Accounting and financial considerations flashcards

Topic 6: Accounting and financial considerations

Short-term vs long-term sources of finance

Short-term: overdraft, trade credit, factoring. Long-term: shares, loans, debentures, retained profit. Internal sources: retained profit, sale of non-current assets, tighter working capital.

Accounting conventions

Consistency, going concern, accruals (matching), materiality, objectivity, prudence (conservatism) and realisation; accounts should give a true and fair view.

Cost centre vs profit centre

A cost centre collects costs. A profit centre earns revenue as well as incurring costs, so its profit can be measured.

Full, absorption and marginal costing

Full costing: all costs charged to units. Absorption: overheads added using a rate (e.g. overheads ÷ total hours). Marginal: only variable costs per unit; fixed costs treated as a period cost.

Fixed costs £18,000, price £9, variable cost £5. Break-even, and margin of safety at 8,000 units?

Contribution £4; break-even 18,000 ÷ 4 = 4,500 units. At 8,000 units, margin of safety = 3,500 units (43.75%).

When should a business accept a special order?

If its contribution is positive, there is spare capacity, and regular sales and prices are unaffected.

Straight-line vs reducing balance depreciation

Straight line = (cost − residual value) ÷ life: (30,000 − 3,000) ÷ 5 = £5,400 a year. Reducing balance = a fixed % of net book value: 30% on £20,000 gives £6,000, then £4,200; NBV £9,800. Depreciation cuts profit, not cash.

Working capital and the working capital cycle

Working capital = current assets − current liabilities. The cycle: cash out for inventory, production, sale, credit period, then cash in from customers.

Income statement: from revenue to retained profit

Revenue − cost of sales = gross profit; − operating expenses = operating profit; − interest = profit before tax; − tax = profit for the year; − dividends = retained profit.

Return on equity, earnings per share and price/earnings ratio

Return on equity = profit for the year ÷ equity × 100. Earnings per share = profit for the year ÷ number of shares. P/E ratio = share price ÷ earnings per share.

Dividend yield and non-current asset turnover

Dividend yield = dividend per share ÷ share price × 100 (6p ÷ 150p = 4%). Non-current asset turnover = revenue ÷ non-current assets.

Creditor days

Payables ÷ cost of sales × 365: how long the business takes to pay its suppliers.