Accounts demystified : how to understand financial accounting and analysis

308 Pages·2003·1.885 MB·English

by  Anthony Rice

ANTHONY RICE
Accounts
Demystified
How to understand financial
accounting and analysis
Pearson Education
an imprint of
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____________________________
First published in Great Britain in 1993
© Anthony Rice 2003
The right of Anthony Rice to be identified as Author of this Work has been asserted
by him in accordance with the Copyright, Designs and Patents Act 1988.
ISBN 0 273 66334 8
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Contents
Preface ix
Acknowledgements xi
Prologue xiii
Introduction xv
Part I: The basics of accounting
1 The balance sheet and the fundamental
principle
3
● Assets, liabilities and balance sheets 3
● Sarah’s ‘personal’ balance sheet 4
● The balance sheet of a company 7
● The balance sheet chart 11
● Summary 14
2 Creating a balance sheet
17
● Procedure for creating a balance sheet 17
● SBL’s balance sheet 18
● The different forms of balance sheet 48
● Basic concepts of accounting 50
● Summary 53
3 The profit & loss account and cash flow
statement
55
● The profit &loss account 55
● The cash flow statement 57
● ‘Definitive’ vs ‘descriptive’ statements 59
● Summary 61
v
CONTENTS
4 Creating the profit & loss account and
cash flow statement
63
● Creating the profit & loss account 63
● Creating the cash flow statement 67
● Summary 78
5 Book-keeping jargon
81
● Basic terminology 81
● The debt and credit convention 84
Part II: Interpretation of accounts
6 Wingate’s annual report
95
● Accounting rules 96
● The reports 97
● Assets 99
● Liabilities 107
● Shareholders’ equity 114
● The P&L and cash flow statement 115
● The notes to the accounts 118
● Summary 119
7 Further features of company accounts
121
● Investments 122
● Associates and subsidiaries 124
● Accounting for associates 125
● Accounting for subsidiaries 127
● Funding 128
● Debt 129
● Equity 131
● Revaluation reserves 134
● Statement of recognised gains and losses 135
● Note of historical cost profits and losses 135
vi
CONTENTS
● Intangible fixed assets 137
● Leases 137
● Corporation tax 140
● Exchange gains and losses 141
● Fully diluted earnings per share 143
● Summary 146
Part III: Analysing company accounts
8 Financial analysis – introduction
149
● The ultimate goal 150
● The two components of a company 153
● The general approach to financial analysis 162
● Wingate’s highlights 163
● Summary 166
9 Analysis of the enterprise
169
● Return on capital employed (ROCE) 169
● The components of ROCE 173
● Where do we go from here? 177
● Expense ratios 177
● Capital ratios 184
● Summary 192
10 Analysis of the funding structure
195
● The funding structure ratios 195
● Lenders’ perspective 199
● Gearing 201
● Shareholders’ perspective 205
● Liquidity 211
● Summary 215
vii
CONTENTS
11 Valuation of companies
217
● Book value vs market value 217
● Valuation techniques 220
● Summary 225
12 Tricks of the trade
227
● Self-serving presentation 228
● Creative accounting 230
● Why bother? 249
● Summary 252
Glossary 253
Appendix 275
Index 286
viii
Preface
A glance at the accounts of most of Britain’s larger companies could
lead you to conclude that accounting is a very complex and technical
subject.
While it can be both of these things, accounting is actually based on an
incredibly simple principle which was devised more than 500 years ago
and has remained unchanged ever since. The apparent complexity of
many companies’ accounts results from the rules and terminology that
have developed around this fundamental principle to accommodate
modern business practices.
I believe that, once you really understand the fundamental principle
and how it is applied, you will find that the rules and terminology
follow logically and easily. This view determines the arrangement of the
chapters in Accounts Demystified and it is important, therefore, to read
them chronologically. You may, however, omit Chapter Five, which dis-
cusses book-keeping jargon and Chapter Seven, which concentrates on
more sophisticated areas of accounting, without losing the thread of
the book.
May I also suggest that, before you reach Chapter Six, you photocopy
the key parts of Wingate Foods’ accounts (pages 278 to 285). From
Chapter Six onwards, the text refers to these pages frequently and you
will find it much easier with copies in front of you.
If you have any comments on the book, you are welcome to email me
at [email protected]
Anthony Rice
ix
This book is dedicated
to Charlotte
x
Acknowledgements
A number of people have contributed to this book.
I am especially grateful to Jonathan Munday and Simon Rees, partners
of accountants Rees Pollock. Jonathan reviewed this edition in detail
and helped update the book for the large number of new rules that have
been instituted since first publication. In some cases, I have decided
to live with technical errors and omissions in the interests of clarity.
For such decisions I am solely responsible.
I would also like to thank the following who volunteered to read this
book and all of whom made valuable comments and suggestions:
Michael Gaston, Debbie Hastings-Henry, Steve Holt, Alex Johnstone,
Keith Murray, Jamie Reeve, Brian Rice, Clive Richardson, David
Tredrea, Martin Whittle, Charlie Wrench.
Anthony Rice
xi