WEEK 4

Programme
BSc (Hons) Business Enterprise and Innovation Management

LD6081- Finance and Operations in Enterprise Context

Module Leader: Emmanuel B Ofori

Weekly Module Content
 Learning Objectives

Upon completion of this session, student will be able to:

1. Understand the meaning and importance of financial statements

2. Understand the main components of financial statements

3. Prepare an income statement and balance sheet for an SMEs

What is a financial statement and why is it
important?
A financial statement is a document that shows the financial
activities of a business.

It is the financial record of any and all transactions the business

has done during a set accounting period.

They are very useful because they provide evidence of your

income and expenditure over a period of time. This is vital in the
event of an audit by a government agency.

Financial statements play a crucial role in assessing the financial

health and performance of a company.

They provide valuable information to stakeholders such as

investors, lenders, and managers, helping them make informed
decisions about investment opportunities, creditworthiness, and
strategic planning.
 The Five Main Financial
Statements
Financial statements are written reports created by a
company’s management to summarize the business’s
financial condition over a certain period (quarter, six-
monthly, or yearly).
These statements, which comprise of:

1.Income statement of Profit & Loss

2.Balance Sheet (Statement if financial

Position)

3.Cash Flow Statement

4.Statement of shareholders’ equity and

5.Notes to the accounts and Disclosures

 What is an Income Statement?
The Income Statement is one of a company’s core financial
statements that shows their profit and loss over a period of time.
The profit or loss is determined by taking all revenues and
subtracting all expenses from both operating and non-operating
activities.

The income statement is one of three statements used in both

corporate finance (including financial modelling) and accounting.
It shows the company’s revenue, costs, gross profit, selling and
administrative expenses, other expenses and income, taxes paid,
and net profit in a coherent and logical manner.
 The Income Statement for a sole trader
INCOME STATEMENT OF GRACELAND FOR THE Y/E • Expenses
31/12/2022
• Wages & salaries x
• £ £
• Rent & Rates x
• Sale revenue x
• Light and Heat x
• Sales return ( return inwards ) (x)
• Depreciation x
• Net Sales x
• Motor expenses x
• Cost of Sales
• Bad debt x
• Opening inventory x
• Advertising x
• Purchases x
• Stationery and Postage x
• Purchase return ( return outwards ) (x)
• Discount allowed x
• Carriage inwards x
• Other expenses x
• Closing inventory (x) (x) (x)
• Gross profit x • Profit for the year
(x)
• Other Income
• Rental income x
• Discount received x
•
Interest received x x
 Some important terminologies
 Revenue – is the inflow of economic benefit from the sale
or provision of services from the ordinary course of
activities
• Return inwards/ sales return – this is where a customer
returns an item purchased
• Return outwards/purchase return – this is where a retailer
return goods to the supplier
• Carriage inwards – the cost of transporting the goods to
the shop or warehouse (e.g. Port charges, Custom duties,
transport charges, etc
• Carriage outwards – the cost of transporting the goods to
customers ( e.g home delivery)
• Cost of sales: Cost of sales, sometimes known as cost of
goods sold (COGS), is simply the cost involved in directly
producing the goods or services that you actually sell.
 Example of an income statement

https://corporatefinanceinstitute.com/resources/accounting/income-
statement/
INCOME STATEMENT FOR A LIMITED LIABILITY COMPANY
Seminar -2 (a) The Income Statement

Questions will be discussed during seminar

 What is a Statement of financial Position (SFP)?

Statement of Financial Position, also known as the Balance

sheet, gives the understanding to its users about the business’s
financial status at a particular point in time by showing the
details of the company’s assets along with its liabilities and
owner’s capital.

It is one of the most important financial statements which

reports the firm’s financial position at a point in time. In other
words, it summarizes a business’s financial position and acts as
a snapshot of events at one point in time.
 Assets= Liabilities +
It is one ofShareholder’s
the most importantEquity
financial statements which reports
the firm’s financial position at a point in time. In other words, it
summarizes a business’s financial position and acts as a
snapshot of events at one point in time. It comprises three
important elements (explained in detail later), namely:

•Assets are the resources owned and controlled by the business.

Assets are further classified into Current Assets and Non-
Current Assets.

•Liabilities are the amount of business owing to its Lenders and

Other Creditors. Liabilities are further classified into Current
Liabilities and Long Term Liabilities.

•Shareholder’s Equity which is the residual interest in the Net

Assets of a business that remains after deducting its liabilities.

The Fundamental Accounting Equation (also known as the

Balance Sheet Equation) through which transactions are
measured equates:
 Examples of tangible fixed assets:
What are assets? Motor Vehicle
Plants & Equipment
Fixtures & Fittings
Tools
Machinery
Land and Building
Current Assets: These are assets that
can be converted to cash within the
shortest possible time. They include:
Cash and Bank
Stocks/Inventories
Debtors or Trade receivables
Prepayment
Short term investments
 The Balance Sheet of a sole trader
BALANCE SHEET FOR JEFFREY AS AT 31 DECEMBER 2022 • Equity and Liabilities
• Cost Accum NBV • Equity
• Valuation Depn • Capital introduced
• £ £ £ x

•Non Current Assets • Profit from the income statement x

•Land & Buildings

• Drawings (
x x x x)
•Plant & Equipments x x x • Non Current Liabilities
•Fixtures & Fittings x x x • Bank Loans
•Motor Vehicle x
x x x
•Intangibles – Goodwill x
• Current Liabilities
•Total non current assets x
• Trade payables
x
•Current Assets • Accrued expenses
•Inventories x x

•Trade Receivables
• Overdraft
x x
•Bank and Cash x • Total Equity and Liabilities
•Prepayment x
x x

Total Assets x
 THE BALANCE SHEET OF A LIMITED LIABILITY COMPANY

BALANCE SHEET FOR JEFFREY ENTERPRISE AS AT 31/12/2022 • Equity and Liabilities

• Cost Acc. Dpn. • Equity
NBV
• £ £
• Ordinary share capital x
£
• Share premium x
• Tangible Non Current Assets
• Profit from the income statement x
• Land & Buildings x x x
• Retained earnings x
• Plant & Equipments x x x x
• Fixtures & Fittings x x x •

• Motor Vehicle x x
x • Non Current Liabilities
• Intangible NCA • Bank Loans
X x
• Goodwill • Current Liabilities
x
• Trade payables x
• Total Non Current Assets
x • Tax liabilities x
• Current Assets • Accrued expenses x
• Inventories x • Overdraft x
• Trade Receivables x x
• Bank and Cash x • Total Equity and Liabilities
x
• Prepayment x
x
• Total Assets
x
 Example of a Balance Sheet or SoFP

https://corporatefinanceinstitute.com/resources/accounting/balance sheet-
statement/
 Seminar -2(b)
The Statement of Financial Position

Questions will be discussed during seminar

 What is depreciation?
• Depreciation measures how much a non-current
asset reduces in value over time
• An attempt to measure that portion of the cost of a non-
current asset that has been depleted in generating the
revenue recognised during a particular period

Here are some examples

A business buys a
A business buys office
new van for £25
000. equipment for £35
It will be worth 000.
less in 5 years’ It will be worth less in
time. 5 years’ time
 Factors causing depreciation
• Wearing out through use
• Passage of time
• Using up, extraction of finite resources (mining)
• Economic reasons including obsolescence

Calculating the depreciation expense

• To calculate the depreciation expense for a
period, 4 factors have to be considered:
1. The cost (or fair value) of the asset
2. The useful life of the asset
3. The residual value of the asset
4. The depreciation method used
 The cost of the asset
• This includes:
• The price paid for the asset
• Any delivery costs
• Any installation costs
• Legal costs
• Costs associated with adapting or improving the asset

Example of asset cost

A business buys a new van. Its cost
is:

Price of van £25 000

Delivery cost 200
Number plates 150
Road tax 220
Total £ 25 570
 The useful life of the asset
• A non-current asset has both a physical life and an economic life
• Physical life is effected through wear and tear and/or the passage of time
• Economic life is decided by the effects of technological progress, by changes in
demand or changes in the way that the business operates

• Economic life
• Physical life • Technological change
• For example, a van will • Changes in demand
deteriorate in condition • Changes in the way a business
operates
over the time it is used • For example, a computer’s economic
life will be quite short, as new
technology replaces it
 Residual value (disposal value)
• When a business disposes of a non-current asset, it
may be able to sell it to someone else (another
business or organisation, or a person)
• The amount of money received by selling the non-
current asset is called its residual value

• For example
• A business may sell its old computers to a school for
£50 each. The money received is the residual value
 Straight-line method
• This method simply allocates the amount to be depreciated
evenly over the useful life of the asset

For example, a business buys IT equipment for £78 124. It

estimates that the equipment will have a useful life of 4 years.
At the end of this period, the business will sell the equipment
for £2000

Cost of IT equipment £78, 124

Estimated residual value £2, 000
Estimated useful life 4 years
Step 1: Calculate the total cost of the non-current asset less
the residual value
£78,124 - £2,000 = £76,124
Step 2: Divide by the number of years of useful life
£76,124 = £19,031
4
 Straight line calculation
Cumulate
Annual
Cost of d Net Book
Year Depreciati
Asset Depreciati Value
on
on
1 78,124 19,031 19,031 59,092
2 19,031 38,062 40,062
3 19,031 57,092 21,031
4 19,031 76,124 2,000
 Reducing balance method
• This method applies a fixed percentage rate of
depreciation to the carrying amount (net book value)
of the asset each year
For example, a business buys IT equipment for £100,000.
Use a fixed percentage of 60% of the carrying amount to
determine the annual depreciation
Cost of IT equipment £100,000

Annual Cumulated Net Book

Year Cost of Asset
Depreciation Depreciation Value

1 £100, 000 60,000 60,000 40,000

2 £40,000 24,000 84,000 16,000
3 £16,000 9,600 93,600 6,400
4 £6,400 3,840 97,440 2,560
WEEK -4 SEMINAR QUESTIONS

SEE SEMINAR WEEK 4

 Recommended Reading

Entrepreneurial Finance by Hume, S. and Drew, C. (2020). Red



Globe Press, UK

 Atrill P. and McLaney E. (2015) “Accounting and Finance for Non-

Specialists, 7th -edition, FT Prentice Hall. Pages

 www.ccaglobal.com
www.icaew.co.uk
www.cfa.com