1. Why do we have accountants?

2. What about cash flow?

3. A whirlwind tour of accounting

4. An example

5. Summary

Example

Description Balance Sheet Profit & Loss Cashflow
A company buys (on credit) some raw materials for 1,000. It is put into stock, so there is no affect on Profit and you haven't paid anything, so there is no effect on Cash. On the Balance Sheet, you increase the value of Stock and Creditors (people to whom the company owes money)

Assets

Stock 1,000 (dr)

Liabilities

Creditors (1,000) (cr)

Nil Nil
The company pays its staff 500 (in cash) to do some work to the materials to make them saleable. You have paid out 500 in cash and increased the value of stock, but there is still no effect on Profit.

Assets

Stock 1,500 (dr)

Liabilities

Overdraft (500) (cr)

Creditors (1,000) (cr)

Nil 500 negative
The company pays for the materials. You have paid out more cash and wiped out the Creditor, but there is still no effect on Profit.

Assets

Stock 1,500 (dr)

Liabilities

Overdraft (1,500) (cr)

Nil 1,500 negative
The company, finally, sells the finished goods to 10 different customers for 200 each. There is no effect on cash, but on the Profit & Loss account the income is recognised, as is the value of the stock that has been sold. On the Balance Sheet, the value of the stock has gone, but we now have some Debtors (people who owe the company money).

Assets

Debtors 2,000 (dr)

Liabilities

Overdraft (1,500) (cr)

Income

Sales (2,000) (cr)

Cost

Cost of Sales 1,500 (dr)

Therefore

Profit (500) (cr)

1,500 negative
The company receives money from 9 of its customers, leaving one that is bad. Cashflow is now positive and Debtors have reduced, but there is no effect on Profit. This leaves Profit adrift from Cashflow by the value of the bad debt.

Assets

Debtors 200 (dr)

Bank 300 (dr)

Income

Sales (2,000) (cr)

Cost

Cost of Sales 1,500 (dr)

Therefore

Profit (500) (cr)

300 positive
The company decides that there is no hope of recovering the outstanding debt, so it writes it off. The Debtor disappears from the Balance Sheet and is written off against Profit. The transaction is now finished and Profit and Cashflow are in line.

Assets

Bank 300 (dr)

Income

Sales (2,000) (cr)

Cost

Cost of Sales 1,500 (dr)

Bad Debts 200 (dr)

Therefore

Profit (300) (cr)

300 positive

Next >>

"Making things as easy as"

 

Attwood Business Consultancy Ltd