Workbook 1 Buying and Selling

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2 Contents Highlights... 2 Quick Practice Session on Buying and Selling... 2 Financial Quiz 1 - Buying & Selling... 3 Learning Zone Buying and Selling... 3 Talk the talk... 4 Understand the link between business and the financials... 5 The presentation of Profit & Loss Accounts and Balance Sheets... 5 Why is Billy s cash position different to his Net Profit... 6 General information about the presentation of financial statements... 6 Different industries use presentations that suit their business activities... 6 Reflection and Discussion Zone Buying and Selling... 7 Progress test Buying and Selling

3 Highlights 1. See how FaBLinker (the Minimum Financial Model) makes it easy to understand finance 2. Learn the purpose, content and use of the financial statements (Profit & Loss Account, Balance Sheet and Cash flow) 3. See how buying and selling activities are reflected in the financial statements and how they are calculated 4. Watch what happens to profit and cash flow when you change one of the metrics in your business model 5. Discover some reasons why Profit and Cash differ 6. See how stock, debtors and creditors are treated in the financial statements Quick Practice Session on Buying and Selling FaBLinker makes learning business finance easy and fun FaBLinker lets you explore the interplay between the business and financial models on one screen even the ratio analysis, which will be covered in detail in Workbook 6. You build knowledge and skills in the most effective way by exploring and by systematic smart practice! Re-create the Buying and Selling element of Billy s business model Set the to display the information icons Work to build a sense of the simple dynamic (cause-andeffect relationship) between business and the financial statements (scorecards) Develop a comfortable familiarity with FaBLinker so that you use it easily as you work through the questions posed in Financial Quiz 1 - Buying and Selling Tip Save your file in FaBLinker you will be adding more information to it in the next sessions 2

4 Financial Quiz 1 - Buying & Selling # Question Your answer 1 What would Billy's new Net profit be if he increased his selling price to 200? What would Billy's new Net Profit be if he sold an additional 50 units for cash? What would the value of opening "Reserves" be if we changed Billy's data to show 200 units in opening stock? What would the value of Billy's closing stock be if he had negotiated a purchase price of 80 per unit? What would Billy's closing cash position be if he chose not to pay for the units acquired on credit until the following year? Correct answer Learning Zone Buying and Selling Let s dissect Billy s situation. The start point is the goals and policies he has planned to steer his buying and selling activities. Then there are the SCORECARDS showing how his business model or at least the Buying and selling part of it would do in financial terms. 3

5 Talk the talk Look up the following terms in the Glossary Assets Balance Sheet Cost of Sales Creditor days Creditors Current Assets Current Liabilities Debtor days Debtors Direct Costs Equity Liabilities Net Worth Profit & Loss Account Revenues Stocks 4

6 Understand the link between business and the financials You will never forget the link between business activity and the scorecards if you think of the acronym REAL_E where: Revenue Expenses = Profit (or Loss) and are shown in the Profit & Loss Account Assets Liabilities = Equity and are shown in the Balance Sheet The presentation of Profit & Loss Accounts and Balance Sheets Expenses is a catch all term for the costs incurred in business and we will need break these down into Direct and Indirect costs as we develop Billy s business. And the Balance Sheet is usually presented in five sections to group long term and short term assets and long term and short term liabilities before deriving the residual Equity or Net Worth of the business as represented by the Share Capital invested by the owners plus retained profits or less accumulated losses. 5

7 Why is Billy s cash position different to his Net Profit Can you explain why the closing balance in Billy s Cash Statement was only 51,808 while his Net profit was 60,000? Answer: There are three causes: 1. He purchased 100 units more than he sold which created a closing stock of 10, His customers owe him 8,877 for goods he sold (debtors) 3. He owes his suppliers 10,685 for goods he bought (creditors) And the calculations are: He should have had 10,000 less in cash than profit because the unsold stock would have been included in cash balances but not in Cost of sales But he owes suppliers 1,808 more than his customers owe him so the cash difference is reduced to 8,192 ( 10,000 less 1,808) And so the profit of 60,000 is reduced by 8,192 to the closing cash balance The distinction between cash and profit in business is an important one and we will return to it in more detail in Workbook 5 - How not to run out of Cash General information about the presentation of financial statements Different industries use presentations that suit their business activities In FaBLinker we use the Retail setting as it addresses all the learning and high level business strategies you need without complicating matters with unnecessary detail. 6

8 Reflection and Discussion Zone Buying and Selling Prompt Key learning points What did you learn from the video? Open specific to individuals What is the Profit and Loss account telling you? And the Balance Sheet? How many sections does the balance sheet have? How were the following calculated? Sales value shown in the P & L Closing Stock in the Balance Sheet The Debtors figure in the Balance Sheet The Creditors figure in the balance sheet The Gross profit in the P & L The Cash-in and Cash-out in the Cash Flow Sales costs and expenses = profit or loss AND remember that the values are cumulative i.e. sales for the period against expenses fairly attributable to the period What the business owns (assets) owes (liabilities) and Net Worth (Shareholders Funds) The fundamental financial equation is in fact: Total assets Total Liabilities = Net Worth AND flag that the values are as at the end the period. Like a snapshot of the business at a specific point in time. Five Fixed Assets, Current Assets, Current Liabilities, Long term Creditors and Shareholders Funds Tip use the to bring up the to see how each item in the financial statements were calculated BUT See can you calculate them first "Selling price" multiplied by "Sell on credit (units)" plus "Selling price" multiplied by "Sell for cash (units)" "Opening Stock" plus "Purchases" less "Used in Sales". "Opening debtors" plus "Selling price" multiplied by "Sell on credit (units)". The resulting value is then divided by 365 and multiplied by the "Debtor days" "Opening creditors" plus "Purchase price" multiplied by "Buy on credit (units)". The resulting value is then divided by 365 and multiplied by the "Creditor days" "Total Sales" less "Cost of Sales" Look for the response using only relevant items (Cash-in is equal to Sales less closing debtors) and (Cash Out is purchases less closing creditors) Rather than The all-embracing calculations shown in the (i) tutor which includes items which we have not yet entered data on. 7

9 Prompt Why do Stock and debtors appear in the Current Assets section of the Balance Sheet? The closing stock has a value of how many units and why are the units in stock valued at that figure Why is the Net Profit Figure different to the closing cash balance? Key learning points We expect to convert them into cash within twelve months which is the dividing line between fixed and curtrent assets. The conservative principle of finance where stock would be valued at the lower of cost or realizable value so the cost price is used rather than the selling price. We will return to this question after Video 3 (Funding & Fixed Assets) when we will add more causes of divergence but here we are looking for two causes: 1. The timing difference created by credit (debtors and creditors) 2. Building inventory (stock) which has no impact on profit until it is sold but obviously has to be paid for in part or in full. Explore this in FaBLinker by changing the debtor and creditor days to zero and reducing the units purchased to match units sold. What would happen if the changes in the value of inventory were because of loss or damage? The reverse of the above as the change would be reflected in the Profit & Loss account but have no impact on cash flow. 8

10 Progress test Buying and Selling Question 1: Which one of the following best describes the purpose of the balance sheet? a) A financial statement showing the assets, liabilities and net worth of a business at a specific point in time b) A financial statement showing the assets, liabilities and net worth of a business over a period of time c) A financial statement showing the balances outstanding on customer s accounts d) A comprehensive statement of the financial performance of the business over the year Question 2: Which one of the following best describes the purpose of the Profit and Loss Account? a) A comprehensive statement of the financial performance of the business over the year b) A financial statement setting all costs against income over a specified period to show the profit or loss for that period c) A financial statement showing the profit or loss of a business by deducting cost of sales from sales d) A statement of the balance remaining after all incomes due to the business have been collected and all expenses due to suppliers have been paid Question 3: Which one of the following business activities belongs in the Profit and Loss Account? a) The cost of purchasing a building to house large scale manufacturing operations b) The cost of insuring that factory against fire c) The value of money outstanding from customers d) The value of new money invested in the business by the owners Question 4: Which of the following is the correct term for "X" in the following equation "Sales - X = Gross Profit"? a) Overheads b) Cost of Sales c) Purchases d) Costs Question 5: Which of the following best describes a Current Asset? a) An asset which the business expects to convert into cash within a year b) An asset which has been acquired within the last twelve months c) A sales order to be delivered within the next month d) A delivery truck bought with the last month Question 6: Which one of the following best defines the meaning of the term "Direct Cost"? a) A cost which can be directly related to sales b) A cost where the supplier insists on cash with order c) A cost that does not change in direct proportion to sales d) An overhead cost such as heating for office facilities 9

11 Question 7: Which one of the following best defines the meaning of the term "Accounts payable" or "Creditors"? a) The money owed to people who have loaned funding to the business b) The excess of current liabilities over current assets c) The difference between Total assets and Current liabilities d) The money owed by the business to suppliers that must be paid within the next twelve months Question 8: Which one of the following best defines the term "Cost of Sales"? a) The costs of advertising, marketing and promotion incurred in generating sales b) The total costs that can be directly traced to sales and excludes overhead expenses incurred in administering and managing the business c) All costs including overheads that may be fairly attributed to the period when the sales occurred d) The value added or sales tax incurred on sales Question 9: Which one of the following best describes an underlying principle applied in the preparation of financial statements? a) Stock (Inventory) is valued at current market value b) Stock (Inventory) is valued at the cost of the most recent purchase in that category c) Stock (Inventory) is valued at the lower of current market value or cost d) d) Stock (Inventory) is valued at the cost of the oldest item in that category Question 10: Which one of the following best describes an underlying principle applied in the preparation of financial statements? a) The goal is to provide a true and fair view of the financial activities and position of the business b) The goal is to provide a reasonably accurate view of the position of the business c) The goal is to provide a completely accurate view of the financial position of the business d) The goal is to provide a fair picture of the business 10