Section 2: Accounting Basics - Part 3: Financial Statements

2.6 Types of Assets
1.  Liquid assets (or available assets) are anything that can quickly be turned into cash.
2.  Net current assets (or working capital) are the excess of current assets (such as cash, inventories, debtors) over current liabilities (creditors, overdrafts, etc.).
3.  Wasting assets are those which are gradually exhausted (used up) in production and cannot be replaced.
4.  Current assets (or circulating assets or floating assets) are those which will be consumed or turned into cash in the ordinary course of business.
5.  Intangible assets are those whose value can only be quantified or turned into cash with difficulty, such as goodwill, patents, copyrights and trade marks.
6.  Net assets or shareholders' equity, on a business's balance sheet, is assets minus liabilities (which is generally equal to fixed assets plus the difference between current assets and current liabilities).
7.  Fixed assets (or capital assets or permanent assets), such as land, buildings and machines, cannot be sold or turned into cash, as they are required for marking and selling the forms products.

2.7 Depreciation
2.7.1 PARAGRAPH:
     Fixed assets such as buildings, plant and machinery (but not land) gradually lose value, because they wear out or decay, or because more modern and efficient versions are developed. Consequently, they have to be replaced every so often. The cost of buying or replacing fixed assets that will be used over many years is not deducted from a single year's profits but is accounted for over the several years of their use and wearing out. This accords with the matching principle that costs are identified with related revenues. The process of converting an asset into an expense is known depreciation.
      Various methods of depreciation exist, but they all involve estimating the useful life of the asset, and dividing its estimated cost (e.g. purchase price minus any scrap or second-hand value at the end of its useful life) by the number of years. The most usual methods of depreciation is the straight line method, which simply spreads the total expected cost over the number of years of anticipated useful life, and charges an equal sum each year. The reducing or declining balance method write off smaller amounts of an asset's value each year in cases where maintenance costs for the use of an asset are expected to increase over time. The annuity system of depreciation spreads the cost of an asset equally over a number of years and charges this, and an amount representing the interest on the asset's current value each year.
     Some tax legislations allow accelerated depreciation: writing off large amounts of the cost of capital investments during the first years of use; this is a measure to encourage investment.
NOTE:
In the US, the word amortization is sometimes used instead of depreciation 

2.7.2 Add appropriate words to these sentences:
1.  A worn out or obsolete machine has to be replaced.
2.  Land, unlike machines, usually appreciate - i.e. it gains (or increases).
3.  To depreciate an asset accurately, you have to estimate its useful life.
4.  The materials that make up an obsolete machine can be recycled if it is sold for scrap.
5.  A percentage of the value of fixed assets is charged against or deducted from the profits and becomes a source of funds.
6.  Writing off a value means reducing it.
7.  Keeping a machine in good working condition is called maintenance.
8.  Accelerated depreciation allows firms that make capital investments to pay less tax.

2.8 Cash Flow

2.8.1 PARAGRAPH:

     Cash flow is essentially a company’s ability to earn cash. It is the amount of cash made during a specified period that a business can use for investment. (More technically, it is net profit plus depreciation plus variations in reserves). The flow of funds is cash  received and payments made by a company during a specific period – except that many people also use the term cash flow to describe this! New companies generally begin with adequate funds or working capital for the introductory stage during which they make contact, find customers and build up sales and a reputation. But when sales begin to rise, companies often run out of working capital: their cash is all tied up in work-in progress, stocks and credit to customers. It is an unfortunate fact of business lie that while suppliers tend to demand quick payment, customers usually insist on extended credit, so the more sell, the more cash you need. This provokes a typical liquidity crisis: the business does not have enough cash to pay short-term expenses. A positive cash flow will only reappear when sales growth slows down and the company stops “overtrading”. But companies that have not arranged sufficient credit will not get this far: they will find themselves insolvent – unable to meet their liabilities.

NOTE:

In the US the word inventory is used instead of stock(s).

2.8.2 Match word partnerships with the definitions:

1. Extended credit:       longer than normal payment terms.

2. Working capital:     the money and stocks of goods held by a company which are used to produce more goods and to continue trading.

3. Cash received:         money already paid.

4. Net profit:                the money made from selling goods after the deduction of all associated costs.

5. Liquidity crisis:       short of cash.

2.9 Financial Statements

2.9.1 PARAGRAPH:

     Companies are required by law to give their shareholders certain financial information. Most companies include tree financial statements in their annual reports.

     The profit and loss account show avenue and expenditure. It gives figures for total sales or turnover (the amount of business done by the company during the year), and for cost and overheads. The first figure should be greater than the second: there should generally be a profit – an excess of income over expenditure. Part of the profit is paid to the government in taxation, part is usually distributed to shareholders as a dividend , and part is retained by the company to finance further growth, to repay debts, to allow for future losses, and so on.

     The balance sheet shows the finance situation of the company on a particular date, generally the last day of its financial year. It lists the company’s assets, its liabilities, and shareholders’ funds. A business’s assets consist of its cash investments and property (buildings, machines, and so on), and debtors – amounts of money owed by customers for goods or services purchase on credit. Liabilities consist of all the  money that a company will have to pay to someone else, such as taxes, debts, interest and mortgage payments, as well as money owed to suppliers for purchases made on credit, which are grouped together on the balance sheet as creditors. Negative items on financial statements such as creditors, taxation, and dividends paid are usually printed in brackets thus: (5200).

     The basic accounting equation, in accordance with a principle of double-entry bookkeeping, is that Assets = Liabilities + Owners’ (or Shareholders’) Equity. This can, of course, also be written as Assets – Liabilities = Equity. An alternative term for Shareholders’ Equity is Net Assets. This includes share capital (money received from the issue of shares), sometimes share premium (money realized by selling shares at above their nominal value), and the company’s reserves, including the year’s retained profits. A company’s market capitalization – the total value of its shares at any given moment, equal to the number of shares times, their market price – is generally higher than shareholders’ equity or net assets, because items such as goodwill are not recorded under net assets.

     A third financial statement has several names: the source and application of funds statement, the sources and uses of funds statement, the funds flow statement, the cash flow statement, the movements of funds statement, or in the USA the statement of changes in financial position. As all these alternative names suggest, this statement shows the flow of cash in and out of the business between balance sheet dates. Sources of funds include trading profits, depreciation provisions, borrowing, the sale of assets, and the issuing of shares. Applications of funds include the purchase of fixed or financial assets, the payment of dividends and the repayment of loans, and, in a bad year, trading losses.

     If a company has a majority interest in order companies, the balance sheets and profit and loss accounts of the parent company and the subsidiaries are normally combined in consolidated accounts.

 2.9.2 According to the text, are the following TRUE or FALSE?

1.  Company profits are generally divided tree ways.                                                                        TRUE

2.  Balance sheets show a company’s financial situation on 31 December .                                        FALSE

3. The total in balance sheets generally include sum of money that have not yet been paid.                 TRUE

4.  Assets are what are own; liabilities are what you owed.                                                               TRUE

5.  Ideally,, manager would like financial statements to contain no items in brackets.                           FALSE

6.  Limited companies cannot make a loss because assets always equal shareholders’ equity              FALSE

7.  A company’s shares are often worth more than its assets.                                                            TRUE

8.  The two sides of a funds flow statement show trading profits and losses.                                       FALSE

9.  Deprecation is a source rather than use of funds.                                                                          TRUE

10.A consolidated account is a combination of a balance sheet and a profit and loss account              FALSE

2.9.3 The text above contains various British terms that are not used in the USA. Match up the following British and American terms:

BRITISH                                                                  AMERICAN

1. creditors                                                                accounts payable

2. debtors                                                                  accounts receivable

3. overheads                                                              overhead

4. profit and loss account                                            income statement

5. shareholder                                                             stockholder

6. share premium                                                         paid-in surplus