Understanding and Managing Finance This Presentation is in Self-Study Form To start the presentation: Press F5 (Top Row of Keyboard) Then use the navigation buttons at the foot of each page.

Understanding and Managing Finance Presentation 2 Self-Study Version

Objectives for This week After studying this week’s work, you should:  Know the three main types of financial statements used in business.  Know and be able to discuss the meaning of some of the important terms used in these statements  Be able to work with simplified versions of these statements, taking account of transactions.

Menu 2a Financial Statements: Terms & Principles 2b Examples of Financial Statements 2c Simple Example 2d Follow-Up Activities

Part 2a Financial Statements Some Terms & Principles

Financial Statements  Apart form day-to-day bookkeeping, there are three different types of ‘official’ financial statements which are used by an organisation:  The Cash-flow Statement is designed to answer the question “What happened to all the money?”  The Profit & Loss Account is designed to answer the question “How much money did we make (or lose)?”  The Balance Sheet is designed to answer the question “What is the current worth of the organisation?”

Financial Statements – Some Terms The first ‘big idea’ is that there is a difference between cash and profit.  Cash is simply the money which flows into and out of the business  Profit is the amount that the business earns for itself at the end of some period of time by carrying out its normal trading activities.

Financial Statements – Some Terms The second ‘big idea’ is the notion of assets and claims.  Assets are what the business owns. This can be anything: money in the bank, stock held, buildings, cars, land etc. and also any monies owed to the business.  Claims are what the business owes. This can be bank loans extended to the business, unpaid bills, profits which can be claimed by the owner or shareholders

Financial Statements – Some Terms  The third ‘big idea’ is the notion of debit and credit. This comes from the idea of ‘double entry bookkeeping’. This is a system for recording financial transactions where each item is recorded twice, once as a debit and once as a credit.  Debits are always put on the left hand side of a bookkeeping system.  Credits are always put on the right hand side of a bookkeeping system  The Balance is what is left after the debit total has been subtracted from the credit total.

Financial Statements – Some Terms The terms ‘debit’ and ‘credit’ are also used in a slightly different way when talking about business transactions. Business mainly buy things on credit (as many people do using a credit card), then pay later.  Creditors are the people you owe money to. Note that these are part of the claims on your business.  Debtors are the people who owe you money.Note that these are part of the assets of your business.

Activity 2.1 Select the appropriate words to complete these statements:  If your business buys goods on credit, the person you buy from is called a creditor/debtor. The goods that you buy become part of your business assets/claims.  If your business sells goods on credit, the person you sell to is called a creditor/debtor. The money that is owed becomes part of your business assets/claims. Answer

Activity 2.1 Solution  If your business buys goods on credit, the person you buy from is called a creditor. The goods that you buy become part of your business assets.  If your business sells goods on credit, the person you sell to is called a debtor. The money that is owed becomes part of your business assets. NB if this last sentence tricked you, please re-read the final sentences in each paragraph carefully.

Part 2b Examples of Financial Statements

Financial Statements – Some Examples  The examples which follow are simply to show you what Bookkeeping and the three Financial Statements ‘look like’. At this stage you should not expect to understand any more than the general idea of what it is that the statements are doing, and possibly look out for the terms which have been introduced.  Please note: these are not all from the same company!

Double Entry Bookkeeping EXAMPLE: Stock is bought for a cash payment of £600 EXAMPLE: Stock is bought for a cash payment of £600 This is entered once as a credit and once as a debit: This is entered once as a credit and once as a debit:

Net Cash-Flow from Operating Activities300,000 Returns from investment and servicing of finance100,000- Taxation 30,000- Capital Expenditure150, Subtotal 20,000 Equity Dividends paid 30, Subtotal 10,000- Management of liquid resource - disposal of investments 10,000+ Financing - additional long-term loan 50, = Increase or Decrease in Cash over Period 50,000+ EXAMPLE OF A CASH FLOW STATEMENT The Bottom Line: How much more/less cash have we than before?

Turnover (Sales) (Income)£ 100,000 Cost of Sales (Direct Costs) Materials£10,000 Transport£ 5,000 Labour£15,000 Total Cost of Sales £ 30,00030% Gross Profit (Gross Margin)£ 70,00070% Overheads (Indirect Costs) Administrative salaries£18,000 Advertising£ 5,000 Rent & Rates£ 4,000 Total Overheads £ 27,00027% Operating Profit (Net Margin)£ 43,00043% Interest on loans£ 3,000 Profit before tax£ 40,00040% Corporation tax due£10,000 Profit after tax & interest£ 30,00030% Dividends payable£22,000 Retained Profit (Earned Surplus) £ 8,0008% EXAMPLE OF A PROFIT & LOSS ACCOUNT The Bottom Line: How much actual profit have we made?

ASSETS CLAIMS Fixed AssetsCapital & Reserves Land£ 120,000Share capital £ 100,000 Buildings£ 150,000Retained profit£ 120,000 Fix & Fit£ 75,000 Total£ 220,000 Total£ 345,000L/T Liabilities Loan£ 250,000 Current AssetsTotal£ 250,000 Stock£ 55,000Current Liabilities Debtors£ 75,000Creditors£ 22,000 Bank£ 25,000Tax & VAT£ 8,000 Total£ 155,000Total£ 30,000________£ 500,000 EXAMPLE OF A BALANCE SHEET The Bottom Line: How much is the organisation worth?

Activity 2.2 On which of the three main financial statements would you find:  The assets of the Business  The costs of running the Business  The profit made by the business this year  The profit retained by the company from previous years  The amount the company has borrowed  The amount paid out in dividends  The interest paid on loans this year  The amount of cash currently held in the Bank  The amount of surplus Cash generated this year Answer

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

Part 2c Financial Statements - A Simple Example

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

Financial Statements – Activity 2.3  You decide to run a soft drinks business at a car boot sale to earn some extra money. You borrow £50 from a friend and you buy 200 cans of lemonade at 20p per can. It costs you £5 entry fee, and on the first day you sell 150 of your cans at 50p each. Some Questions  How much did you start with?  How much did you borrow?  How much did you pay back?  How much did you spend?  How much were your takings?  How much money have you now?  What is the value of any unsold stock? Answer

Financial Statements Activity 2.3 Solution  You decide to run a soft drinks business at a car boot sale to earn some extra money. You borrow £50 from a friend and you buy 200 cans of lemonade at 20p per can. It costs you £5 entry fee, and on the first day you sell 150 of your cans at 50p each. Some Questions  How much did you start with? Nothing  How much did you borrow? £50  How much did you pay back? Nothing  How much did you spend? £45 (£40 Lemonade + £5 entry)  How much were your takings? £75  How much money have you now? £80  What is the value of any unsold stock? £10 (50 x 20p)

Cash Flow Example  You decide to run a soft drinks business at a car boot sale to earn some extra money. You borrow £50 from a friend and you buy 200 cans of lemonade at 20p per can. It costs you £5 entry fee, and on the first day you sell 150 of your cans at 50p each. 1. Produce a statement showing accounting for the Cash which your business has received and has been spent. You should start with an opening balance (what you had at the beginning of the day), record each item of cash as it comes in and goes out, and end with a closing balance (the cash you have at the end of the day).

What happened to all the money? Opening Balance: £ 0 Loan from friend:£ 50+ Goods purchased:£ 40- (200 x 20p) Entry Fee:£ 5- Cash received:£ 75+ (150 x 50p) Closing Balance:£ 80 This is an example of a Cash-flow Statement

Financial Statements – Activity 2.4  On the second car boot sale that you attend, you purchase another 150 cans of lemonade at 20p per can. There is another £5 entry fee, and you sell 100 of your cans at 50p each. You decide that you will pay back £30 of the original £50 that you borrowed.  Construct a cash flow statement for the second day. Answer

Activity 2.4 Solution Cash Flow Statement Day 2 Opening Balance: £ 80 Loan from friend:£ 30- (paid back) Goods purchased:£ 30- (150 x 20p) Entry Fee:£ 5- Cash received:£ 50+ (100 x 50p) Closing Balance:£ 65

Profit & Loss Example  You decide to run a soft drinks stand at a car boot sale to earn some extra money. You borrow £50 from a friend and you buy 200 cans of lemonade at 20p per can. It costs you £5 entry fee, and on the first day you sell 150 of your cans at 50p each. 2. Produce a statement showing accounting for any Profit your business has made. You should start with the takings, and subtract from this any expenses (outgoings). The final figure should give you the profit that has been made in the course of the day’s tradings.

How much money did we gain or lose? Sales: £ 75 (150 x 50p) Cost of Sales:-£ 30 (150 x 20p) Entry Fee:-£ 5 Net Profit: £ 40 This is an example of a Profit & Loss Account Notice here that we only account for what the sales have originally cost us.

Financial Statements – Activity 2.5  On the second car boot sale that you attend, you purchase another 150 cans of lemonade at 20p per can. There is another £5 entry fee, and you sell 100 of your cans at 50p each. You decide that you will pay back £30 of the original £50 that you borrowed.  Construct a Profit & Loss Account for the second day. Answer

Activity 2.5 Solution Profit & Loss Account – Day 2 Sales: £ 50 (100 x 50p) Cost of Sales:-£ 20 (100 x 20p) Entry Fee:-£ 5 Net Profit: £ 25

Balance Sheet Example  You decide to run a soft drinks stand at a car boot sale to earn some extra money. You borrow £50 from a friend and you buy 200 cans of lemonade at 20p per can. It costs you £5 entry fee, and on the first day you sell 150 of your cans at 50p each. 3. Produce a statement of two halves, one side of which shows what the business owns (money, unsold stock etc.), and the other side showing what the business owes. You should try to ensure that you Balance one side with the other. The left hand side should show your assets, (what is owned); The right hand side should show the liabilities (what is owed). (NB Any profit made by your business is owed to you as a person!).

Do the Books Balance? Assets: Cash: £ 80 Stock: £ 10 (50 x 20p) Total: £ 90 This is an example of a Balance Sheet Liabilities (Claims): Loan outstanding: £ 50 Retained profits: £ 40 Total: £ 90

Financial Statements – Activity 2.6  On the second car boot sale that you attend, you purchase another 150 cans of lemonade at 20p per can. There is another £5 entry fee, and you sell 100 of your cans at 50p each. You decide that you will pay back £30 of the original £50 that you borrowed.  Construct a Balance Sheet for the second day. Answer

Activity 2.6 Solution Balance Sheet Day 2 Assets: Cash: £ 65 Stock: £ 20 (100 x 20p) Total: £ 85 Can you see where all the figures are from? Liabilities (Claims): Loan outstanding: £ 20 Retained profits: £ 65 Total: £ 85

Balance Sheet Day 2 Assets: Cash: £ 65 Stock: £ 20 (100 x 20p) Total: £ 85 Liabilities (Claims): Loan outstanding: £ 20 Retained profits: £ 65 Total: £ 85 CASH: Final Line on the Cash Flow Statement CASH: Final Line on the Cash Flow Statement ASSETS: Opening Stock: 50 cans Stock Purchased+ 150 cans Stock Sold cans Closing Stock: 100 cans ASSETS: Opening Stock: 50 cans Stock Purchased+ 150 cans Stock Sold cans Closing Stock: 100 cans

Balance Sheet Day 2 Assets: Cash: £ 65 Stock: £ 20 (100 x 20p) Total: £ 85 Liabilities (Claims): Loan outstanding: £ 20 Retained profits: £ 65 Total: £ 85 LOAN: Original Loan £50 Paid back-£30 Amount Owing £20 LOAN: Original Loan £50 Paid back-£30 Amount Owing £20 PROFITS: Previous £40 Today £25 (see P & L Account) Total £ 65 PROFITS: Previous £40 Today £25 (see P & L Account) Total £ 65

Part 2d Follow-Up Activities 1

Follow-up Work  Reading: M & A pp 24-top of p 29.  Reading: M & A pp 24-top of p 29. Work through the text and the activities. Challenge yourself by doing Exercises 2.1 and 2.2 on page 54. The solution is on page 587.  You should bring the result of these Exercises to the seminar.  In addition, read the details of the Activity which follows. You should bring to the Seminar the three statements for day 3 of the lemonade stall.

Seminar Preparation Activity  On the third car boot sale that you attend, you decide to pay your friend back entirely. In addition you purchase another 250 cans of lemonade at 20p per can. This time the entry fee is £10, but it rains and you only sell 50 of your cans at 50p each.  Construct a cash flow statement, profit & loss account and a balance sheet. for the third day.