AAT Level 4 Cash and Financial Management

Accounting for profit:

Profitability =  The amount by which income exceeds expenditure (An increase in the wealth of thne business). To calculate we use cash-based reciepts and payments - making adjustments for items that should be in the SOFP. Such as: 

- Receviables & Payables

- Deprectaion 

- Adjusting provisions & Accruals / Prepayments

The profit figure is reflected is reflected in the net result of all assets and liabilities in the SOFP. This is the 'accruals' system of accounting. 

Accounting for cash

Cash recipets and payments are recorded in a business's cash book. The balance of the cash book only represents one of the business assets / liabilities if overdrawn. 

Reciepts and payments (only relate to cash items). Don't include any adjustments to income and expenditure. 

The importance of cash 

Cash is the amount of money the business has. This is money in a liquid form as it can be spent as and when. Cash is important for the day to day activities of the business because of the dependability of being able to make and recieve cash payments when they become due. Also needs to have sufficient cash to meet its obligations. 

Using this format we can see how a profit figure can be reconciled with the increase / decrease in cash over the same period. We start with the profit figure and then adjust it for non-cash items to arrive at the change in cash. 

BUDGETED PROFIT FOR PERIOD                                                                              

ADD non-cash expenditure used in cal of profit (Depreciation)                                       

DEDUCT cash payments not used in cal of profit (Purchase of Non-Current Asset)      

ADJUST for changes in inventory (- increase / + decrease)                                          

ADJUST for changes in recieveables (- increase / + decrease)                                     

ADJUST for changes in payables (+ increase / - decrease)                                         

INCREASE / DECREASE IN CASH                                                                      

Working capital is the part of the net resources of the business that is made up of current assets minus current liabilities. 

CA & CL are shown in the SOFP. The total working capital is also known as 'net current assets'

Working capital invloves the circulation around the business of the elements of inventory, TR, cash and TP. 

The diagram shows the trading situation. Payables provide inventory which is then sold on credit terms to create receivables. When they are eventually paid it generates cash which is then put back in to pay the payables due. For manufacturing inventory must be turned into finished goods before the cycle can be completed. 

Suppliers won't want to wait until the cycle is complete to receive payment for the goods and so a business must plan to have sufficient resources available in working capital to pay suppliers on time. 

Calculating the cash cycle is only looking at when a payment is made for goods bought and when a payment is received for goods sold. 

The shorter the cash cycle = more efficient use of resources

The longer the cash cycle the more money is tied up in working capital. 

Another way to calculate the cash cycle is to use average timings that can be established for inventory, receivables & payables. These will be in the workinf of inventory holding period, receivables collection period & payables payment period. 

CASH CYCLE = Inventory (HP) + Receivables (CP) - Payables (PP)

The usefulness of these performance indicators & cash cycle will be limited if the data used is not typical. A seasonal increase in inventory would not refelct a true figure of normal operations. 

Liquidity management is very important and a fundamental part of it is having enough cash available to pay accounts when they become due. By liquidity it means assets that can be turned into cash quickly. Inventory is the least liquid as it is two statge away from being cash, receivables are one stage away and cash is the most liquid. 

Only current assets are considered due to non-current assets being purchased not for the intention of turning them into cash. 

Liquidity is the term used to describe the liquid assets / cash a company can use to meet its current and future debts and other obligations (Foreseeable & unforeseeable). Such as payments for goods and services. The liquidity is assessed by how readily available the cash can be accessed. 

The following performance indicators are useful for managing liquidity. 

Simple assessment of liquidity. The higher the figure the more easily the organisation will be able to meet their short-term obligations.

Calculation removes inventory as it is less liquid compared to the other current assets. Forms a more critical measure of liquidity. 

Both the current and quick ration are expressed as X:1. X being the answer calculated from the data. 

Capital employed = total equity + non-current liabilities 

Measure of profability rather than liquidity. Profability is an important factor in mamaging liquidity.

Measure of profit attributable to shareholders and uses the profit that they own instead of their share in the business. 

Shows the percentage of revenue that remains as profit after operating costs have been deducted

Total debt in this context means all non-current liabilities only. 

Gearing shows the percentage of total financing that comes from debt. Debt involves the obligation to pay interest regardless on the amount of profit earned. 

A HIGH gearing percentage = a high level of debt. This can be risky, especially if profit levels are uncertain. 

This shows how many times larger the operating profit is than the interest that is paid out of it. The HIGHER the figure the more stable the position is. 

This measure is linked to gearing since the greater the debt the greater the interest and the likelihood of low interest cover.