1. What is the difference between cash and accrual accounting?
Cash Accounting: Recognizes revenue and expenses when cash is actually received or paid.
Accrual Accounting: Recognizes revenue when earned and expenses when incurred, regardless of when the cash is exchanged.
Which one should I use?: Small businesses may use cash accounting for simplicity, while larger companies or those that follow GAAP/IFRS use accrual accounting for more accuracy.
2. What are the key financial statements a company needs to prepare?
Balance Sheet: Shows the company’s financial position, including assets, liabilities, and equity, at a specific point in time.
Income Statement (Profit & Loss Statement): Shows the company’s revenue and expenses over a period, reflecting profitability.
Cash Flow Statement: Reflects the movement of cash in and out of the business, showing operating, investing, and financing activities.
Statement of Changes in Equity: Displays changes in the company’s equity over the reporting period.
FAQ's
1. What is the difference between cash and accrual accounting?
Cash Accounting: Recognizes revenue and expenses when cash is actually received or paid.
Accrual Accounting: Recognizes revenue when earned and expenses when incurred, regardless of when the cash is exchanged.
Which one should I use?: Small businesses may use cash accounting for simplicity, while larger companies or those that follow GAAP/IFRS use accrual accounting for more accuracy.
2. What are the key financial statements a company needs to prepare?
Balance Sheet: Shows the company’s financial position, including assets, liabilities, and equity, at a specific point in time.
Income Statement (Profit & Loss Statement): Shows the company’s revenue and expenses over a period, reflecting profitability.
Cash Flow Statement: Reflects the movement of cash in and out of the business, showing operating, investing, and financing activities.
Statement of Changes in Equity: Displays changes in the company’s equity over the reporting period.
3. What is the difference between profit and cash flow?
Profit: The financial gain after subtracting all expenses from revenue (shown on the income statement).
Cash Flow: Reflects the actual movement of cash in and out of the business. A company can be profitable but still have cash flow problems if revenues are tied up in receivables or inventory.
4. What is double-entry accounting?
Double-entry accounting is a system where every transaction affects at least two accounts, maintaining the accounting equation: Assets = Liabilities + Equity.
For every debit entry, there is an equal and corresponding credit entry to ensure balance.
5. What are the key differences between a bookkeeper and an accountant?
Bookkeeper: Handles day-to-day financial transactions, including recording sales, purchases, receipts, and payments.
Accountant: Analyzes financial data, prepares financial statements, offers tax advice, and ensures compliance with financial regulations.
6. What is the purpose of a trial balance?
A trial balance is a report that lists all ledger account balances at a specific point in time. Its purpose is to check the accuracy of the accounting entries and ensure that total debits equal total credits.
7. What is depreciation, and why is it important?
Depreciation: A method of allocating the cost of a tangible asset over its useful life.
Importance: Depreciation helps in matching the cost of an asset with the revenue it generates over time, which is a key principle of accrual accounting.
8. What is the difference between a tax deduction and a tax credit?
Tax Deduction: Reduces the amount of taxable income. For example, if you have a £1,000 deduction and a 20% tax rate, it reduces your taxes by £200.
Tax Credit: Directly reduces the amount of tax you owe. A £1,000 tax credit reduces your tax bill by £1,000.
9. What are accounts receivable and accounts payable?
Accounts Receivable (AR): Money owed to the company by customers for goods or services delivered but not yet paid for.
Accounts Payable (AP): Money the company owes to suppliers for goods or services received but not yet paid for.
10. What is a chart of accounts (COA)?
A Chart of Accounts (COA) is a list of all accounts used in the company’s general ledger, categorizing them into assets, liabilities, equity, revenue, and expenses. It provides a framework for recording financial transactions in a structured way.
11. What is working capital, and why is it important?
Working Capital: The difference between current assets and current liabilities.
Importance: It measures a company’s ability to meet its short-term obligations. Positive working capital indicates the company can cover its short-term liabilities, while negative working capital may signal liquidity problems.
12. How is VAT accounted for?
VAT (Value Added Tax): A consumption tax added to the sale of goods and services. Businesses registered for VAT must charge it on sales (output VAT) and can reclaim VAT on purchases (input VAT).
The net VAT payable/receivable is the difference between the output VAT and input VAT, which must be reported to HMRC periodically (e.g., quarterly).
13. What is the difference between gross profit and net profit?
Gross Profit: Revenue minus the cost of goods sold (COGS). It measures how efficiently a company uses its resources to produce goods or services.
Net Profit: Gross profit minus all operating expenses, taxes, and interest. It represents the final profit after all expenses have been accounted for.
14. What is deferred revenue?
Deferred Revenue: Money received by a company for goods or services not yet delivered. It is considered a liability until the company delivers the product or service, at which point it is recognized as revenue.
15. What are accruals and prepayments?
Accruals: Expenses or revenues that have been incurred or earned but not yet recorded or paid. They are added to the accounts to ensure expenses and revenues are recorded in the correct period.
Prepayments: Payments made in advance for expenses that relate to a future accounting period, which need to be allocated properly over time.
16. What is the importance of an audit?
An audit is an independent examination of financial records to ensure accuracy and compliance with accounting standards and regulations.
External Audits: Provide assurance to shareholders, investors, and regulators that financial statements are accurate.
Internal Audits: Focus on assessing internal controls and risk management processes.
17. What is payroll accounting?
Payroll Accounting: Involves recording all employee compensation, including wages, salaries, bonuses, taxes, and benefits. Proper payroll accounting ensures employees are paid accurately and that the business complies with tax regulations.
18. What are the key financial ratios that businesses should monitor?
Profitability Ratios: Measure the company’s ability to generate profit (e.g., net profit margin, return on assets).
Liquidity Ratios: Assess the company’s ability to pay off short-term debts (e.g., current ratio, quick ratio).
Efficiency Ratios: Indicate how well a company uses its assets (e.g., inventory turnover, accounts receivable turnover).
