Understanding Business Accounting For Dummies, 2nd Edition (12 page)

Sales Revenue
(from the sales of products and services to customers)

Less
Expenses
(which include a wide variety of costs paid by the business, including the cost of products sold to customers, wages and benefits paid to employees, occupancy costs, administrative costs, and income tax)

Equals Net Income
(which is referred to as the bottom line and means
final profit after all expenses are deducted from sales revenue)

The profit and loss account gets the most attention from business managers and investors - not that they ignore the other two financial statements. The very abbreviated versions of profit and loss accounts that you see in the financial press, such as in
The Financial Times,
report only the top line (sales revenue) and the bottom line (net profit). In actual practice, the profit and loss account is more involved than the basic format shown here. Refer to Chapter 5 for more information on profit and loss accounts.

The cash flow statement

The cash flow statement presents a summary of the sources and uses of cash in a business during a financial period. Smart business managers hardly get the word
profit
out of their mouths before mentioning
cash flow.
Successful business managers can tell you that they have to manage both profit
and
cash flow; you can't do one and ignore the other. Business is a two-headed dragon in this respect. Ignoring cash flow can pull the rug out from under a successful profit formula. Still, some managers become preoccupied with making profit and overlook cash flow.

For financial reporting, cash flows are divided into three basic categories:

Basic Format of the Cash Flow Statement

(1)
Cash flow
from the profit-making activities, or
operating activities,
for the period (
Note:
Operating
means the profit-making transactions of the business.)

(2)
Cash inflows and outflows
from
investing activities
for the period

(3)
Cash inflows and outflows
from the financing activities for the period

You determine the bottom-line net increase (or decrease) in cash during the period by adding the three types of cash flows shown in the preceding list.

Part 1 explains why net cash flow from sales revenue and expenses - the business's profit-making operating activities - is more or less than the amount of profit reported in the profit and loss account. The
actual
cash inflows from revenues and outflows for expenses run on a different timetable than the sales revenue and expenses which are recorded for determining profit. It's like two different trains going to the same destination - the second train (the cash flow train) runs on a later schedule than the first train (the recording of sales revenue and expenses in the accounts of the business). Chapter 7 explains the cash flow analysis of profit as well as the other sources of cash and the uses of cash.

Part 2 of the cash flow statement sums up the major long-term investments made by the business during the year, such as constructing a new production plant or replacing machinery and equipment. If the business sold any of its long-term assets, it reports the cash inflows from these divestments in this section of the cash flow statement.

Part 3 sums up the financing activities of the business during the period - borrowing new money from lenders and raising new capital investment in the business from its owners. Cash outflows to pay off debt are reported in this section, as well as cash distributions from profit paid to the owners of the business.

The cash flow statement reports the net increase or net decrease in cash during the year (or other time period), caused by the three types of cash flows. This increase or decrease in cash during the year is never referred to as the
bottom line.
This important term is strictly limited to the last line of the profit and loss account, which reflects net income - the final profit after all expenses are deducted.

Imagine you have a highlighter pen in your hand, and the three basic financial statements of a business are in front of you. What are the most important numbers to mark? Financial statements do
not
have any numbers highlighted; they do not come with headlines like newspapers. You have to find your own headlines.
Bottom-line profit
in the profit and loss account is one number you would mark for sure. Another key number is
cash flow from operating activities
in the cash flow statement, or some variation of this number. Cash flow has become very important these days. Chapter 7 explains why this internal source of cash is so important and the various definitions of
cash flow
(did you think there was only one meaning of this term?).

Accounting as a Career

In our highly developed economy, many people make their living as accountants - and here we're using the term
accountant
in the broadest possible sense. Despite the introduction of new technology, the number of people employed in accountancy as a profession has shown extensive growth in the past three decades. Accountants work in many areas of business and the public sector in roles ranging from sole practitioner to chief executive of a multinational company. In public practice firms, from small high street to large international practices, accountants provide professional services to a wide range of fee-paying clients from the private individual to large commercial and public sector organisations. These services include audit/assurance, accountancy, tax, business advisory, and other management services. In commerce/industry and the public sector, chartered accountants work in a variety of financial management and financial reporting roles. It is possible for accountants to set up their own firm or become a partner in a private practice. This requires a Practising Certificate, which is awarded by one of the relevant qualifying bodies to accountants with at least two years' experience. There are also opportunities to work abroad.

Because accountants work with numbers and details, you hear references to accountants as bean counters, digit heads, number nerds, and other names we don't care to mention here. Accountants take these snide references in their stride and with good humour. Actually, accountants come out among the most respected professionals in many surveys.

Chartered Accountant (CA)

In the accounting profession, the mark of distinction is to be a
CA
, which stands for
chartered accountant.
The majority of chartered accountants train in public practice and the first three years are devoted to achieving the chartered qualification. The training involves completion of professional exams together with a period of structured work experience. The professional exam training is provided by the Institute of Chartered Accountants in England and Wales (ICAEW) (
www.icaew.co.uk
), which is the largest, the Institute of Chartered Accountants of Scotland (ICAS) (
www.icas.org.uk
), and the Institute of Chartered Accountants in Ireland (ICAI) (
www.icai.ie
) - Dublin Office. The structure of the exams and methods of training delivery vary slightly between the institutes and full details can be found on their Web sites. However, the qualifications cover broadly similar syllabuses and are of equal status and recognition, all leading to the designation ‘chartered accountant' (ACA or CA). The syllabuses cover subjects such as accounting, audit, business finance, taxation, law, and business management, which are assessed primarily through formal exams. Chartered accountants must remain up-to-date on technical and business issues, so there is a strong emphasis on continuing professional development after qualification.

Other professional bodies that train accountants and are useful to know about include the Chartered Institute of Management Accountants (
www.cimaglobal.com
), who focus on accounting for and in business, the Chartered Institute of Public Finance and Accountancy (
www.cipfa.org.uk
), who specialise in the public sector, and the Association of Accounting Technicians (
www.aat.org.uk
), whose 36,000 members assist chartered accountants in their work, or can themselves join a chartered institute after further study.

The Financial Controller: The chief accountant in an organisation

After working for an accountancy firm in public practice for a few years, most CAs leave public accounting and go to work for a business or other organisation. Usually, they start at a mid-level accounting position with fairly heavy accounting responsibilities, but some step in as the top accountant in charge of all accounting matters of a business. The top-level accountant in a business organisation is usually called the
Financial
Controller
,
or
chief accountant.

The Financial Controller designs the entire accounting system of the business and keeps it up-to-date with changes in the tax laws and changes in the accounting rules that govern reporting financial statements to outside lenders and owners. Controllers are responsible for hiring, training, evaluating, promoting, and sometimes firing the persons who hold the various bookkeeping and accounting positions in an organisation - which range from payroll functions to the several different types of tax returns that have to be filed on time with different government agencies.

The Controller is the lead person in the financial planning and budgeting process of the business organisation. Furthermore, the Financial Controller designs the accounting reports that all the various managers in the organisation receive - from the sales and marketing managers to the purchasing and procurement managers. These internal reports should be designed to fit the authority and responsibility of each manager; they should provide information for managers' decision-making analysis needs and the information they need to exercise effective control.