Financial Language 1.The language of business 2.Key concepts 3.Common terms 4.Fixed v. Variable Costs 5.Capital v Revenue Expenditure 6.Limitations of Financial Information 7.Smart Practice Guide Overview

Finance is … The language of business not just of accountants ❶ Communicate with colleagues and staff ❷Deal with accountants, investors and lenders

Key Concepts ConceptWhat it means True and fair The first principle guiding accountants when preparing a set of accounts is that they present a “true and fair “ picture of the results and position of the business Going concern The accounts are prepared on the basis that the entity will continue in the same business. This is important in matters like valuing assets which might have a very different value should the business fail or change its activity Historical cost or fair value Assets are valued at cost or market value whichever is lower. This can cause consternation when non-accountants see a balance sheet showing e.g. buildings at decades old values. Matching principle Matching is an accounting principle that requires a company to match expenses incurred within a period with the revenues arising in the same period. PrudenceObliges accountants to take the conservative view on events to ensure that assets are not overvalued, liabilities undervalued or profits overstated

Are items owned by a business: to generate sales and hence profits (fixed assets such as premises, plant and vehicles) Or to convert into cash (a current asset such as debtors and stocks) Assets

Are the funds provided to the business by way of loans, credit and deferred payments i.e. what it "owes". The amounts to be settled within the next twelve months are Current Liabilities And Those after twelve months “Long Term or “Non-current” Liabilities

Means rights and in finance refers to the rights of the owners to the surplus of assets over liabilities i.e. the Net Worth of the business aka Owners’ Funds. Equity (Owners’ Funds)

Capital employed is the total long term funding in a business i.e. Owners' Funds + Long Term Creditors. Capital Employed

Working capital (Net current assets) is the difference between Current Assets and Current Liabilities. A surplus of Current Assets over Current Liabilities means that funds are available to develop the business after meeting current commitments. A deficit means that the business is overtrading and could be at risk of failure, unless it can introduce additional capital. Working Capital (Liquidity)

A business is insolvent when it is unable to satisfy Creditors or discharge liabilities, either because: a)Of an inability to pay debts as they fall due or b)Its Liabilities exceed Assets and Owners Funds combined a) is a “liquidity crisis” i.e. an urgent but often recoverable situation. b) is called “Balance Sheet Insolvency” and is usually terminal as there is little if any value left in the business. Insolvent X

Fixed and Variable Costs Variable costs change in direct proportion to changes in sales volume. Materials which have to be included in every unit sold would be a good example. Fixed Costs: These are costs such as salaries and rent which do not automatically change as volume increases/decreases. They change abruptly in a steps-of-stairs pattern when their capacity is reached. € Increasing volume of output Sales Variable Costs Fixed Costs

Capital expenditure refers to "material" (significant relative to the scale of the business) expenditure on fixed assets. Such expenditure will not be charged in full to the profit and loss account in the period that it is made but will be phased or "written off" over the anticipated useful life of the asset in the form of a depreciation charge. This conforms to the principle of "true and fair" and avoids misleading distortions to profit from one period to the next. Revenue expenditure is repetitive expenditure on day to day items such as wages, goods for resale and overheads. The test is that the benefit of the expenditure will be used in the current accounting period as opposed to capital expenditure which creates benefits for a number of accounting periods. Capital v. Revenue expenditure

Limitations of Financial Information AreaWhat it means MoraleFinancial statements do not provide any direct information on staff morale MarketFinancial statements provide no information about market structure, trends or position. Game ChangersFinancial statements will not reveal anything about future technological, social, political or economic events that may have a major impact on the business.

Exercise Over 100 questions and 400 options in 6 categories

Test how variable and fixed costs behave What happens to Overheads when you increase selling price or the number of units sold? What would happen as you change sales if the Overheads were composed only of fixed or variable costs? Practice 6 – fixed and variable costs The best way to embed knowledge is to use FaBLinker to actually see how the terms and concepts work in practice Commission on sales

Practice 7 – Your ideas Liquidity Working Capital Gearing Loss Insolvent Profit Capital Expenditure Set up these situations in FaBlinker Revenue expenditure And any others you can think of