount or timing of the obligation, or both %eg enironmental and warranty

 proisions(.

Prudence

The accounting concept that re1uires preparers of financial statements to err on the side of caution.

Put option

A contract that gies the purchaser the right but not the obligation to sell a financial instrument,

commodity or some other underlying asset at a gien price at or before a specific date.

G

Guick ratio

The ratio of current assets ecluding stock %inentory( to current liabilities. Also called the ‘acid

test ratio’.

2eceivables

#ee accounts receiable.

2edee%able shares#hares which can be repurchased by the company at a predetermined alue.

2eK$orecast

A prediction of the final performance for the year made part*way through the year in the light of

 performance achieed to date and anticipated performance for the remainder of the year.

2etained earnings

&art of the ordinary shareholders’ inestment in a company which represents the accumulated of

 profits earned which hae reinested in the company rather than being paid out as diidends.

2eturn on capital e%ployed ;2C*=

The ratio of operating profit for a period relatie to the amount of long*term funding that has been

used by the business.

2eturn on sales ;operating pro$it %argin=The ratio of operating profit to sales reenue for a period.

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2evenue

#ee turnoer.

2evolving credit

An arrangement whereby a borrower can draw short term loans as the need arises up to maimum

limit, oer a specific time period.

2isk 

The potential that the future return might be different from the leel epected.

S

Securitisation

A structured finance process in which assets %eg receiables( or financial instruments are offered as

security for third*party inestment. $noles selling financial instruments which are backed by the

cash flows or alue of the underlying asset.

Security

An asset that is pledged to support or secure a loan %eg a house taken as security by a bank to

support a loan(. $n the case of term loans, the property %eg land, buildings, e1uipment( being purchased with the loan usually forms the security for the loan. %Also known as ‘collateral’(.

Secondary %arket

#ecurities already issued that are traded between inestors.

Senior debt

0lement of a financial package which consists of bank lending. $t is called senior debt because if the

 business goes bankrupt, the lender has higher priority than those who proided e1uity or meMManine

finance.

Shareholders

<wners of one or more shares in a business. %@nder @# and $nternational Accounting, shareholders

are known as ‘stockholders’(.

Short sellingThe selling of financial securities %eg shares( that are not yet owned, in anticipation of being able to

 buy the securities at a lower price before the sale is made. )ompare with ‘going long’.

Solvency

The ability of a business to meet its long*term obligations.

Stock 

Another name for inentory. For a manufacturer represents the amount of raw materials, work in

 progress and finished goods. For a retailer represents the amount of goods aailable to be sold.

%@nder @# and $nternational Accounting, stock is another name for ‘shares’(.

Stock e+change

A market where financial securities %eg shares and bonds( are bought and sold.

Stock holding periodAn $ndication of the length of time stock is held in the business before being sold. %Also known as

‘inentory days’(.

Subordinated debt

A debt that an unsecured creditor can only claim, in the eent of li1uidation, after the claims of

secured creditors hae been paid.

S@ap

An echange of cash payment obligations %eg interest rate or currency swap(.

Syndication

An arrangement in which a group of inestors come together to inest in a business or proposition

which they would not be prepared to consider indiidually, whether because of risk or the amount

of funding re1uired. There is usually one inestor who leads the deal.

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,

,angible assets

Assets with a physical substance.

,er%

The duration of a loan.

,er% structure o$ interest rates

The patterns of interest rates on bonds with different lengths of time to maturity but otherwise with

the same risk. 0pressed graphically as a ‘yield cure’. /e would normally epect bonds with a

longer maturity period to carry a higher interest rate than otherwise e1uialent bonds with a shorter

maturity period, due the higher risk from the lender’s perspectie.

,i%e value o$ %oney

A pound receied in the future is worth less than a pound receied today for three reasons: the effect

of inflationK our impatience to consumeK the effect of risk.

,otal shareholder returns ;,S2=

The total return earned on a share during a period, based on capital gains and diidends, epressed

as a percentage of the price of the share at the start of the period.,rade sale

#ale of a company to another company. As a form of eit, it is an alternatie to flotation and more

common.

,rue and <air ie@

The re1uirement that financial statements should be prepared using numbers that are as accurate as

 possible, consistent with current best accounting practice and free from deliberate bias or distortion.

,urnover

#ales reenue earned in a period.

,urnover on capital e%ployed

The ratio of sales reenue generated relatie to the amount of long*term funding used in the

 business.

,urnover on $i+ed assets

The ratio of sales reenue generated relatie to the amount of fied %non current assets( inested in

the business %measured at net book alue(.

ariable costs

)ost of doing business, which aries in line with changes in the olume of business. 0amples

might include raw materials and direct labour costs for production staff for a manufacturing

 business.

arianceThe difference between what was planned as part of a budget %the budgeted figure( and what

actually happened. @sed as a tool for budgetary monitoring and control.

enture capital

<riginally, capital supplied to early stage, innoatie businesses where the risks were high but so

were the potential returns. The term has now come to encompass almost all types of inestment in

un1uoted companies and includes priate e1uity and management buy*outs.

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W

Working capital

The amount of money a business needs to coer its day*to*day actiities such as paying wages,

 buying raw materials and paying bills. <n a balance sheet, represents the difference between

current assets and current liabilities %ie net current assets or net current liabilities(.

Work in progress

For a manufacturing business represents the costs associated with incomplete production. For

serice proiders, represents work done not yet inoiced .

O

Oero Based Budgeting ;OBB=

An approach to budgeting, where the budget prepared for the current year must be justified from a

Mero starting point.