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School of Mechanical, Materials and Manufacturing Engineering

MM2MN1 – Management Studies “1”

Balancing the Books

Objectives and Learning Outcomes • • • • • • • Double entry accounting The balance sheet The balance sheet equation The trial balance The trading, profit and loss account Opening and closing stock The ledger

Prof John Dominy February 2013

MANAGEMENT STUDIES “1”
BALANCING THE BOOKS

Introduction Now that we have planned our business and established that it is viable, the next steps that are necessary are: •raise the finance necessary to start, •maintain the financial books, •report the financial state of the company.

Finance This is a private business which will be financed mainly from within the group. While there are many ways of raising funding in practice, this example is typical of the origins of many small businesses. The options used are: •shares - a number of people buy shares in the company. This provides funding but makes them owners of the company. They can sell their shares (in the case of a private company, only to other share holders) if they wish. The disadvantage is that, while their shares might gain value, they may also fall in value if the business fails to perform as expected. In the limit, they could lose their investment if the company collapsed. The degree of loss would depend on the type of business.

•Debentures - a fixed term loan (generally long term) to the company. A debenture is a loan, not a share. It does not change value with shares. If the business collapses then the Debenture holders are high on the list to be repaid the loan, or a proportion of it, when the company is wound up. •Loan - a simple loan on which interest is paid. In many cases, such as a bank loan, the lender will demand some security to ensure repayment in the event of the collapse of the business. Typically the loan will be secured against the houses of the owners. Our coffee business is funded as follows:

Prof J Dominy February 2013

1

MANAGEMENT STUDIES “1”
BALANCING THE BOOKS

STARBRIGHT COFFEE STARTUP FUNDING Initially we need Who Tim Bank Candice Blodwyn Edward Lara Type Debenture loan shareholder 1 shareholder 2 shareholder 3 shareholder 4 £ 451.50 Amount £ £ £ £ £ £ 150.00 100.00 100.00 50.00 50.00 50.00

Total Investment

£

500.00

The cash flow projection showed that we need £451.50 to fund the company through its start up period. We have actually raised £500 to allow some leeway.

Now that the funding is in place, the business can start. Before any cash is spent, the available funds must be entered in the books. Double Entry Accounting. Double entry accounting has been the basis of accounting practice since the 15th century. The main advantage is that it requires a balance of assets and liabilities which, if not achieved, gives an immediate indication of any errors. Assets are entries which the business has available as cash or items that can be converted into cash. Liabilities are those entries which the business owes to others. For example, a positive bank account is an asset, while a loan is a liability.

Prof J Dominy February 2013

2

MANAGEMENT STUDIES “1”
BALANCING THE BOOKS

To start the treasurer will construct a table showing the cash account. This will have columns for assets and liabilities, with the assets on the left. Each cash transaction will be entered. CASH ACCOUNT ASSETS debenture Tim shares bank loan cash in bank £ 150.00 £ 250.00 £ 100.00 £ 500.00 LIABILITIES

Each of these entries\will have second entry in a separate account. For example, the debenture account will be: DEBENTURE ACCOUNT ASSETS Cash - Tim LIABILITIES £ 150.00

Note that from the point of view of the business, this is an asset as it is cash in, while the debenture holders will see it as a liability, or cash out. These two entries are the basis of double entry accounting. Traditionally, these accounts were written up in a single book, known as the ledger....
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