Sunday, 20 January 2008

The Cash Flow Statement

What information does a cash flow statement provide? Using a self-created example, explain the direct and indirect methods for calculating cash flows from operating activities.

The cash flow statement that a business produces "reveals the movement of cash over a period of and the effect of these movements on the cash position of a business" (Atrill & McLaney, 2006). This third mandatory financial statement is required because of the vital importance that cash has to a business. The cash flow statement summarises the receipt and payment of cash (and cash equivalents such as deposits held in a bank account which are easily accessible) over a period, and displays the net increase or decrease of cash in the business.

The cash flow statement will contain four main sections. The first shows cash flow from operating activities. It is the cash received from sales and trade receivables minus the cash paid to purchase stock, pay the workforce and other such activities. This section is calculated after tax and financing costs have been taken into account. The next section shows cash flow from investing - cash received from payment for non - current assets minus cash paid for non - current assets. The third section shows cash flow from financing - long term borrowings and share - related activities are examples of this. Finally, the fourth section will show the net increase or decrease in cash.

While the direct method of preparing a cash flow relies on combining all cash - related transactions for a particular category of operating activity, the indirect method uses the income statement as its starting point and works out the cash flow of the business from that (this appears to be much less work than crunching all the numbers for the direct method). "Most of the items in an income statement are related to operating activities as defined by the cash flow statement rules. Therefore, it is possible to reconcile the net income from the income statement to the cash from operating activities" (Trent, 2007).

A direct cash flow statement would look similar to the following:

Cash Flow Statement for month ended December 31, 2007

Operating Activities (£)
Cash collected from customers 50,000
Cash paid for rent (2,000)
Cash paid in wages (5,000)
Cash paid for utilities (1,000)

Investing Activities (£)
Purchase of machinery (75,000)
Sale of machinery 10,000

Financing Activities (£)
Issue of Shares 80,000

Total Cash Flow 57,000
Starting Cash 0
Ending Cash 57,000

whereas an indirect cash flow statement will resemble this:

Cash Flow Statement for month ended December 31, 2007

Operating Activities (£)
Net Income 10,000
Less Increase in Inventory (8,000)
Less increase in A/C Receivable (7,000)
Plus increase in A/C Payable 47,000

Investing Activities (£)
Purchase of machinery (75,000)
Sale of machinery 10,000

Financial Activities (£)
Issue of Shares 80,000

Total Cash Flow 57,000
Starting Cash 0
Ending Cash 57,000


Atrill, P. & McLaney, E. (2006) Accounting and Finance for Non - Specialists (5th Ed.) Essex, Pearson Education Ltd.

Trent, W (2007) Cash Flow Statement - The Indirect Method [Online]
Available from (Accessed 19th Jan 2008)

Financial Ratios and Trend Analysis for Financial Statements

How are financial ratios and trend analysis used to analyze and interpret financial statements? Which category (profitability, efficiency, liquidity, gearing, or investment) of ratios is most useful for company managers and why?

"Financial ratios can be very helpful when comparing the financial health of different businesses" (Atrill & McLaney, 2006). The percentage values calculated by the ratio equations remove the issue of scale from the comparison, and allow an analyst to see, for example, how an older IT leviathan like IBM compares to one of the IT industry upstarts such as Facebook. The ratios can also be used to show the performance of the same company over a period of time and indicate why it is succeeding (or failing). They are also used by analysts to compare the performance of similar companies in the same industry and show if a company is achieving the financial targets that it has set itself. The most common financial ratios can be largely divided into five categories; Profitability, Efficiency, Liquidity, Financial Gearing and Investment.

Trend analysis is extremely useful in understanding the performance of one or several businesses over a period of time. Plotting key financial ratios on a graph can quickly illustrate which companies are doing better than their rivals, what the general trends are, and even help to see into the future - very important when considering investment opportunities.

In answer to the second part of this question I would say that different management roles within a company will find different ratios useful. Speaking from personal experience of having worked on the shop floor of multinational wholesalers the most important ratio for the store manager was the profitability ratio. This could quickly inform him of any problem areas - for example, if the net profit of fresh food fell below a certain threshold then it was usually down to too much wastage, and he would be able to get his line managers to take corrective action - review what was being ordered or review stock rotation. In my current job in local government the profitability ratio has absolutely no relevance to the upper echelons of management. I would think that ensuring the financial viability of the Council - making sure that all its liabilities such as benefit payments and services are met. A report prepared by PriceWaterhouseCooper on the financial sustainability of local government in Australia stated that interest cover ratio, median sustainability ratio (which is capital expenditure / depreciation) and current ratio were important financial ratios in this particular industry which backs this theory up.


Atrill, P. & McLaney, E. (2006) Accounting and Finance for Non - Specialists (5th Ed.) Essex, Pearson Education Ltd.

Pritchard, J. (2006) National Financial Sustainability Study of Local Government [Online] Canberra, Australian Local Government Association
Available from (Accessed 20th Jan 2008)

Saturday, 19 January 2008

Accounting & finance features for limited companies

List and describe three accounting and finance features for limited companies? How is accounting and financial reporting regulated in your country?

There are a number of accounting and finance features that are specific to limited companies. The first of these is the way in which the company is owned. This is facilitated by the creation of shares when a company is formed, which allows the ownership to be spread between an infinite number of parties. The existence of shares grants a company perpetual existence, encourages investors because of their high liquidity, and enables ownership in the company to be expanded, or change hands, very quickly.

A limited company is legally required to produce financial statements and make this available to the public. These financial statements - the balance sheet and the income statement - follow the same format to those produced by non - incorporated companies but do have some subtle differences. The income statement will show more extensive profit details - operating profit (profit before financial expenses), profit before tax, profit after tax, and retained profit that has not been used to pay a dividend to shareholders or transferred to a reserve. The income statement will also show an audit fee, a dividend, and the amount transferred to the reserve. The balance sheet will differ in that it shows corporation tax (only paid in the UK by limited companies) and a figure for equity in the company.

As soon as a limited company grows beyond a certain size it is a requirement for the shareholders to appoint a qualified team of auditors to report on the accuracy of the financial statements of the company. The auditors will investigate the details of the financial statements and the evidence on which they are based. In my personal experience the field of auditing has become much more profile in recent years, and large auditing companies such as PriceWaterhouseCooper are better known than the companies that they are hired to audit.

In the UK, accounting is legislated by the Accounting Standards Board. This organisation issues accounting standards and protocols autonomously (but in consultation with the companies that its decisions will affect). The ASB expresses the need to harmonise international accounting standards, "in most cases, compliance with an FRS (Financial Reporting Standard) automatically ensures compliance with the relevant IAS" (Financial Reporting Council, 2008). This has to be the approach taken; every year sees increased European harmonisation in terms of legislation. "The European Commission adopted a regulation requiring Stock Exchange listed companies of EU member states to prepare their financial statements according to International Accounting Standards Board standards" (Atrill & McLaney, 2006). Much of the big business in the UK is now just part of an international conglomerate and this approach to international accounting will help that greatly.


Financial Reporting Council (2008) Foreword to Accounting Standards [Online] London: Financial Reporting Council
Available from (Accessed 19th Jan 2008)

Atrill, P. & McLaney, E. (2006) Accounting and Finance for Non - Specialists (5th Ed.) Pearson Education Ltd., Essex, England

Sunday, 13 January 2008

The Profit and Loss Account

What information does a profit and loss account (income statement) provide? How does the selection of accounting methods for depreciation and stock costing affect measuring and reporting financial performance?

"The purpose of the profit and loss account is to measure and report how much profit the business has generated over a period" (Atrill & McLaney, 2006). Where the balance sheet recorded the relationship between assets and claims, the profit and loss account shows the relationship between revenue - which is a measure of economic benefit to a business that comes from activities such as sales, services and interest - and expense - which is a
measure of economic loss that is caused by activities such as the purchasing of stock, paying salaries or renting plant. The profit and loss account shows the result of the equation:

Profit (loss) for period = total revenue for period - total expenses incurred creating the revenue

Depreciation models the fact that the majority of non - current assets do not have an infinite amount of use - in the act of generating revenue they will be used up. An example of this is a piece of manufacturing equipment - as it performs its duties in working towards producing whatever the business needs it will, over time, begin to wear out, malfunction, and maybe even cease working altogether. Depreciation is almost like double entry accounting for assets - its benefit to the business is recorded on one side of the equation while the cost of providing this benefit in terms of maintenance and value is recorded on the other side.

Depreciation is made up of four concepts. Fair Value is the cost of purchase, delivery, installation as well as future alterations or upgrades. Useful Life differentiates between physical life - how long an asset will work for - and economic life - how long the benefits of using an asset remain higher than the costs involved. Computer equipment may work for ten years, but the rapid improvements in speed and performance make its economic life much shorter. Residual Value is a disposal value - basically a payment made to the business by someone buying the asset. Depreciation method is how the depreciable amount of the assets life is allocated amongst accounting periods.

Choosing this method is based on the pattern of benefits consumed by the asset - an even spread of benefits over time would lead to a business choosing to adopt the straight line method, but an increasing decline in benefit over time - this is the return you would expect from computer equipment - would lead a business to choose a reducing balance method.

The measuring of the cost of stock in a business is important because of the effect that it has on both the calculation of profit and financial position. A business will calculate the cost of stock at the start and end of a reporting period, and can make common assumptions about how stock is handled - stating that the oldest inventories are the first to be sold (known as FIFO or first in last out) or that the newest inventories are the first to be sold (known as LIFO or last in first out). A business could also use an average cost of inventories held - useful, I suppose, if the business holds a lot of stock that is older and has less value because it will hide this fact on the profit and loss account.


Atrill, P. and McLaney, E. (2006) Accounting and Finance for Non - Specialists 5th Ed. Harlow, Essex: Pearson Education Ltd.

The Balance Sheet

What information does a balance sheet provide? How do accounting conventions and asset valuation affect measuring and reporting financial position?

"The purpose of the balance sheet is simply to set out the financial position of a business at a particular moment in time" (Atrill & McLaney, 2006). This broad definition can be made more specific by stating that the balance sheet shows the assets of a business on one side and the claims made against a business on the other side, and ensures that the two sides always balance. The assets that it shows are the resources of the business and these must always have some future monetary value, be exclusively owned by the business, exist as a result of a past transaction and be measured in monetary terms. Cash, plant, trademarks and investments are all examples of business assets. Claims do not have the same requirements as assets in terms of their definition, but can be divided into Capital claims - which are the claims of the owner against the business - and Liability claims - which are the claims of everyone else against the business.

The balance sheet essentially shows the result of the 'balance sheet equation' which is defined as Assets = Capital + Liabilities. For example, if a business purchases £5,000 worth of stock on any given day then £5,000 will be added to the assets section of the balance sheet, but this purchase is also now a claim against the business by an external party (the supplier) so £5,000 must also be added to the Liability claims section of the balance sheet. A business will normally use the balance sheet in three ways; "for reporting purposes as part of annual accounts, to help all parties interested in a business to assess the worth of a business and as a tool to help improve the management of a business" (Business Link, 2008).

A number of accounting conventions affect the reporting of financial position. Business Entity convention ensures that the business and its owners will always be treated as seperate bodies regardless of the type of ownership. This means that the two types of claim will always be applied. Money Measurement convention keeps assets and liabilities that cannot be assigned a monetary value off the balance sheet. Historic Cost convention values assets at their acquisition cost, not an adjusted cost for factors such as depreciation. Going Concern convention assumes that the business will continue to operate in the future and has no need to sell non - current assets, and that the financial reports should be prepared on this basis. Dual Aspect convention keeps the balance sheet 'balanced' by recording transactions with two aspects, as explained in the second paragraph of this essay. Prudence convention (now Gordon Brown's nickname as Chancellor of the Exchequer makes more sense) makes financial reports lean towards caution - making any expected bad news clear straight away. Stable Monetary Unit convention assumes that money will not change in value over time, and finally Objectivity convention means that financial reports will be prepared based on objective facts rather than subjective opinion.

Asset valuation is important to the balance sheet because Historic Cost convention isn't really practical in the real world, some allowance has to be made for the fact that assets can appreciate or depreciate in value over time, and this must be recorded to accurately show the true value of a business. In terms of tangible non - current assets such as delivery vans either the net value of the asset after depreciation can be shown on the balance sheet, or a 'fair value' which is usually the market value of the asset. Implementing this latter method of valuation can have a drastic change on how the business looks on paper - especially if the business owns assets that have considerably increased in value.


Atrill, P. and McLaney, E. (2006) Accounting and Finance for Non - Specialists 5th Ed. Harlow, Essex: Pearson Education Ltd.

Business Link (2008) Balance sheets: the basics [Online]
Available from: (Accessed 13th Jan 2008)

Similarities & Differences of Financial & Management Accounting and Finance

What are financial accounting, management accounting, and finance? How are they similar and different?

Financial accounting, management accounting and finance are all three concerned with making financial decisions in a business. Atrill and McLaney draw a distinction between financial and management accounting through this statement: "the differences between the two types of accounting reflect the different user groups that they address" (2006). Management accounting reports are targeted at fulfilling the information needs of managers within a business and are likely to be much more detailed, to contain information about other areas of he business too,
to be both backward and forward looking, and to be much more specific than generalised financial accounting reports. "Financial accounting is something performed to agreed standards designed to accurately report the true worth of a accounting, on the other hand, is a mechanism for using a financial metric for making a decision about different choices" (Anderson, 2004). Perhaps the biggest difference between the two strands of accounting is that reports produced in financial accounting must meet the guidelines laid down by international bodies such as the International Accounting Standards Board, whereas management accounting reports can be produced in any format the management see fit - they are for internal consumption only.

Finance "is concerned with the ways in which funds for a business are raised andinvested" (Atrill & McLaney, 2006). It is similar to financial and management accounting in the sense that it is another source of information about the business. Finding concrete reasons on why the two disciplines are different is harder because no two authors seem to agree. Broadly speaking, the difference lies in the type of information that accounting and finance will seek to interpret. Management accounting could potentially gather information on any decision that had to be made within a business - for example, the merging of two staff departments, or the decision to upgrade all the desktop computers owned by the business. The information produced by financial reporting would be much narrower in its scope - looking at issues such as the type of investments that should be undertaken. A slightly different differentiation between finance and accounting is provided by Bonnie Coleman; "take stock of where you've been (accounting) and plan where you want to be (finance)" (2005). I disagree with her analogy though; the accountants working in my organisation play a key role in deciding where the organisation is heading and their influence is not restricted to money.


Atrill, P. and McLaney, E. (2006) Accounting and Finance for Non - Specialists 5th Ed. Harlow, Essex: Pearson Education Ltd.

Anderson, D. J. (2004) Management vs Financial Accounting [Online]
Available from (Accessed 13th Jan 2008)

Coleman, B. (2005) The Difference Between Accounting and Finance: A Plan New Mexico Business Journal, March, 2005 [Online]
Available from (Accessed 13th Jan 2008)

Sunday, 6 January 2008

If the Brain is a computer...

If the brain is a computer and the mind its workings, is this a fitting analogy of the computer and its software? What would happen if we had dedicated computers with a huge numbers of neuron circuits? Would intelligence develop? Would we be able to understand it?

"If the brain is a computer and a mind its workings" is not a particularly fitting analogy of a computer and its
software. Certainly you could see how the latter is representative of the former but the computer just does as it
is told, rather than being able to figure things out for itself.

The question "would intelligence develop" has two answers, I think. It has been proven in studies that
intelligence (and we must bear in mind that there is more than one definition of this) can develop inside closed
environments, inside 'worlds' that are subject only to a pre-defined set of stimuli. In his dissertation The
Evolutionary Emergence Route to Artificial Intelligence Alistair Channon sets out to "develop AIs that can grasp
profoundly new situations on their own". He concludes that "some of the observed behaviours could indeed be
considered intelligent if only at a very low level" (1996). Within the system boundaries (a computer program)
intelligence existed but it is unlikely that this intelligence would pose a threat to the modern world - it has no
way, for example, to keep itself alive if the power to the computer it is running on is cut.

The problem is that much of our experience of Artificial Intelligence is seen working within 'Expert Systems'
rather than within the world that we all live in. A neural network that decides if my mortgage application can be
approved or not is intelligence but only within the boundaries of learning how to process data related to a
mortgage application. If it was fed data about a blood test or the communication between two computers it would
still try decide whether to approve a mortgage or not.

"When we examine very simple level intelligence we find that explicit representations and models of the world
simply get in the way. It turns out to be better to use the world as its own model" (Brooks, 1991). Brooks argues
that we need to build intelligence in components - starting with a very simple autonomous system that is
intelligent in the real world, and then building on this. This approach gives agents basic survival skills -
knowing how to avoid danger, knowing to get the equivalent of food and water, and where to get this from. Then
higher levels of intelligence are built on these basic layers, the process mirroring human biological evolution
from single cells to beings comprised of billions of inter-operable neurons. I think this biological approach is
how machines will become intelligent, rather than simply stringing together thousands of processors into a neural


Channon, A (1996) The Evolutionary Emergence Route to Artificial Intelligence [Online] University of Sussex
Available from (Accessed 6th Jan 2008)

Brooks, R. A. (1991) Intelligence without representation [Online] Cambridge: MIT
Available from (Accessed 6th Jan

Benefits and Perils of AI

In our discussions we exalted AI. Do you think that there are also dangers involved? Please discuss the benefits and the perils of artificial intelligence.

In I, Robot, one of the characters finds himself in grave danger on the surface of Mercury. The robot that has carried him onto the surface "said stupidly, 'you are in danger, Master'" (Asimov, 1968). At the start of the twenty first century the human race is still a long way off creating artifical intelligence that is this... intelligent. We do benefit from some early advances in the field, but I must agree with much of what science fiction writers predict - AI holds more perils for us than benefits in the long term.

The neural network is the most commonly implemented form of AI, "constructed from many individual processors in a manner that models networks of neurons in living biological systems" (Brookshear, 2007). These have two major benefits - they allow for extremely sophisticated models to be built from data that has a non - linear relationship and they can be trained to learn how the data in the model is ordered.

Two fields where neural networks are becoming increasingly are medicine and finance. "Using artificial neural networks, it can be monitored a lot of health indices (respiration rate, blood pressure, glucose level) or can be predicted the patient response to a therapy. Artificial neural networks have a very important role in image analysis, too, being used together with processing of digital image in recognition and classification" (Albu & Ungureanu, 2005). It is often the case that a patient will have a range of symptoms and a range of lifestyle choices and a neural network can quickly identify illness and treatment based on this set of seemingly non - related data. It has been proved that AI is better than humans at working the stock market. In a review of the book Using Artificial Intelligence to Improve Real-World Performance Lou Mendelsohn states "the authors show that the neural network approach yielded better performance than MDA [a traditional statistical model]" (2008). It can't be too long - with the cost of computer hardware falling and its power increasing - before AI increasingly replaces people in making financial decisions. When I apply for a loan, a credit card or car insurance it's not an underwriter who decides if I'm a good risk any more - it's a neural network.

All this improves accuracy and removes human error. But therin lies the problem - as the requirement for intelligent machines increases, the need for the humans that they are replacing will decrease. Already the manufacturing industry has cut "as many as 10 million jobs involving physical labor and repetitive the coming years, a large number of first-level jobs in service industries related to customer service, help desk and directory assistance will be lost due to the advent of intelligent systems" (CNET, 2004). Artifical intelligence will mean a shrinking labour market, and while this was once restricted to jobs at the lower rungs of the employment ladder I am sure that so called 'skilled' jobs will eventually simply be a case of sitting and making sure that the machine works properly. This is a scary thought indeed.


Asimov, I. (1968) I, Robot London: Granada Publishing Ltd.

Brookshear, J. G. (2007) Computer Science, An Overview (9th Ed.) Boston: Pearson Education Ltd.

Albu, A. & Ungureanu, L. (2005) Artificial Neural Networks in Medicine [Online] Timisoara: Politehnica University of Timisoara
Available from (Accessed 6th Jan 2008)

Mendelsohn, L. (2008) Neural Networks in Finance and Investing [Online] Florida: Market Technologies
Available from (Accessed 6th Jan 2008)

CNET (2004) Smart systems will erase jobs, report warns [Online] CNET Networks Inc
Available from,-report-warns/2100-1022_3-5247644.html (Accessed 6th Jan 2008)