Finance for non finance managers

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Manjit graduated at the prestigious Aston Business School, the largest business school in Europe. His degree in Business Administration included a placement year with Deloitte Haskins & Sells, one of the top five Accountancy firms at the time.

He won the Ernst & Young prize for best Dissertation, based on his placement year.

He proceeded to continue his career with the newly merged firm Coopers & Lybrand Deloitte. His experience included auditing some of the top firms including National Grid, Barratt Homes and United Biscuits along with a number of local government institutions. He also spent some time in the insolvency and administrator department.

After 2 years with this firm he moved on to complete his CIMA accountancy qualification working for a number of firms including GRT Transport, Boots and Central & Carlton Television.

He spent 4 years in Edinburgh working for Lloyds TSB as a Business Implementation Manager and then went on to work for AMP UK Financial Services, the largest Insurance Company in Australia, as an internal management consultant.

He went on to work for Hays PLC as a Commercial Accountant, then finally decided to run his own business and get street experience, putting his entrepreneurial skills to the test. After selling his business at a young age, he now enjoys semi-retirement, working as a part-time lecturer, free-lance trainer, business consultant & Internet Marketing Coach.

Manjit has had extensive training in the Thompsett Project Management program, Quality Management Techniques and Customer care implementation. He delivers courses on all aspects of Accounting, Finance & Business including Finance for Non Finance Managers, Risk Anaylisis & Management, Forensic Accounting & Auditing, Corporance Governance.

The financial crisis brought turmoil to the world's financial markets and triggered a global recession that is only now showing tentative signs of abating in some of the major economies. Things have been tough for enterprises of all sizes and as the credit squeeze shows no immediate sign of easing it is likely to remain so for the foreseeable future. Some famous name companies have already gone out of business and no doubt there will continue to be high levels of business failures.

Lack of credit finance, fear of redundancies and loss of consumer confidence have all been blamed for the demise of many companies across several business sectors. But research shows that in any economic climate a lack of essential business finance skills is a major factor in the failure of many businesses. And when things get tough it is these key financial skills that will sort out the winners from the losers.

So what do we mean by “essential business finance skills”?

First and foremost we mean the efficient control of working capital and cashflow. Cashflow is the “lifeblood” of business and many businesses fail due to lack of cash. If you do not understand how working capital affects cashflow then you are much more likely to run out of cash!

We mean making the right pricing decisions so that we not only achieve strong sales but also produce the strong gross margins we need to cover the fixed costs of the business and generate strong profit. When funds are hard to find it is profit that generates the vital cashflow needed to fuel the engine of business growth.

And fundamentally, we mean the ability to interpret the financial statements that give us the information we need to apply these business finance skills.

If you are running your own business, or are a senior manager in a large organisation, these finance skills are critical in making the right decisions that will help your business to survive and thrive in any economic climate.

Acquiring these financial skills is not as difficult as many people believe. Of course, finance has its own jargon, but the principles are not difficult to master and in the hands of an experienced manager these financial skills can provide the formidable competitive advantage that comes from superior business decision making.

This manual accompanies the Mastering Financial Management course and has been designed and written to give you the essential business finance skills to help in the effective management of your business.

Paul Lower fcma

Key course topics

• Understanding Financial Statements

• Managing Working Capital

• Gross Margin and Profit

• Measuring Performance

• Budgeting

There is a glossary of financial terms at the back of this manual. It is not exhaustive but covers some of the terms we will be using in the course.

Fundamental requirement of financial statements

• Show “true and fair view”

• Prepared in accordance with:

o Generally Accepted Accounting Principles

o Financial Reporting Standards

o Local FRS

o International FRS

Four basic accounting concepts

• Going concern concept

o Assumes business will continue to trade for the foreseeable future.

o Assets are valued based on the cost to the business rather than what they might fetch in a winding up sale

• Accruals concept

o Also referred to as the “matching concept”

o All costs must be matched with sales in the period they were incurred

o Regardless of when they were actually paid

• Consistency concept

o Things must be treated the same from one period to the next

• Prudence concept

o Profit is not realised until a sale has taken place

o Provision is made for all known losses

Accounting policies

In addition to the basic accounting concepts a business will usually also have its own rules for treating certain items in the financial statements.

These “accounting policies” must be stated in the published company accounts and should be applied consistently from one period to the next.

Accounting policies will usually cover things like:

• Sales income recognition

• Depreciation of fixed assets

o Depreciation reduces the net asset value of fixed assets by an amount each year that reflects the reduction in value through its use.

o Depreciation is charged as a cost in calculating profit.

• Stocks and work in progress

o There are different ways of valuing stocks, each of which produce quite different results in the Balance Sheet and Profit and Loss Account.

• Research and development costs

Double entry bookkeeping

• Each transaction shown by two entries

• Two simple rules apply:

o DEBIT the account of the RECEIVER of value

o CREDIT the account of the GIVER of value


The Mega Toy Company Limited started trading on 1st January 2007.

The company imports toys and sells them to UK toy wholesalers and retailers. The two business partners had considerable experience in the trade and their good connections meant they quickly had orders from some of the large toy wholesalers.

The following transactions took place in the first three months and you have been asked to prepare the accounts and financial statements at the end of this period.

1. The partners put £400,000 cash in to the business as share capital.

2. The company rented a warehouse for £60,000 per year of which £30,000 was payable by cheque on signature of the lease as a prepayment of rent.

3. Racking and office equipment was bought by cheque for £40,000.

4. Salaries in the first three months were £20,000 and other overheads £18,000; both of these were paid by cheque.

5. In January stock costing £200,000 was bought and paid for by cheque.

6. In March stock costing £75,000 was bought on 30 days credit.

7. Sales and cost of sales in the period were:

Sales £245,000 sold on 60 days credit

Cost of stock sold £147,000

Freight costs £ 14,000

8. In March the company rented a stand at a major toy trade fair. Agreed rent was £17,000, but none of this had been paid or invoiced at 31st March.

9. Fixed assets are depreciated on a straight line basis over 5 years

Balance sheet

• A snapshot of the company’s financial position

• As at the balance sheet date

• The balance sheet shows

o What the company owns = assets

o What the company owes = liabilities

o How these are financed = capital employed

IFRS versus US terminology

If you use or have seen US financial statements you have probably noticed some different financial terms being used:


Balance sheet Statement of financial position

Land and buildings Property (real estate)

Stocks Inventories

Debtors Receivables

Creditors Payables

Bank loans and overdrafts Notes payable

Called up share capital Capital stock – common

Gearing Leverage

Merger Pooling of interests

Company Corporation

Profit and loss account Income statement

Turnover or sales Net sales or revenue

Profit after tax Net income or earnings


Simon Scott founded the company in 2006. Simon’s background was as a software developer and until 2006 he had worked for a large software company. After founding Sapphire Software he continued to work for his former employee as a consultant in order to finance the development of an innovative software product.

At the end of 2009 the new software was completed, debugged and beta tested. The new software was unlike anything that was previously available; according to the trade press the product had enormous potential. Sapphire Software planned to start marketing the new product in the first quarter of 2010.

Until the end of 2009 the company had made small profits entirely from the consulting activities undertaken by Simon Scott. The Balance Sheet is shown below.

Simon’s former employer had been disappointed when he left the company in 2006. They had established their own reputation by developing innovative new software products for more than 25 years. When they heard that Sapphire Software had beaten them to developing a valuable new product they were very keen to acquire both the product and Simon Scott for themselves.

They offered Simon £750k to buy 95% of the shares in Sapphire Software on condition that he took up the position as their Senior Software Developer.

How might Simon Scott’s former employer have arrived at the valuation of £750k to buy 95% of the shares in Sapphire Software?

What items not shown on the Sapphire Software Balance Sheet might have been taken in to account in arriving at the offer price?

Profit and loss account

• Technically part of the capital section of balance sheet

• A statement of trading performance for the period

• The profit and loss account shows

o Sales

o Cost of goods and services sold

o Gross profit

o Other costs of running the business

o Profit

What is EBITDA?

ebitda is earnings (ie. profit) before interest, tax, depreciation and amortisation.

ebitda is the company’s operating profit excluding non-cash accounting charges reflecting the write-off of tangible (depreciation) and intangible (amortisation) assets.

It is used as an approximation to cashflow generated, although it does not take in to account the impact on cashflow of increases or reductions in net working capital.

Where net working capital is relatively stable ebita is a very good indication of cash generated by the business and which can be used to pay:

the banks, in the form of interest,

the taxman and

the shareholders, in the form of dividends

Cashflow statement

• A bridge between profit and loss account and balance sheet

• The cashflow statement shows

o Where funds have come from

o How funds have been applied in the business

o Cashflow in the period


Big Tree Books publishes children’s books and has been trading for several years.

The Trial Balance at 31st December 2007 is shown below.

Please use the pro forma statements on the following pages to prepare:

The Balance Sheet as at 31st December 2007

The Profit and Loss Account for the year ending 31st December 2007

The Cashflow Statement for the year ending 31st December 2007

Working capital is the circulating cash in the business

People say that cashflow is the lifeblood of the business

That’s a good way to think about working capital


Kosi-Knit Sweaters has been in business for several years selling hand knitted sweaters to the UK clothing retail trade. In the two years to the end of 2006 sales had been declining; a significant number of the company's traditional small retail customers had suffered in recent years under competition from the major chain stores. However, it was thought that the sales decline was also due in part to the fact that many of the company's knitwear designs were old fashioned.

In 2007 the company employed a young new designer added some new and fashionable designs to the product range.

The company also opened new accounts with several large fashion chain stores, albeit on longer payment terms than the 30 days allowed to their traditional accounts.

As a result of these measures sales increased in 2007.

Until 2007 all of the sweaters had been manufactured in Eastern Europe. Delivery from this supplier takes 4-5 weeks from order and stock is invoiced on shipment. Payment terms are 60 days on invoice.

In 2007 several batches of sweaters were imported from China in an effort to reduce costs and improve gross margins. These sweaters were paid for by 50% cash transfer on order and 50% paid in cash before shipment. Delivery from the Far East usually takes 14-15 weeks from the order being placed.

In January 2008 the company was ready to place and order for £500,000 worth of new spring stock from China but found itself without the cash to pay the deposit.

The Profit & Loss Account for the most recent two years is shown below.

Please comment on sales and profit performance for the most recent year.

The Balance Sheet as at the end of the last two years is also shown below.

Please comment on any significant changes in the balance sheet.

How would you describe Kosi-Knit’s cash position?

What factors might have resulted in changes to the balance sheet?


Quick Byte Computers makes desktop and laptop computers. In July 2008 the company gets great news: the Sales Manager has negotiated a deal to supply a major retail chain with their new laptop. The sales value of the order is £600,000.

The company’s gross margin on this order will be 25%. This is less than the 40% margin they normally make but there is spare production capacity and the computers can be built without incurring any additional labour costs. This will guarantee a profit of £150,000 on the deal.

The customer wants the whole of the order to be ready to ship in the first week of September but has said it will probably have them delivered in three equal monthly batches starting from September 2008

Quick Byte will invoice the customer on delivery of the laptops. Payment terms are 60 days after the end of the month in which the invoice is submitted.

The components for the laptops are imported from Eastern Europe. Delivery takes 3 days and the supplier’s payment terms are 30 days after the end of the month in which the components have been delivered.

It will take 30 working days (6 weeks elapsed time) to build the computers.

Quick Byte’s most recent profit and loss account and balance sheet is attached.

Please use the pro forma below to prepare the cashflow statement for the year ending 30th June 2008

Comment on the financial performance of the company in 2007 and 2008

Comment on the financial strength of the company at 30th June 2008

Estimate how much Quick Byte Computers will need to fund the deal for each of the next six months.

How might Quick Byte Computers fund this working capital requirement?

Would you recommend that the company sign the deal in its present form?

If so, why?

If not, why not?


The UK is suffering its deepest and longest recession

for many years; there have already been many

business failures and no doubt there will be more

before we see economic recovery. But not all sectors

have suffered to the same extent.

Come boom or bust the barrow boys always do well;

they never seem to be short of cash and still take their

foreign holidays. How do they do it?

The barrow boy is the master of the essential business finance skills – but you

never see him reading a computer report. So why are they so successful?

Here are ten reasons why these businesses perform consistently well. The same principles could be applied to many other businesses with the similar results.


• Barrow boys understand business cashflow and deal in cash whenever possible

• They maintain short supply chains and can accurately estimate daily demand

• All or most stock is sold on the day and little unsold stock has to be funded

• Barrow boys don’t give credit to their customers

• They know the gross margin on every item in their small product range

• Barrow boys know exactly where their break-even point is and use ‘dynamic pricing’ to maximise their cashflow and profit

• Their businesses have flat management structures and few decision makers

• Salary costs are kept low

• Other business overhead is kept low: fixed costs are kept to a minimum

• They have clear objectives; they know which market they are in and they understand how to satisfy their customers’ needs


You are the Chief Financial Officer of The Bright Spark Electronics Company.

The Bright Spark Electronics Company has been in business for 10 years. The company imports electronics components and sells them wholesale to electronics shops and to manufacturers of electronic equipment and computers.

Over the last two years sales and profits have been falling.

The Profit & Loss Account for the last two years is shown below:

Calculate the break-even sales level for each of the two years

Fixed costs

Gross margin percentage


Explain why the profit in 2008 less than it was in 2007

Suggest five ways in which profit might be improved


The company sell thousands of different electronic components. The calculation on the next page shows the gross margin per unit, average annual sales volume and the resulting margin on sales produced by this special memory chip.

This is one of the company’s best selling items. The Sales Director has suggested that in order to boost sales, the price of this item should be reduced by 10%. The Sales Director believes this could increase annual sales volume by 20%.

Calculate the unit gross margin after the 10% price reduction.

If the selling price is reduced by 10% what percentage reduction will there be in the gross margin on each memory chip?

If after the price reduction the annual sales volume goes up by 20% what will be the annual margin on sales from this component?

If this is less than the gross margin on sales before the price reduction, what increase in sales volume will be required as a result of the price reduction in order to produce the same gross margin on sales as before the price cut?

What other pricing strategies could the company apply?


Skanda Kitchens imports Scandinavian kitchen cabinets to supply UK wholesalers and retailers; The company also sells directly to UK consumers through its planning and design service.

Originally formed in 1998, the company was listed on the Alternative Investment Market (AIM) in 2001 and raised capital for expansion through a share issue and a long term bank loan.

The financial statements for the company are shown on the pages following

Who might be interested in the company’s performance and why?

What kind of financial measures will tell them about the company’s performance?

What kind of non-financial measures be interesting to them and why?

Who might be interested in the performance of Skanda Kitchens?






How might they measure the company’s performance?

Financial measures:






Non-financial measures:






BP is one of the world’s leading oil and gas companies and is also one of the world’s largest companies by any measure. The company has been in the news this year because of the disastrous events in the Gulf of Mexico, the impact of which will be reflected in the company’s results for the year ending December 2010.

BP’s financial statements for the year ending 31st December 2009 are shown on the following pages.

Refer to the formulae on the previous page to calculate the ratios in the following:

1. Calculate the Return on Net Assets for BP for 2008 and 2009. Remember that to calculate Net Assets the current liabilities should be deducted from total assets.

2. Calculate the Profit Margin for 2008 and 2009.

3. Has the company’s Profit Margin improved or deteriorated?

4. What additional information would you request to find out more about the profit margin and explain the change from 2008 to 2009?

5. Calculate the Net Asset Turnover for 2008 and 2009.

6. Has the Net Asset Turnover improved or deteriorated?

7. Is it possible to explain why the Net Asset Turnover has changed?

8. Calculate any other ratios you think might be helpful to explain why the Net Asset Turnover ratio has changed. What do they tell you?

9. Calculate the company’s Debt Ratio for 2008 and 2009.

10. What other information would you ask for in order to form a full opinion about the BP’s financial performance in the two years?

Tesco is a UK company and is the third largest supermarket business in the world. Tesco operates 4,300 stores in 14 countries and employs 470,000 staff.

The company has grown steadily over the last twenty years.

Sales in 2009 were over £59 billion

Profit before tax was £3 billion

What kind of risks might Tesco identify?

Which of these risks might pose the most serious threat to the business?

Skanda Kitchens

The company has traditionally sold its kitchens through three channels:

1. Contract sales to construction companies for installation in new build properties

2. Wholesales to do-it-yourself stores

3. Online direct sales to retail consumers with a web-based planning service

The company is now considering whether to open its first traditional retail store. You have been asked to advise the company whether it is better to buy its own store or to rent the equivalent space in one of the large department stores. Please base your advice on the following assumptions:

000’s omitted OWN STORE DEPT STORE

Annual sales £2,000 £2,000

Gross margin £ 800 £ 800

Rent £ nil £ 100

Other operating costs £ 400 £ 400


Depreciation £ 100 £ 100


Cost of freehold building £1,000 £ nil

Cost of fixtures and fittings £1,000 £1,000

Freehold property is not depreciated. Fixtures and fittings are depreciated over 10 years on a straight line basis.

You can assume that at the end of 5 years the freehold value of the property will be £1.3m and the fixtures and fittings will have a net disposal value of £600.

You can assume that the trade in the retail business could be sold for £1.5m under both scenarios at the end of 5 years.

The company will finance the project from its own funds. The company’s weighted average cost of capital is 10% pa.

Taxation can be ignored.

You are required to evaluate and compare the two investment opportunities

1. Using the Accounting Rate of Return method

2. Using the Payback Method

3. By calculating the Net Present Value after 5 years using discounted cashflow

Drucker’s Categories of Objectives

• Financial

• Innovation

• Market standing

• Productivity

• Worker performance and attitude

• Social responsibility

Balancing objectives

• Take care to avoid goal conflict

• Establish primary and secondary objectives

• Optimise to satisfy various stakeholders

• Third largest supermarket business in the world

• Operates 4,300 stores in 14 countries

• Has 470,000 staff

• Sales in 2009 were over £59 billion

• Profit before tax was £3 billion

What might be the objective(s) of Tesco’s various stakeholders?

Use the table below for your suggestions

|Stakeholder group |Objectives |

| | |

|Shareholders | |

| | |

|Managers / directors | |

| | |

| | |

|Employees | |

| | |

|Customers | |

| | |

|Suppliers | |

| | |

|Government | |

| | |

|Public | |

Strategic planning is concerned with matching the external environment with the organisation’s internal environment. Various tools can help with this process:

PESTEL analysis







Porter’s Five Forces

SWOT analysis





Tesco is an international business and has grown its business significantly over the past 20 years by expansion in to new countries.

You have been asked to advise Tesco on its possible entry in to the Nigerian market.

Prepare a PESTLE analysis of the external environment in which Tesco would find itself operating in Nigeria.

Use Porter’s Five Forces model to analyse the competitive environment Tesco would encounter in Nigeria with respect to the supermarket and grocery sector.

What might be Tesco’s strengths in entering the Nigerian market?

What might be Tesco’s weakness?

What opportunities might Tesco encounter?

What threats might they find?

The Contemporary Style Store

CSS is a large retail department store selling furniture, curtains and other soft furnishings. Two years ago CSS recruited a new Chief Executive Officer from a large business services company. One of the new CEO’s first actions was to introduce a new budgetary control system that was intended to bring more accountability to the department managers. The new system gave the managers full responsibility for the controllable department costs; the central costs of the business are allocated to the departments by means of a recharge system. A new Chief Financial Officer was recruited to make sure the new system was successfully implemented.

The business has developed well under the guidance of the new CEO. However, the introduction of the new budgetary control systems has not gone well. You have been recruited as a management consultant to investigate the problems with the new budgeting system. You have made the following transcriptions of interviews you recorded with some key people.


I don’t understand it. I certainly didn’t have these problems in my last company. The people understood the system and its objectives; they certainly didn’t play games! By that, I mean that they didn’t build in a ‘fudge factor’ to their budgets. In the first year of the new system we were well over budget on expenses. This year, because the managers gave themselves soft targets, we are well under budget but higher than last year. I didn’t see the kind of cost reductions I was looking for after the big capital investment we made in up to date IT and electronic point of sale equipment; in other words sophisticated electronic tills. It looks like the managers are just taking the previous year’s costs and adding 10%. As for the monthly reports – I never know whether they are real overspends or whether it is just because they have been careless with the way the costs have been phased across the year. I really need more warning about the way the year is shaping up. What I would really like is budget figures that make people stretch a little but also fit our business objectives.


I am not going to put forward another brave budget like I did last year. Last year they published a league table of how department managers performed against their budget and it was pretty embarrassing for me, I can tell you. This year I am going to build in plenty of slack to my budget; if they publish that table again it won’t be me at the bottom! I will budget for next year on the basis of what I have spent this year with 15% on top. I know that when they look at my budget they will ask for a 5% saving straight away, without even discussing the issues I have to deal with. As far as the income budget is concerned I will tell them that there is no way we can expect to increase it in this economic climate.

As for the forms and budget procedures – they just take way too long. I have a department to run. Every month I am expected to complete this massive form about everything I have spent and what I am going to spend the rest of the year. What use is all of this? It was designed by the accountants FOR the accountants so that it looks like they are important. There is no help from them to show us how to get the best from it or to show us how it might make us better at doing our jobs. There asking me about forecasts for next year and it takes them three weeks to tell me how well I did in the previous month. It’s nonsense!


Every month we produce reports that show the actual spending compared to budget and we never get any sensible response back from the managers to explain the budget variances or to say what action they are going to take to fix the over-spending. All we get is complaints and moans about the way we have phased the budgets over the year. They don’t understand that it’s not down to us accountants how their budgets are cut; but that doesn’t make any difference. At all management levels in this company they have poor budget discipline – it’s like they don’t know that the budget is there to be followed. They’re always trying to be too creative and too clever for their own good. They try to hide costs in the wrong accounts so that we think they are managing costs. All they are doing is messing up our financial accounting system.


I am completely fed up with this new budgeting system – it just gives me a headache. First of all it’s far too complicated; secondly it seems to take the accountants weeks to get the reports out showing how much I have made in income and how much I have spent. When I get the report it’s worked out to the penny: maybe they spend too long worrying about the pennies instead of the pounds! When I finally get the report I get no explanation from my department managers about any of the variances so it’s all pretty meaningless. What’s more the department managers have become clever at beating the system. I found out that Freddie Hubbard, the manager of the furniture department, was spending money just to make sure that he used up his entire budget so that it wouldn’t be cut next year. I also found out that Ben Webster from the curtain department had arranged with one of his suppliers to hold back an invoice for two weeks so that it wouldn’t make his costs overspent. This is no way to run a business!

Please answer the following questions

1. What should be the main purpose and objectives of the CSS budget system?

2. How is the current budget system failing to meet these objectives?

3. Comment on the “games” being played in the budget process, for example

Deliberate miscoding of invoices

Managers submitting low targets to make life easy and improve ratings

Delaying invoices in order to depress current month costs

Using budgets as a maximum spending limit rather than target

4. How could these games be stopped?

5. Should managers be allowed to exceed budget spending limits?

6. Should managers be allowed to offset savings in one area against over-spends in a different cost area?

7. Why might managers complain that too much time is being spent on budgeting?

8. What steps would you recommend to make the budget system more effective?


Shown below is the summary Budget Report for June 2008, showing the company’s actual performance compared to budget for the month and the year to date.

Please comment on the company’s performance for the month and year to date.

What further information would be helpful in getting the “full picture”?

What action do you think should be taken?


A budget can be an important tool to both control the business and act to motivate the managers responsible for running the business. Variances are the differences between actual and budgeted results that highlight areas where action might be needed to bring the company’s performance back in to line with budget. Key to this process is keeping managers informed about actual results and how they compare to budgeted expectations.

• Reports should be clear and comprehensive

• The ‘exception principle’ should be applied to highlight significant variances

• Reports should identify controllable costs and revenue items which can be directly influenced by the manager who receives the report

• Reports should be timely to allow corrective action to be taken as soon as possible

• Information must be accurate enough for its purpose but without unnecessary detail

• Reports should be directed to the manager who has responsibility and the authority to act on the matter

Accruals and accrued charges

Outstanding expenses which have been incurred in an accounting period but which have not yet been paid.

Also relates to cash received for goods and services to be provided in a future accounting period which is also referred to as Deferred income.

Accruals accounting

A method of maintaining financial accounts and preparing financial statements using the Accruals concept. Income and costs are recognised in the financial accounts and financial statements when they are earned and incurred, rather than when cash is received or paid out. This is unlike Cash accounting, where income and expenditure is recognised purely on the basis of when the cash receipt or payment has taken place.

Accruals accounting is generally considered to be the better basis for assessing how well an enterprise has managed or exploited its resources and it is a better basis for financial decision making. For these reasons accruals accounting is used by the vast majority of business enterprises. It is also used by many countries for government budget accounting, when it is often referred to as resource accounting.

Accruals concept

One of the four basic accounting concepts that form part of gaap. The Accruals concept says that income should be recognised in the financial statements in the period in which it is earned, rather than in the month in which payment is actually received in cash from the customer.

Costs should be “matched” with the income which they have generated and recognised in the financial statements in the month in which they are incurred, rather than the month in which they are actually paid.

The Accruals concept is also referred to as the “Matching concept”.

Acid-test ratio

A measure of the company’s ability to meet its short-term commitments. It is calculated by dividing current assets, excluding stock, by current liabilities. Current assets are debtors (amounts from customers and others), cash balances, and short-term investments which can easily be converted into cash. Current liabilities include amounts due to suppliers, bank overdrafts, amounts due for unpaid expenses, such as telephone bills, and taxes payable.


A reduction in debt by periodic payments covering interest and part of the principal. The term is also used for the process of writing down intangible assets such as a leases, copyrights and patents etc.


Everything that a company owns or that is due to it: including cash, investments, cash due, materials and stocks, which are called current assets; buildings and machinery, which are known as fixed assets; and patents and goodwill, called intangible assets.

Asset turnover

This is a ratio which measures the effectiveness with which a business uses its assets to generate sales activity. It is calculated by dividing sales by total assets. A variation is to divide sales by the capital employed.

Balance sheet

A statement of the financial position of a business at a particular date showing the various categories of assets and how they have been financed.

Book value

The value of an asset as recorded in the accounts. For a fixed asset it will be the original cost (unless amended by revaluation) less the depreciation which has so far been accumulated on it, often called the written down value.

The book value of an ordinary share is the sum of the ordinary share capital and reserves divided by the number of issued shares.

Break-even point or break-even sales

The most important dividing line in business: break-even point is the sales level at which the business just covers its costs. At sales below this level the business will make a loss; at sales above this level the business will make a profit. Break-even sales units can be calculated by dividing fixed costs by the gross margin per unit.

Business cycle

See trade cycle.

Capital employed

This is a term for which there are a variety of definitions. Two common ones are:

total assets less current liabilities, equal to the long-term funds invested in the business in the form of long-term liabilities, debt and equity.

equity plus total interest-bearing debt

Capital expenditure (CapEx)

Expenditure on fixed assets such as plant and equipment. Except for land, the cost is spread over several financial periods through the process of depreciation. The value of the fixed assets (at cost or valuation less the depreciation accumulated to date) is shown in the balance sheet. The depreciation charged each year is an operating cost in the profit and loss account of income statement.

Capital gearing or gearing

The proportion of total finance debt or borrowings in relation to shareholders’ funds. It is commonly measured by the debt to equity ratio.

In US terminology, gearing is known as financial leverage.

Capitalisation or market capitalisation

Usually the value of a company based on the market rates for its shares; it is therefore, equal to the number of shares issued times the market price for the share, summed for all the types of shares issued.

Sometimes used to include the market value of all the company's traded securities, including bonds and debentures.

Cash accounting

A method of maintaining financial records and preparing financial statements based purely on the movement of cash and where income and expenditure is recognised purely on the basis of when the cash receipt or payment has taken place.

Although Accruals accounting (or resource accounting as it is also known) is generally considered to be a better basis for assessing how well an enterprise has managed its resources, cash accounting is still used by many countries as the basis for government accounting. This is because cash accounting is simpler to operate and, perhaps more importantly for some countries, makes it easier to match income received through taxation with government expenditure.


Usually used to mean the generation of cash by a business through its operations, and to be equal to profits, plus amounts charged which do not reflect movements of cash (such as depreciation), less any fresh working capital investment (or plus working capital divestment).

Cash flow statement

A statement which explains the impact of a company's trading, investment and other financial transactions on changes in the company's cash position. The cashflow statement provides a bridge between the Profit and loss account and the opening and closing Balance sheets.

Collection period

The average length of time taken for a customer to pay a sales invoice. It is calculated by dividing trade debtors by annual sales times 365 days to give the average number of days for which the sales invoice has been outstanding. (An allowance may have to be made for any sales, taxes or VAT included in invoices but not in reported sales).

Consistency concept

One of the four basic accounting concepts that form part of gaap. The Consistency concept says that items must be treated in the financial statements in the same manner from one period to the next.


The charge against profits made for the use or consumption of resources during an accounting period. It is not necessarily the same as the cash actually spent in the period in view of adjustments for depreciation, accruals and provisions. Different definitions of cost are required for different purposes.

Cost of sales or Cost of goods sold

This is the cost to the business of the products or services sold to its customers.


Any person or organisation to whom a business has a commitment apart from shareholders (who own the business). For example, trade creditors are suppliers of goods and for whom unpaid bills are outstanding. It is a legal requirement to distinguish between short-term creditors (due to be paid within 12 months of the balance sheet date) called current liabilities, and long-term creditors (amounts due to be paid after one year). A typical example of a long-term creditor is a bank term loan. Short- and long-term borrowings are disclosed separately and so are other creditors.

Current assets

Assets such as debtors and stocks, which can be converted into cash within 12 months of the balance sheet date. Cash balances and short-term investments (such as stock market investments) are also part of current assets, and they are referred to as liquid resources.

Current liabilities

Short-term liabilities which have to be paid normally within 12 months of the balance sheet date. Examples are trade creditors, bank overdrafts and accrued charges.

Current ratio

The ratio of current assets divided by current liabilities. It is a broad measure of the ability of a business to meets its short-term commitments. The acid-test ratio, however, is a more sensitive measure. Current assets less current liabilities equal net current assets or working capital.


A form of long term borrowing which may be secured by a mortgage or lien on a specific asset, on which a stated rate of interest (which may float) is paid, and which normally has a fixed repayment date (or range of repayment dates). Debentures may be traded on the Stock Exchange. See Bond.


Interest-bearing liabilities such as short- and long-term bank loans.

Debt-equity ratio

The relationship of total interest-bearing borrowings to shareholders’ funds. It is known as a gearing or leverage ratio.


Amounts due from third parties. The largest element is usually trade debtors - amounts due from customers (US term is Accounts Receivable).


Charges against earnings to write off the cost, less salvage value, of an asset over its estimated useful life. It is a bookkeeping entry and does not represent any cash outlay, nor are any funds earmarked for the purpose.

Deferred income

Cash received for goods and services which are to be provided in a future accounting period. Such receipts cannot be taken in to current period under the Accruals accounting convention because the income has not yet been earned.


A payment designated by the board of directors and approved by the shareholders to be distributed pro rata among the shares outstanding. On preferred shares, it is generally a fixed amount. The dividend for ordinary shares varies with the fortunes of the company and the amount of cash available, and may be omitted at the discretion of the directors. Sometimes a company will pay a dividend based on past earnings even if it is not currently operating at a profit (to meet the expectations of the investors); the dividend is then said ‘not to be covered’.


The profit after taxation and all other charges less preference dividends and the minority interest and after exceptional and extraordinary items. It is the profit attributable to the ordinary shareholders.

Earnings per share

The earnings divided by the number of issued ordinary shares.


Earnings before interest, taxation, depreciation and amortisation. EBTIDA is effectively a measure of operating cashflow generated during the period, ignoring any changes in the level of working capital. Sometimes used as a method of valuing business in terms of a multiple of EBITDA.

Sceptics have suggested that its popularity in recent years is due to the fact that the large interest payments and goodwill amortisation charges associated with highly levered takeovers and acquisitions are excluded from the EBITDA calculation.


The ownership interest of ordinary and preferred shareholders in a company.


Bonds denominated in a currency other than that of the national currency of the issuing company or organization (nothing to do with Europe!).

Fixed assets

Assets such as property, plant and equipment, which have been invested to provide the basis of the company's long term future.

Fixed costs

The costs of a business that are related to time rather than the level of sales; salaries and rent are examples of the fixed costs most businesses incur. One of two fundamental types of business cost, the other being variable costs.

Funds flow

Any transaction which has led or will lead to cash inflows and/or outflows.

The funds flow from operations is the sum of profits and those items included in the calculation of profit, such as depreciation, which do not involve the flow of cash.


See Capital gearing

Generally accepted accounting principles – gaap

The basic accounting principles applied in the preparation of the financial statements of most companies in the developed economies. gaap is based on the basic requirement that the financial statements give a “true and fair view” of the financial performance and position of the company and is also based on the four basic accounting concepts of Going concern concept , Accruals concept, Consistency concept and Prudence concept.

Going concern concept

One of the four basic accounting concepts that form part of gaap. The Going concern concept says that financial statements should be based on the assumption that the business will continue to trade for the foreseeable future. This means, for example, that fixed assets are valued at net book value (the cost of the asset minus the accumulated depreciation) rather than what they might fetch in a winding up sale.


The excess paid by an acquiring company over the book value or fair value of the net assets of another company.

Gross margin

What is left after deducting variable costs from sales. Gross margin is used to calculate break-even point; break-even is achieved when the fixed costs are covered bv the gross margin.

Gross profit

The difference between sales and the direct cost of sales. Gross profit is shown in published financial statements and is calculated by deducting direct costs which can be either fixed costs or variable costs.


The reduction or elimination of risk and uncertainty by taking out a position in a financial market opposite to the actual position held. Forward contracts are a means of hedging, as is the use of various financial instruments known as derivatives. Derivatives for hedging commodities, currencies and interest rates include futures, options and swaps.

An example of hedging would be a company with an unpaid customer invoice for €1m that was due for payment in 6 months time. There is a risk for the company that the £/€ exchange rate could deteriorate significantly over that period and reduce the amount the company would realise in £. One way to remove the risk would be to enter in to a forward contract with the bank to sell €1m in 6 months time at a rate that could be contractually fixed today.

Historical cost (HCA)

This is the traditional way of valuing assets in a balance sheet and costs in the income statement. The criterion for valuation is the acquisition cost. This system of accounting is known as historical cost accounting (HCA), or as accounting in accordance with the historical cost convention.

Income statement

See Profit and loss account.

Intangible assets

Items of value to a company that do not have a physical shape; examples are patents and trade marks (often at notional values), goodwill, and brands may also be included.

Interest cover

An indicator of solvency; it is calculated by expressing profit before interest and taxation (the operating or trading profit) as a multiple of the interest charge.


The American term for stock.


Leasing is a means of financing the use of capital equipment ( Fixed assets ), the underlying principle being that use is more important than ownership. Usually a medium term financial arrangement of one to ten years by which the lessee has the use of the equipment and a contractual obligation to make payment to the owner of the equipment, known as the lessor. The two main types of equipment leases are Capital leases and Operating leases.


Amounts owed by the business. Its usage varies: ‘total liabilities’ can mean the shareholders’ interest plus amounts due to creditors, or it may be used to mean amounts owed to third parties (creditors) only (US).

London Interbank Offer Rate – LIBOR

The interest rate at which banks lend to each other. Closely related to bank base rate, it is frequently used as the reference by which variable interest rates on bank loans to its customers are determined: for example LIBOR plus 2 percentage points.


A measure of the ability of a business to meet its short-term commitments. If expansion is too rapid trade debtors and stocks may increase to such an extent that creditors cannot be paid reasonably promptly because cash flow or cash generation is inadequate. This is called overtrading. See also the ‘acid-test’ and the current ratios.

Liquid resources

Cash and bank balances plus short-term investments which can be easily liquidated.

Matching concept

See Accruals concept

Net assets

Total assets less all creditors. It is therefore equal to shareholders’ funds or equity. Revisions of asset value from book value to realisable value, say, during an appraisal of a company's worth will increase net assets and involve an appreciation of the value of the shareholders’ investment.

Net asset turnover

See Asset turnover.

Net current assets

See Working capital

Net realisable value

The value that could be obtained by disposing of assets. It is normally not used in accounts, except in the valuation of stocks. If the realisable value is less than cost, then net realisation value should be the basis of stock valuation.

In the UK, property companies revalue their property investments to market or realisable value in their accounts.

Net worth

Synonymous with Net Assets, and therefore with Equity (US).

Nominal value

The face value of a security. In the case of a share, it is also known as the par value, and often reflects the price at which shares were originally issued. However, a new share issue later may be issued at a price well above the nominal value (see Share premium). The nominal value has normally no significance for the market value at which a share is traded.

Operating costs or Operating expenses

All costs excluding interest charges and taxation. They represent those costs most directly under the control of line or operating management. Turnover or sales less operating costs equals operating or trading profit.

Operating gearing

The relationship between the fixed costs and the variable costs of a business. A business with fixed costs of £3m and variable costs of £1m is highly geared. The higher the gearing, the greater will be the impact on operating profit of any changes in sales volume.

Operating profit

Profit before interest, finance charges and taxation.

Ordinary shares

Usually the bulk (if not the entirety) of the Share Capital of a company. There may also be preferred shares; there can be different classes of ordinary shares. The equivalent US term is common stock.


Overtrading is caused by a rapid expansion in sales resulting in an increased working capital requirement beyond the level that can be funded by the business. See liquidity.


Money owed on a bank current account. A form of short-term borrowing repayable on demand.

P/E ratio

The market price of a share divided by the earnings per share.

Preferred shares

Dividends or preferred shares must be paid before dividends may be paid on ordinary shares. They are paid at a set percentage of the nominal value of the preferred share. For cumulative preferred shares, all past unpaid dividends must be paid before an ordinary share dividend is paid.


A cash payment includes an element covering a future accounting period. An example is rent paid in advance. Prepayments and Accruals are a feature of Accruals accounting.


The difference between sales and costs for an accounting period. In view of the ‘matching’ principle, it is not the same as cash since revenue is recognised when goods or services are supplied (rather than when paid for by the customer) and costs are incurred during the time period to which they relate (rather than when they are paid in cash). See Income.

Profit and loss account or Income statement

A summary of the sales revenue or turnover and costs for an accounting period. The profit and loss account is concerned with financial performance during a given time period whereas the balance sheet is concerned with the financial position at a particular date. The US term is Income statement

Profit margin

A measure of the profitability of sales. It is defined as the profit before or after interest and taxation expressed as a percentage of sales.


An additional allowance for a cost or charge incurred but not paid for at the balance sheet date. A provision is included as a cost in the profit and loss account and a liability in the balance sheet. See accruals and accrued charges.

Prudence concept

One of the four basic accounting concepts that form part of gaap. The Prudence concept says that the profit on any item should not be recognised until the sale of that product has taken place. Provision should be made in the financial statements for all known or likely losses, as soon as they become apparent.

Realisable asset value

The price at which an asset, a group of assets or a business could be sold.

Replacement cost or current cost

Assets may be valued at their replacement cost rather than their historical cost. This is sometimes done in management accounts so that a business is charged with current cost rather than historic levels. It is the basis of Current cost accounting.


Realised and unrealised gains which have added value to the business, and which form part of the shareholders’ investment. Realised gains are retained profit; unrealised gains arise from revaluation of assets. A third form of gain is the share premium paid over and above the nominal or par value of new shares issued.

Retained profits

The profit for the year after all charges and the distribution of dividends to shareholders. The figure for retained profit in the balance sheet will be the accumulated retained profit since the business started to trade.

Replacement cost

The cost of replacing the asset in question, used as the basis for depreciation in current cost accounting.

Resource accounting

See Accruals accounting.

Return on capital employed (ROCE) or Return on net assets (RoNA)

Operating profit before interest and taxation expressed as a percentage of capital employed (or Net assets). It is a basic measure of business financial return.

Return on equity (RoE)

One definition is profit after taxation divided by the Shareholders’ funds. It is a measure of financial return for the investors in the company.

Revenue expenditure

Expenditure charged to the Profit and Loss Account or income statement in the year of the expenditure, and not capitalised. See Capital Expenditure.

Rights issue

The sale of additional shares by a company to its existing shareholders (in proportion to their existing holdings) normally at a discount to the prevailing stock market price in order to ensure a successful issue.


The invoiced values of the goods and services provided to customers during the accounting period. Also termed revenue or turnover (UK).

Secured loan

As loan against which a certain asset or assets has or have been pledged. If the company with the loan falls into default, the lender will have the first available proceeds from the sale of these assets before any unsecured creditors.

Share capital

The permanent capital contribution by the owners of a business (the shareholders) both at the start of trading and, subsequently, when additional capital is required to finance expansion, stated as the nominal or par value of the shares. (In the case of partly paid- up shares, the paid-up value is the share capital).

Shareholders’ interest or Shareholders’ funds

The sum of share capital plus share premium plus retained profit plus other reserves, at the balance sheet date. Synonymous with equity and net worth.

Share premium

The difference between the issue price and the nominal or par value of a share. When a premium is paid for new shares, a share premium reserve is created or increased. The US term is paid-in surplus.


The ability of a business to meets its long-term commitments. See also the debt-equity ratio and interest cover.


The investment that a company makes in raw materials, work in progress, finished goods and supplies. It is normally valued at cost or net realisable value, whichever is less. The US term is inventory.

Stock turnover rate

The average number of times each year that stocks are ‘turned over’ in the course of trading activity. It is calculated by dividing the cost of sales by average or closing stocks. (When computing the ratio from published accounts, the cost of sales may not be known; in such cases, the sales figure is normally substituted).

Trade creditors

Amounts due to suppliers for goods and services received but not yet paid for. They are normally due for payment within 12 months of the balance sheet date, and, therefore, form part of current liabilities.

Trade cycle or business cycle

The name given to the process in which a business converts cash funds firstly in to stock and then, when the products have been sold, in to debtors. The trade cycle is completed when the customers have paid their invoices and the business converts the debtors back in to cash. Cashflow is affected by both the amount of funds invested in stock and debtors and by the speed with which the cycle is completed.

Trade debtors

Amount due from customers in respect of goods supplied but not yet paid for. Usually reported as current assets, but a note may disclose that some are not expected to be paid within the coming year.

Trading or Operating profit

Profit after all charges except interest, taxation, and exceptional and extraordinary items.


See Sales

Variabel costs

The costs of a business that are related to the level of sales. Product costs and delivery costs are examples of variable costs. One of two fundamental types of business cost, the other being fixed costs.

Working capital

Current assets less current liabilities (also called net current assets).

Stock market Ratios & Terms

1. EPS – Earnings Per share Profits Attributable to ordinary Shareholders

Number of Ordinary Shares

2. P/ E ratio Share Market Price


3. Dividend Yield Dividend__

Share price

4. Total Shareholder Return (TSR) Price Inncrease + Dividend

Price (Start)

5. Market Capital = Market value (Share Price x Number of Shares)

6. Enterprise Value = market capitalization plus debt, minority interest and preferred shares, minus total cash and cash equivalents.


Mastering Financial Management

Practical tips to manage working capital and improve cashflow

• Healthy cashflow is the most important factor that will decide whether your business will survive and thrive.

• When overdrafts are unavailable or expensive good working capital control is vital for healthy cashflow.

• Make sure that you hold sufficient stock to supply customers what they want, when they want it. But take steps to liquidate surplus and obsolete stocks without damaging normal sales.

• Make sure you invoice promptly after delivery or completion of work.

• Make it easy for your customers to pay by quoting purchase order numbers and all other relevant details on the invoice - including bank details.

• Make sure your customers pay on time. Make time to chase up slow payers; this is likely to be more of a problem during a recession and you will need to keep on top of it to avoid cashflow problems.

• Talk regularly to your key customers and suppliers to keep them “on side”. Treat them as part of your business support network.

• |

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mY5?B*[pic]CJ(OJ[?]QJ[?]\?^J[?]aJ(ph)hÞGx5?B*[pic]CJ(OJ[?]QJ[?]\?^J[?]aJ(phAjh-o,5?B*[pic]CJ(OJ[?]Resist the temptation to use your suppliers as a source of free loans. You will risk damaging the key business relationships that you depend on.

• Make time to maintain a simple monthly cashflow forecast. This will help you focus on the key things on which your cashflow depends and it will prevent any nasty surprises coming out of the blue.

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