Macmillan Professional Masters Company Accounts Macmillan Professional Masters Titles in the series Company Accounts Roger Oldcorn Constitutional and Administrative Law John Alder Contract Law Ewan McKendrick Cost and Management Accounting Roger Hussey Criminal Law Marise Cremona Data Processing John Bingham Employee Relations Chris Brewster Land Law Kate Green Landlord and Tenant Law Margaret Wilkie and Godfrey Cole Management Roger Oldcorn Marketing Robert G. I. Maxwell Office Administration E. C. Eyre Personnel Management Margaret Attwood Study Skills Kate Williams Supervision Mike Savedra and John Hawthorn Company Accounts Roger Oldcorn Deputy Director of the Management Development and Advisory Service at Henley - The Management College M MACMILLAN © Roger Oldcorn 1984, 1989 All rights reserved. No reproduction, copy or transmission of this publication may be made without written permission. No paragraph of this publication may be reproduced, copied or transmitted save with written permission or in accordance with the provisions of the Copyright Act 1956 (as amended), or under the terms of any licence permitting limited copying issued by the Copyright Licensing Agency, 33-4 Alfred Place, London WC1E 7DP. Any person who does any unauthorised act in relation to this publication may be liable to criminal prosecution and civil claims for damages. First published by Pan Books Ltd in 1984 as Understanding Company Accounts in the Breakthrough series. Fully updated and revised edition published by MACMILLAN EDUCATION LTD Houndmills, Basingstoke, Hampshire RG21 2XS and London Companies and representatives throughout the world Typeset by TecSet Ltd, Wallington, Surrey British Library Cataloguing in Publication Data Oldcorn, Roger Company accounts.-Updated and rev. ed. 1. Companies. Accounts I. Title II. Oldcorn, Roger (Understanding company accounts) 657.95 ISBN 978-0-333-48793-8 ISBN 978-1-349-20131-0 (ebook) DOI 10.1007/978-1-349-20131-0 ISBN 978-0-333-48794-5 Pbk export Contents Acknowledgements Introduction How to Use this Book Part I ACCOUNTING STATEMENTS- WHAT ARE THEY AND WHAT ARE THEY FOR? I What the different statements are for 3 1.1 A working definition of 'profit' 3 1.2 Profit and loss 4 1.3 What about the money? 5 1.4 The basic business problem - money and profit are not the same 7 1.5 What is the business worth? 8 1.6 Where did the money come from? 10 1.7 The big balance 11 1.8 The balance sheet - a working definition 12 1.9 Summary 12 2 The balance sheet (1)- assets 13 2.1 A case for consideration 13 2.2 People - the human asset 14 2.3 The money drain 15 2.4 Some other assets 18 2.5 What value has an asset? 20 2.6 The traditional basis for valuation 21 2.7 The assets and their valuation 22 2.8 Summary 24 3 The balance sheet(2) - capital and liabilities 25 3.1 Money from individuals 26 3.2 Money from banks 28 3.3 Money from insurance companies and other organizations 28 3.4 Money from government departments 29 3.5 Suppliers as a source of finance 29 3.6 Finance from customers 29 3.7 Other sources of finance 30 3.8 Share capital - a closer look 31 3.9 Share prices 33 3.10 Other types of share 34 3.11 A closer look at loans 35 3.12 Reserves 36 3.13 Summary 36 vi Contents 4 The balance sheet (3) - the complete picture 38 4.1 A two-minute history 38 4.2 The traditional British balance sheet 39 4.3 The traditional American balance sheet 40 4.4 Traditional layout - vertical methods 41 4.5 Modern British method 41 4.6 The Companies Act 1985 balance sheets 44 4.7 Summary 46 5 The profit and loss account 48 5.1 Why have accounts? 49 5.2 What do you mean - 'profit' 49 5.3 The profit and loss account - what is shown 50 5.4 The profit and loss account - a real example 56 5.5 Summary 57 6 Source and use of funds 58 6.1 A case to consider 58 6.2 Sources of finance 60 6.3 The funds flow statement - the complete picture 62 6.4 Funds flow in practice 63 6.5 A real funds flow statement 64 6.6 Final points on funds flow statements 64 7 Current cost accounts statement 65 7.1 Today's versus yesterday's money 68 7.2 The inflation danger 69 7.3 Current cost profit - the adjustments to make 69 7.4 The gearing adjustment 70 7.5 Adjustments to the balance sheet 71 7.6 Summary 72 8 Value added and other information 73 8.1 A working definition 74 8.2 Value added- three points to remember 78 8.3 Company accounts - other information 78 Part II ACCOUNTS-EVALUATION AND INTERPRETATION 9 Accounts analysis (1) - growth and profitability 89 9.1 Analysis- the four key steps 91 9.2 Growth 93 9.3 Profitability 95 10 Accounts analysis (2) - assets, operations and financial 102 10.1 Financial strength 102 10.2 Assets 106 10.3 Financial structure 109 10.4 Operating efficiency 110 10.5 How a business works 112 10.6 Completing the picture 113 Contents vii 10.7 Summary of chapters 9 and 10; limitations of accounts 114 11 Real company accounts 115 12 Accounts in other countries 172 12.1 American balanace sheets 172 12.2 Profit and loss account USA style 173 12.3 Summary of French and German accounting terms 174 Glossary of Accounting Terms 176 Further reading 180 Appendix: Schedule 4 to the Companies Act 1985 181 Index 193 Vlll Acknowledgements The author and publishers wish to thank United Biscuits (Holdings) PLC for giving permission to reproduce so much of the company's annual report and accounts, and also Marks and Spencer pic for permission to reproduce the statement on p. 79. ix Introduction This book has been written for anyone who needs to understand and use company accounts, especially those who do not want (nor have any desire) to become accountants. Its purpose is to explain accounting statements to the layman - to translate the language of finance - and to show the reader how to study the accounts for clues about the organiza tion, its efficiency and its effectiveness. Accounting statements have improved out of all recognition during the last twenty years and, as far as published company accounts are concerned, now contain a great deal of useful information. Similarly, there has been a tremendous upsurge in the number of people who 'need to know' about companies in greater depth and more objectively than is provided by a few short paragraphs in the financial newspapers. The list of types of people who have a more than passing interest in companies is quite lengthy: it is not just the owners or shareholders who need to know, but employees (and prospective employees), bankers, other lenders, customers, suppliers and all others who feel that, at least if you understand it, you will know better how to behave towards it. Most of these people are not accountants, yet the bulk of 'hard' information about a company comes in the form of accounting statements. Is it any wonder that companies are misunderstood, that well-run firms do not always receive the recognition due to them, and that poor companies can get away with their inefficiencies for a long time? Also, is it surprising that so many small firms go out of business after trading for only a year or two? All the warning signs will have been there in the accounts; lack of understanding in these circumstances is fatal. In this book I have concentrated on the accounting information that is usually made available to the public ('published accounts'). If you are inside the business, more information is available to you and, if you have a special interest in a firm (like the bank manager), you will need more information than the accounts themselves provide. Even so, the published accounts are an excellent starting point for anyone who wants to understand.