8 Forms of Businesses Business is always accounted for separately Sole Traders (single owner) Partnerships (multiple owners) Companies (single or multiple owners) LLPs (multiple owners)
9 Incorporation as a Company Limited liability of owners Taxation differences (corporation tax not personal income tax) Succession and control (company is independent of its owners) Greater financing opportunities (e.g. listed companies sell shares to the public) Costs of compliance and administration
10 3 Main Financial Statements Balance Sheets:Show: ‘A snapshot of a business at a point in time.’Show: The net worth of a business.Net Worth = Owners’ equity.Profit and Loss Accounts:Show: The profitability of the business.Explain changes in Net Worth.Cash Flow Statements:Show: The liquidity of the business.Show: Sources and applications of funds.Explain changes in cash
11 show them Somerfield accounts explain assets, liabilities point out layout of items
12 Balance SheetsShow:snapshot of business at point in time (the balance sheet date)net worth = net assets = total assets - total liabilitiesworking capital (= net current assets)owners’ equity (= capital + reserves)sources of finance (= owners’ equity + long-term liabilities)
13 The Balance Sheet Equation Net Worth = Owners’ EquityHorizontal Format:Total Assets = Total Liabilities + Owners’ EquityVertical Formats:1 Fixed Assets + Working Capital - Long-Term Liabilities = Owners’ Equity2 Fixed Assets + Working Capital = Long-Term Liabilities + Owners’ Equity
14 Discuss pictorial representation, Bristol Industries and Invented Ltd Point out differences in vertical formatsnote horizontal format as example 2.2 in textbookExplain briefly what each item isStart talking about differences between company accounts and other business accounts (e.g. proprietor’s capital)Capital and reserves:If you don’t know how much was invested or brought forward from last year, and how much is this year’s profit, just use the total figure.
15 Impact of Different Business Forms The owners’ equity bit at the bottom of the balance sheet changes depending on the business formSole traderno share capital, just capital. No dividends - drawings may be either in P&L or B/SPartnershiplike sole trader, but show each partner’s share separatelyCompanyshare capital and reserves, dividends in P&L
16 Profit and Loss Accounts Show:history book of transactions over past periodprepared on accruals basis (matching)explains changes in net worth from one balance sheet to the nextprofit = income - expenditureincome = sales revenue (turnover) + otherexpenditure = cost of sales + expenses (+ divs)COS = op. Stock + purchases - cl. stock
17 Discuss Invented Ltd, esp Discuss Invented Ltd, esp. with reference to dividends, and net profit/operating profit/PBIT.Note bank interest (on overdraft) is part of operating profitExplain idea of depreciation - non cash item
18 Cash Flow Statements Show: Remember: history book of cash flows over past periodliquidity (without cash, businesses fail)sources and applications of fundsexplan changes in cash from one balance sheet to the nextRemember:profit is not the same as cash, and cash is not the same as profit
19 Discuss Invented Ltdnote depreciation is added back as it is a non cash item - explain (briefly) what it is (again!)
20 Balance Sheet Examples (remember the impact of different business forms) A. Dr Seatham Rythe
23 The Ashton CompanyThis is still a simple example, but notice that there are ‘incomplete records’This is very common - get used to it now!Here the only missing information is the retained profit reserve for the balance sheet - we can work it out because we know that the balance sheet should balanceIn future questions could be missing figures for sales, debtors, purchases, creditors, etc.Pay careful attention to the layout
24 How Transactions Affect the Balance Sheet 1. Joe Smith invests £1,000 cash in his new business.
25 How Transactions Affect the Balance Sheet 2. The business spends £100 cash on stock.
26 How Transactions Affect the Balance Sheet 3. The stock is sold for £150 cash.What would have happened if the stock was sold on credit?
27 How Transactions Affect the Balance Sheet 4. More stock costing £50 is bought on credit.
29 The Ashton Company Again We have the opening balance sheet (p.19)We are told what transactions have occurred over the past period (September)We have to piece together the new (closing) balance sheet, and the profit and loss accountRemember to distinguish cash and profit
32 Cash Flow Statements Remember, these explain changes in cash First, calculate the net cash flow from operating activities, adding back non-cash items to operating profit (=net profit=PBIT)Depreciation is a non-cash itemdepreciation is way of spreading the cost of a fixed asset over its useful economic life (application of the accruals concept)it is deducted from fixed assets in the balance sheet (accumulated amount), and from the P&L account (charge for period only)
33 Go through first example NOTE ERROR RE OPERATING PROFIT! see corrected version on additional handoutNOTE ERROR RE INTEREST PAID!Nick’s Newsmart example