Step 5

KCQ 1- Accrual accounting

While reading the second chapter of the study guide, I found an interesting concept: Accrual Accounting. I understand that companies can record certain sales as revenue before receiving payment on a deliverable. An example of this may be water as properties use water and pay the bill at the end of the month. Also, accrual accounting works in reverse, such as when we go to the movie theatre and pay money upfront before watching the movie.

This was interesting because while I can see the idea at work in business, I can also see it working on small scales, such as between two individuals. For example, I sold my guitar to my neighbour for $400, but he paid me $50 weekly for eight weeks. In this instance, I could count myself as having $400 once the agreement was made for my neighbour to buy my guitar. Additionally, the concept in reverse occurred when I purchased a local band's t-shirt from a friend in the band. In this situation, I  told my friend I was buying the shirt, and he bought it the next time we met. Therefore, the band could have recorded revenue from that sale even though they had not received the payment yet.

However, I wondered about the risks in using accrual accounting to record revenue. What if I never paid my friend for the shirt, and what if my neighbour never paid me the money for the guitar? Likewise, if someone refuses to pay their water bill, does the revenue recorded now become a loss for the company as the water has been used?  What are the advantages in using accrual accounting?

KCQ 2 - Quality of information 

A concept I found interesting in chapter 2 of the study guide was Quality of Information, specifically the ideas of relevance and faithful representation. I understand that firms should present financial statements containing information that assists them with future decisions. An example of this could be how much debt a firm has and when it will be paid. Faithful representation, on the other hand, is about presenting unbiased and accurate information, essentially “telling the truth” regarding a firm's financial position.

What stood out to me about faithful representation is that it requires firms to have minimal mistakes, not zero mistakes, in their statements. This implies that some mistakes are tolerated or expected, and I wondered at what point do the errors in financial statements become serious enough that the information no longer faithfully represents the firm?

Working in a busy kitchen, I understand that teams can be rushed, short-staffed, and under pressure, and that mistakes can happen. When I think about this, I imagine that there are many teams in similar situations, and I wonder, in the case of global companies, how they are able to keep mistakes to a minimum.

KCQ 3- Balance Sheet

As I read chapter three, I could not help but agree with the statement that annual reports are also designed to be marketing documents. When I looked at Dunelm’s annual report, the first few pages were exactly as Martin described: glossy photos with happy people and optimistic comments. Something I found interesting was how the balance sheet only shows the financial position of a firm on a particular day, in Dunelm’s case, June 30. This made me realise that a firm's financial position may fluctuate throughout the year. Considering this, would potential investors be interested in viewing a firm's financial position over some time instead of only seeing a snapshot?

Reflecting on my time working for JB Hi Fi, the store would hold sales at the end of the financial year, offering big discounts, and this would usually result in high sales. Considering that the balance sheet is a snapshot of a firm's financial position at a moment in time and that annual reports could be considered marketing material, are end-of-financial-year sales held to increase revenue and make the annual reports look as attractive as possible to stakeholders?

KCQ 4- Statement of Cash Flows

I found Chapter 3.2 very sensible, and I felt I could understand it fairly easily. However, something that piqued my interest was the statement of cash flows section. I understand that a firm must have enough cash to continue trading; if they run out of cash, they can no longer trade regardless of other assets the firm has in their possession. For example, if a firm owns a warehouse valued at 300 thousand dollars but has no cash to pay its employees, then the firm cannot continue trading. I wondered if firms could sell some assets to raise the cash necessary to keep trading. I felt that this would be preferable to ceasing trade.    

During my time as a chef, I worked for a franchise that went into receivership as the owner had mentioned that he had run out of money to pay his employees. While the business had several assets at the time, such as a functioning kitchen, food items, a large dining room and the building itself, the restaurant still ceased trade and was eventually sold to new owners. Reflecting on this, what was interesting was how quickly a business ceases trade once it runs out of cash. The goodwill of employees and suppliers does not last long, and once people stop getting paid, food stops getting delivered, and people stop showing up for work. Reading this section and considering my own experiences have made me realise how important the statement of cash flow is for understanding the health of a firm. Even if a company appears to be doing well, without cash firms can fall apart quickly.