2. Accounting Principles

Question 1

What are the key financial statements that companies provide?

Answer 1

• The key financial statements are:-
  o Profit and loss accounts.
  o Balance sheets.
  o Cash flow statements.

Question 2

What is the difference between management and financial accounts?

Answer 2

• Management accounts are for the internal use of the management team.
• Financial accounts are the company accounts that are required by UK law

Question 3

What is the difference between a profit and loss account and a balance sheet?

Answer 3

• A profit and loss account shows the incomes and expenditures of a company and the resulting profit or loss.
• The balance sheet shows what a company owns (it’s assets) and what it owes (it’s liabilities) at a given point in time.

Question 4

What is a cashflow statement?

Answer 4

• It is the summary of the actual or anticipated ingoing and outgoing of cash in a firm over the accounting period.
• It measures the short-term ability of a firm to pay off its bills.

Question 5

Explain your understanding of the following Terminology:
Capital Allowances
Sinking Funds
Insolvency
Companies House
HMRC

Answer 5

• Capital Allowances - Tax relief on certain items purchased for the business for example tools and equipment.
• Sinking Finds – Funds that are set aside for future expense or long-term debt.
• Insolvency – An inability to pay debts where liabilities exceed assets.
• Companies House – An agency that incorporates and dissolves limited companies within the United Kingdom.
• HMRC - Her Majesties Revenue and Customs.

Question 6

What are Liquidity ratios?

Answer 6

• Liquidity rations measure the ability of a company to pay off its current liabilities by converting its current assets into cash.
• Liquidity ratio calculation = current assets / current liabilities.
• The ratio is usually around 1.5 but it depends on the sector of activity.

Question 7

What are Profitability ratios?

Answer 7

• Profitability ratios measure the performance of a company in generating its profits.
• The trading profit margin ratio = turnover – (cost of sales / turnover).
• Low margins may be due to a growth strategy from the company and do not always result from bad management.

Question 8

What are Financial Gearing Ratios?

Answer 8

• These measure the financial structure of the company which are crucial indicators for the external suppliers of debt and equity as well as for internal management.
• They help to measure solvency.
• Highly geared companies rely mainly on borrowing.
• The payment of interests reduces the profit.

Question 9

Why do chartered quantity surveyors need to understand and be able to interpret company accounts?

Answer 9

• To aid in preparing their own business accounts.
• For assessing the financial strength of contractors and those tendering for contracts.
• For assessing competition.

Question 10

What is the purpose of a P & L?

Answer 10

• To monitor and measure profit (or loss).
• To compare against past performance and against company budgets.
• For valuation purposes and to compare against competitors.
• To assist in forecasting with future performance.
• To calculate taxation.

Question 11

What is the difference between debtors and creditors?

Answer 11

• Creditors are business entities that are owed money by another entity that they have extended credit to.
• For example if you have provided services to a client and they owe payment of your fees, you become a creditor to that client.
• Debtors are business entities that owe money to another respective company.
• For example if you have used a sub-consultant and still owe them payment of their fees then you become a debtor of the sub-consultant.

Question 12

What are Management Accounts?

Answer 12

• The accounts prepared by a company for internal management use.
• Accounts prepared for a lender, such as a bank to evaluate how you will be able to repay the funding.
• These accounts are not be audited externally.

Question 13

What is a Financial Statement?

Answer 13

• Forecasts of income and expenditure that can be used as an analytical tool to identify potential shortfalls and surpluses.

Question 14

What is a Profit and Loss account?

Answer 14

• They demonstrate a companies sales, running costs and profit or loss over a financial period (usually 1 year).
• They are used to show sales vs expense (invoicing vs time and disbursements).
• They can also be used to identify non-profitable work.

Question 15

What is a Balance Sheet?

Answer 15

• They shows the value of everything the company owns made up of its assets and liabilities.
• The balance sheet demonstrates the value of the business at any given point in time.

Question 16

What is a Cash Flow forecast?

Answer 16

• A cash flow forecast summarises the amount of cash or cash equivalents entering and leaving a company or project entity.
• On construction projects they usually show as an ‘S’ curve.
• There is typically a small financial outlay at the start, a steep increase during the midway point and a taper towards the end.

Question 17

What is an S-Curve?

Answer 17

• S-Curve means ‘standard’ and refers to the shape of the expenditure profile when shown in graphical form.
• During the start of a project, the rate of expenditure is typically lower due to site setup and lower value enabling works.
• As the scheme progresses to the middle of the programme, the rate of expenditure will
  typically increase as more expensive building components such as M&E and Structural Steel Work are installed.
• Towards the back end of the programme, the rate of expenditure will slow down which is shown by the flattening of the S-Curve.

Question 18

How are S curves used by Surveyors?

Answer 18

• To track, analyse and assess business accounts and performance.
• For assessing the financial strength of contractors.
• To compare actual progress of the work against pre-contract predictions.

Question 19

What are Escrow Accounts?

Answer 19

• A sperate account owned by a third party, held on behalf of two other parties.
• A bank account with defined contractual conditions for the release of funds.
• They can be used as a project bank account.
• Mechanisms must be in place for the release of funds such as payment certificates

Question 20

When have you used company accounts in your work?

Answer 20

• To assess the financial strength of contractors at Pre-Qualification Stage and tender stages.

Question 21

How do you analyse a company’s accounts?

Answer 21

• The client’s accountants will carry out the detailed analysis but I can look at the warning signs by calculating ratios such as liquidity ratios, profitability ratios and gearing ratios.
• I should always calculate the ratios myself as those included in the company accounts may have been manipulated.
• I should always use the group or consolidated accounts rather than the company accounts unless it is a
  limited company.

Question 22

How do you carry out a credit check? Give an example.

Answer 22

• I use the Credit Safe website to which my company subscribes to access a company’s accounts.
• I considered both the group accounts and the company accounts.
• If the credit rating is low, I calculate some key ratios and pass on all the information to my client’s accountants for them to analyse further.

Question 23

What are signs of insolvency in company accounts or credit checks?

Answer 23

• A low credit rating.
• A liquidity ratio below 0.75.
• A falling working capital ratio suggesting that the company has taken on more contracts than it can finance.
• A low return on equity.
• A highly geared company that is heavily reliant on loans.
• A falling cashflow statement.

Question 24

Why would you not recommend the appointment of a contractor with a low credit rating?

Answer 24

• There may be an increased risk of the contractor not performing satisfactorily.
• It could present increased risk of the contractor failing to deploy sufficient resources and materials to the project.
• It could increase the risk of the contractor’s insolvency.

Question 25

What measures would you recommend if your client wanted to appoint a contractor with a low credit rating?

Answer 25

* I would explore the option of requesting a performance bond that my client could call on if they Main Contractor failed to perform. * I would also review the tender submission to ensure this is not excessively front loaded. * When reviewing interim valuations, I would ensure that these are accurate and not over claimed. * A project bank account may also provide an additional level of assurance and should be considered.

Question 26

Explain your understanding of the term tax depreciation

Answer 26

Tax depreciation is where the declining value of an asset is offset against a companies taxable profit The depreciation in value can be recorded as an expense in order to reduce the amount of taxable income

Question 27

What are overheads

Answer 27

The operating cost of the business that are incurred on an ongoing basis

Question 28

Please name the three different types of accounting ratios

Answer 28

Liquidity ratio Profitability ratio Gearing ratios - compares capital within the company against its debts. It measures the companies financial leverage and sets out what proportion of the firms activities are funded by shareholders vs its creditor funds

Question 29

Why do business keep company accounts?

Answer 29

Calculates tax Measure profitability Legislation requires this

Question 30

What is financial leverage

Answer 30

Financial leverage is the concept of using borrowed funds in the form of debt to enhance business operations and increase the companies profitability and rates of return