Limited Companies (Copy)

3.1.5 Limited Companies – Cheat Sheet

Key Concepts of Limited Companies

1. Statement of Profit or Loss (Income Statement)
   • Purpose: To show the company’s revenue, expenses, and profit or loss over a given period.
   • Components:
     • Revenue: The total income from selling goods or services.
     • Cost of Goods Sold (COGS): Direct costs of production.
     • Gross Profit: Revenue – COGS.
     • Operating Expenses: Selling, general, and administrative expenses.
     • Operating Profit (EBIT): Gross Profit – Operating Expenses.
     • Other Income and Expenses: Interest, taxes, etc.
     • Net Profit: Operating Profit – Other Expenses.
2. Statement of Financial Position (Balance Sheet)
   • Purpose: To show the company’s assets, liabilities, and equity at a specific point in time.
   • Components:
     • Assets:
       • Non-Current Assets: Long-term assets like property, plant, and equipment.
       • Current Assets: Short-term assets like cash, receivables, and inventory.
     • Liabilities:
       • Non-Current Liabilities: Long-term debts like loans and bonds.
       • Current Liabilities: Short-term debts like accounts payable and short-term loans.
     • Equity: The owners’ share of the business, including share capital and retained earnings.
3. Statement of Cash Flows
   • Purpose: To show the company’s cash inflows and outflows over a period.
   • Categories:
     • Operating Activities: Cash generated from day-to-day operations (e.g., receipts from customers, payments to suppliers).
     • Investing Activities: Cash flows related to the purchase or sale of assets (e.g., buying or selling property).
     • Financing Activities: Cash flows related to changes in equity and borrowings (e.g., issuing shares, taking on loans).
4. Statement of Changes in Equity
   • Purpose: To show changes in equity from one period to another.
   • Components:
     • Share Capital: The amount invested by shareholders.
     • Retained Earnings: Profits kept in the company after dividends are paid.
     • Other Reserves: Adjustments such as revaluation reserves or other comprehensive income.
5. Schedule of Non-Current Assets
   • Purpose: To provide a detailed breakdown of the company’s non-current assets.
   • Components:
     • Property, Plant, and Equipment (PPE): The cost and accumulated depreciation of physical assets used in operations.
     • Intangible Assets: Assets like goodwill, trademarks, and patents.
     • Investments: Investments in other companies or long-term financial assets.

Key Principles in Limited Company Financial Reporting

1. International Accounting Standards (IAS)
   • IAS 1: Presentation of Financial Statements.
   • IAS 7: Statement of Cash Flows.
   • IAS 10: Events after the Reporting Period.
   • IAS 16: Property, Plant, and Equipment.
2. Legal Requirements
   • Companies Act: Provides legal guidelines for the preparation and presentation of financial statements for companies.
   • Audit: Public limited companies (PLCs) are required to have their financial statements audited by an independent auditor.
3. Dividend Policy
   • Dividend Distribution: Dividends are distributed to shareholders from retained earnings.
   • Impact on Financial Position: Payment of dividends reduces the retained earnings on the statement of financial position.

Understanding the Financial Statements of Limited Companies

1. Statement of Profit or Loss
   • Revenue is the total sales made during the period.
   • COGS includes all costs directly related to production, such as raw materials and labor.
   • Operating Profit (EBIT) is derived from gross profit after accounting for operating expenses (e.g., selling expenses, administrative costs).
   • Net Profit is the final profit after accounting for interest, taxes, and other non-operating costs.
2. Statement of Financial Position
   • The assets section is divided into non-current and current assets.
   • Liabilities are split into non-current liabilities (long-term) and current liabilities (short-term).
   • Equity includes share capital and retained earnings.
3. Statement of Cash Flows
   • Operating Activities show how much cash is generated or used by the company’s core operations.
   • Investing Activities show the company’s investment decisions, such as purchasing equipment or acquiring other businesses.
   • Financing Activities show how the company funds its operations, through issuing stock or borrowing money.
4. Schedule of Non-Current Assets
   • PPE should be shown at its historical cost less accumulated depreciation.
   • Intangible assets should be accounted for based on their acquisition cost and amortization.
   • Investments should be valued at cost or fair value depending on the accounting treatment (e.g., if classified as available-for-sale).

Key Ratios and Metrics for Limited Companies

1. Profitability Ratios
   • Gross Profit Margin = (Gross Profit / Sales) * 100
   • Net Profit Margin = (Net Profit / Sales) * 100
   • Return on Capital Employed (ROCE) = (Operating Profit / Capital Employed) * 100
2. Liquidity Ratios
   • Current Ratio = Current Assets / Current Liabilities
   • Acid Test Ratio = (Current Assets – Inventories) / Current Liabilities
3. Efficiency Ratios
   • Inventory Turnover Ratio = COGS / Average Inventory
   • Trade Receivables Turnover (Days) = (Trade Receivables / Revenue) * 365
4. Leverage Ratios
   • Debt to Equity Ratio = Total Debt / Shareholders’ Equity
   • Interest Coverage Ratio = Operating Profit / Interest Expense

Key Considerations for Limited Companies

1. Taxation: Limited companies are subject to corporate taxation on their profits. Tax planning and efficient management of profits are important for reducing the tax burden.
2. Dividend Distribution: The payment of dividends reduces the company’s retained earnings and impacts the financial position.
3. External Financing: Limited companies may raise funds through share issues or debentures. The cost of capital and financing strategies should be managed efficiently.
4. Financial Reporting Compliance: Compliance with international accounting standards (IAS/IFRS) and local legal requirements is crucial for maintaining transparency and gaining investor confidence.

Summary

1. Limited companies prepare a range of financial statements, including the Statement of Profit or Loss, Statement of Financial Position, Statement of Cash Flows, and Statement of Changes in Equity.
2. Financial statements must comply with international accounting standards and local legal requirements.
3. Key metrics such as gross profit margin, current ratio, and return on capital employed (ROCE) are essential for assessing a company’s financial health.
4. Proper management of costs, profit margins, and financing decisions is crucial for a limited company’s long-term success.