Financial accounting is concerned with the recording of financial transactions and the preparation of financial reports to communicate past financial performance. Subject to accounting regulations, financial accounting ensures:
- That reports/statements follow a standard approach
- A broad overview of the whole business using totals
- Information to a particular date
- General statements and reports
- Information in monetary terms and values.
Management accounting
In management accounting is looking to the future using knowledge of past performance, where relevant, to aid the management of the business. In management accounting reports are only for internal use so no restrictions are necessary. This sector of accounting:
- Uses information extracted from parts of the organisation where it is used to help with a particular decision
- Will look at future performance as well as at past performance
- Produces reports with a specific decision in mind
- May have non-financial information such as stocks
Liquidity (solvency)
This is basically to be able to meet financial obligations. A business becomes ‘technically insolvent’ when it has sufficient assets to meet all its financial obligations but insufficient time to convert these assets into cash. It is ‘legally insolvent’ if it is a situation of permanent cash shortage. Managers will want to know the extent of solvency so that they can restructure assets and liabilities into an appropriate form. For example, they will want to manage their assets in a way that enables them to pay bills as and when they arrive in the organisation, without being too liquid and having too much cash or cash not doing anything. Solvency is a base-line for ongoing business operations.
Assets
Assets are things which an organisation owns. The word asset normally appears frequently in a balance sheet, which provides a statement of what a business owns and owes at any fixed point in time. Assets are divided into fixed and current assets. Fixed assets tend to have a life span of more than one year. They comprise items that are purchased and generally kept for a long period of time. Examples of fixed assets are premises, machinery.
Current assets are sometimes called ‘circulating assets’ because the form they take is constantly changing. Examples of current assets are stocks, debtors etc
Liabilities
Liabilities are anything an organisation owes and are usually set out either as current liabilities or long term liabilities, depending on their duration. Current liabilities are debts a business needs to repay within a short period of time (normally a year).
Expenses
Expenses help an organisation to:-
- Create short-term, medium-term and long-term plans
- Control an organisations activities
- Decide between alternative strategies.
Every business has expenses and a range of overheads. These might include:
- Rent of premises
- Gas
- Electricity
- Cleaning costs
- Insurance etc.
Revenues
Revenues come from either sales or from fees charged to customers. The sales figure can be derived by looking at the selling price of the units sold. Some businesses may receive income from sources other than sales. This may include rent received on properties that the business owns, profits from the sale of assets such as cars, as well as income from other areas such as investments.
Constructing financial statements
Profit and loss account below I have shown how gross profit is arrived at:
Net sales – Cost of sales = Gross profit
Sales are often described as turnover; below I have shown how gross profit is arrived at:
Sales – Returns inwards (sales returns) = Net sales
Below I have constructed a basic profit and loss account for my business, and after that I have done a cash flow forecast.
Profit and Loss Account for Gill’s Car Wash year ending 31 December 2006
Sales £38,750
Cost of Sales £6750
Gross Profit £32,000
Expenses
Advertising £6,500
Telephone £500
Insurance £1050
Electricity & Gas £1100
Wages £8800
Rent £8840
Total Expenses £26,790
Net profit £5,210
Below I have devised a cash flow forecast
How I got certain figures for cash flow forecast
The payments that will be made out of the business will be rent, electricity and gas, wages, advertising, insurance, loan and equipment. It is very important for me to be honest when entering the data in the cash flow forecast because I want the must accurate results that can be achieved because I want a rough idea on how much money I can make or even if I will survive, so I have given the accurate results by asking family and friends. The rent I have to pay each year is £8,820 so I divided it by 12 and got my results.
The main usage of business will be water and electricity because I will use a pressure washer, which runs on electricity so I have entered accurate results here.
Insurance on my premises from more than insurance direct £1200 I did this instant quote on the Internet at . I need insurance because if the premises are burnt down I can reclaim some of the money and receive money from the personal possessions in the garage.
Advertising will be done through flyers and posters I will stand outside the town centre and give out flyers because on the flyers it will have a 10% discount on them I will also post these through housing estates near by the location. In shops poster will be up telling people about the business. The reason for this is because I have just set up a business I must advertise wisely to get customers if I don’t advertise then I want have no customer = no sales. To advertise in the chronicle which is distributed every Thursdays through the whole of Sandwell to advertise a year it is £150. After year one I wouldn’t advertise as much because I will have the same amount of customers so the main focus will be to keep the current customers.
The loan/family section is about given the money back to family or loan I have picked up I would like to hope that my application form was of a good standard because I would like to receive £1500 from prince’s trust I have to pay a low amount of interest on this. My family will borrow me £4000 they don’t want interest but we both have agreed that I will pay them back each month as reasonable amount, this helps because then they will trust me when they borrowed me money and by me giving the money back makes them feel confident in the business however I will not consider into going a partnership. Sales have been gathered through market research and it is obvious to me that at summer time I will wash more cars than winter.
Equipment I have already said that I will buy my equipment from Stax there pressure washers are £150 these are powerful washers in Argos they are selling for £230 so I am saving a lot of money I need 2 of these, sponges for a pack of ten cost £5, car shampoo is £1.29 and on the bottle it says you can wash up to 300 car washes.
As you can see the figures are giving are accurate so therefore my business results (outcome) is likely to be true and that I make a profit, survive etc so therefore I reached my aims and objectives.
I could of have made mistakes if I had just entered the figures so I used formulas to make sure that I entered in correct data (look below)
As you can see the formulas look complicated put it helps me because now the cash flow is correct. If I didn’t use formulas then one mistake would make the cash flow no good to me.
Balance sheet
A balance sheet is a clear statement of the business assets, liabilities and capital of a business. Looking at a balance sheet provides valuable data.
Balance sheet is represented by the formula below:
Assets = Liabilities + Capital
Break-even analysis
This helps my business by telling me roughly how many cars I have to wash in order to break-even. The break-even is the point at which sales levels are high enough to make a profit.
To calculate the break-even point there are two stages: Calculate the unit contribution (selling price less variable cost per unit) divide the fixed costs by the unit contribution:
Break-even point = Fixed costs
Unit contribution
The following is the procedure to construct a break-even chart:
- Label the horizontal axis for units of production and sales
- Label the vertical axis to represent the values of sales and costs]
- Plot fixed costs (variable and fixed costs). This will be a line rising from where the fixed line touches the vertical axis
- Sales are then plotted by taking two or three random levels of turnover.
The limitations of break-even analysis
The limitations are as follows:
- It can be argued that, in real life situations, fixed costs actually vary with different levels of activity.
- Many businesses fail to break even because of a limiting factor restricting their ability to do so (e.g. a shortage of space)
- The variable cost and sales lines are unlikely to be linear (i.e. straight). Discounts, special contracts and overtime payments mean the cost line is more likely to be curved.
- Break-even charts depict short-term relationships, and forecasts are therefore unrealistic when the proposals cover a number of years.
- Break-even analysis is (like all other methods) dependent upon the accuracy of forecasts made about costs and revenues. Changes in the market and in the cost of raw materials could affect the success of this technique.
Below is a break even chart for Gill’s Car Wash
Before I show the break even chart I will show the fixed costs and variable costs.
The fixed cost
£735 rent
£100 Insurance
£750 Loan/Family
£100 electricity
Variable costs
Equipment
Advertising
Wages
Break even = 667 cars wash a month.
Break even sales revenue in (£’s) £2335
As we can see in order for Gill’s Car Wash to break-even I must wash 667 cars every month. This sounds a lot but it basically means I must wash 27 cars a day in order to break-even so the break-even point is 667. But my target would be to wash around 1000+ cars because then I can earn a decent income from the business. I noted for the fixed cost the rent each month £600 and a part time employee £200 the rest would come for electricity gas and advertising. The way I got the variable cost was because I am charging £3.50 50p would go to getting new equipment example shampoo brushes etc, so I would save £3 each time I washed a car.
Definitions
Production quantity (Q) = the number of products/services you are going to provide.
Fixed Costs FC = these are costs which do not change when the amount of production changes. Even if you produce nothing at all, you will still have to pay these costs. For example rent, loans.
Variable Costs (VC) = this is the additional amount that you have to pay for each item you make for example workers wages.
Total Variable Costs (TVC) = if you multiply the variable cost per unit by the production quantity you get the total variable costs.
Total costs TC = FC+TVC = add fixed costs to total variable costs, & you get total costs.
Total Revenue TR = SP * Q = the amount of money you get from products sold.
Break-even point = this is the point where you have made enough money to pay for all your total costs.
Profit or loss = profit is when total revenue is greater than the total costs. Loss is when total costs are greater than total revenue.
Selling price SP = the price you sell each unit.
Creating budgets
There are three main areas of budgetary forecasts:
-
The capital budget the word ‘capital’ refers to the buying of fixed assets. The capital budget is a simple statement of intent or forecast, which specifies the planned purchase of assets, the date of intended purchase and the expected cost of purchase.
-
The cash budget or cash flow forecast this forecast looks at the cash coming in to the organisation as well as the cash going out. It is a prediction by a business of how much money it thinks it will receive and how much it thinks it will pay out over a specified time.
-
Subsidiary budgets and the master budget these are functional budgets for different business activities and budgets for individual balance sheet items are called subsidiary budgets.
The capital budget
Capital expenditure refers to the acquisition of fixed assets. Capital budgets are prepared to plan for the purchase of fixed assets. The capital budget is prepared after reviewing fixed asset needs for the budget period. Classifications of capital expenditure will follow those you are already familiar with from constructing the fixed assets section of the balance sheet. Typically they include:
- Land and buildings
- Factory plant and machinery
- Office fixtures and fittings
- Computer equipment/motor vehicles
Expenditure may be further analysed into assets required for:
- Expansion of existing product ranges
- Expansion into new products
- Replacement of existing assets
- Satisfying health and safety requirements
Variance analysis
Variances are recorded as being either adverse (A) or favourable (F), depending upon whether actual expenditure is more or less than budget. For example if the expected amount of expenditure on cleaning costs was going to be £650 a month but it was actually less £500 then this would be a favourable variance where as if the expenditure was £1000 then this would be an adverse variance. Sometimes variances can’t be controlled like depreciation which can’t be controlled.
Understanding Variances
Variances may arise for a number of reasons. These include:
- Random deviations which are uncontrollable as I gave an example of depreciation this is outside of control of managers
- An incorrectly set budget this may require further research and management action
- Failure to meet an agreed budget this would be because a manager has failed to meet the appropriate figures and deadlines.
Future of Gill’s Car Wash
I have already shown you my business plan next I will discuss which type of software I will use, before that I am going to say what will happen to Gill’s Car Wash after the first year or so. Once you have set up a business what would you like to do next may steady output or expand out more.
I would want Gill’s Car Wash to expand out and service cars as well then I could use the name as ‘Gill’s Motor Service’ or a neutral name such as ‘Motor World’ I would like to expand and turn the company into a private limited company and open new garages across the area of Birmingham and then move the regional, also to gain extra revenue from shareholders.
The competitor that I have is HS Valeting they started off as a local car wash but then they expanded.
It is important that the first aim is to survive because many businesses close down within 3 years then after the three years it would be important to make a profit not too much of a large figure but I want to earn a decent income because if I was going to make less than the minimum wage then there is no point in me having all the hassle to run a business I may as well work for someone else, but I believe that this idea of a car wash will make a success.
Analysis/explanation of finance
I will now give the detailed explanation of the break even chart and the cash flow forecast. Also make points about the weaknesses or limitations.
Cash flow forecast
The main important thing for the cash flow was to make sure that I had accurate readings i.e. the figures used in the cash flow were accurate, I believe that I did put in the cash flow realistic figures because I have got a real premises I have the real figure for the rent. I want on and expected a quote of £1200 insurance a year for the business. I used accurate figures based on advertising how I got accurate figures was by asking members of my family a person who also knows a car wash. The cost of the materials is very accurate business I would buy from a real trading store STAX. (More on page 58)
I believe that the work done on the cash flow forecasts is very accurate and I believe that I would gain finance from the Princess Trust for example.
Liquidity on cash flow forecast
Liquidity is important for the cash flow because it can cause problems. Liquidity is to meet financial obligations. I.e. payments,
Weaknesses
The main weaknesses for my cash flow forecast is that even though the figures I believe are accurate they might not be accurate for example the electricity bills could be more than I anticipated therefore this would but the break even un real because if my business is paying more money out then the break even will be increased i.e. I will have to wash more cars.
Another weakness could be that I could enter a number by mistake therefore is I was unable to see the problem then I could be heading for disaster but because I have shown my cash flow to a number of people i.e. teachers they also think he cash flow forecast is accurate.
Evaluation
To see if I could real obtain finance from the Princess Trust I could of sent this application this assignment to see that if it would be expect to gain finance but the process would be long because I would have to meet up with an advertiser etc, but if I told them that I am a student and want to see if you could generate a loan for me I know they wouldn’t reply because they will have real applications to go through that’s why I didn’t sent it off.
Analysis/explanation of Break-even-chart
The purpose of the break-even chart is that it tells my business how many cars I have to wash a month in order to break-even i.e. I cover all my fixed cost (rent) + total variable costs (equipment) this is own as the break-even point after this point money coming into the business is own as a profit.
Like with the cash flow forecast I believe this is an accurate reading because I worked everything out properly fixed cost don’t change these are:-
All these prices add up to £1,685.00
Variable costs I worked out at 0.75p per wash these were pay for the equipment etc.
I believe all the data is accurate.
Weaknesses
The number one weakness is that this is quite a lot of cars to wash for a business that is just opening 667 cars a month that is a lot of work that has to be done I mean that around nearly 30 a day car washes but if a few cars come in for Gill’s A1 valet service then the number will drop must people won’t have the full valet service because it is expensive most people will have the normal £3.50 car wash.
Another major is weakness what happens if no turns up into the business? I mean if 667 people don’t turn up to the business what will I do will the business become shut, if I can’t give with expenses money going out what will I do. I hope that this wouldn’t happen but if it did I would try and get the local newspaper to the a report on my business this way I could have a good public relation with the press, this will increase customer awareness so new potential customers. I could also cut costs i.e. lose a employee to save money buy less equipment etc.
Evaluation
One of the things I could do is I could ask someone who currently owns a car wash maybe someone with experience in this sector or maybe a business advisor to talk to and ask what a realistic target would be to opening a new business (car wash) from each discussion if I find out that my cost are to high then I could cut back on equipment an employee or potential I could move location and find cheaper rent etc.
Now I will move onto section D and give detail analysis of how software could help my business.