Some basic accountancy questions - please help

deadl0ck

Hi all,

I am doing a basic introduction to accounts.

On a Profit And Loss Accounts, my book says:

"Capital repayments are not taken into account" - Now, this may sound stupid, but what exactly is a "Capital Repayment", is it a repayment on a loan ?

If so, why would you not take it into account in a profit and loss account ?

The book says "The level of profit determines the standard of living, capacity to invest, borrowing capacity, etc.." but if you're not taking a repayments into account then how can it determing your borrowing capacity ?

Sorry, if these are very basic questions, but any help would be appreciated !!!

ronbyrne2005

deadl0ck wrote:

Hi all,

I am doing a basic introduction to accounts.

On a Profit And Loss Accounts, my book says:

"Capital repayments are not taken into account" - Now, this may sound stupid, but what exactly is a "Capital Repayment", is it a repayment on a loan ?

If so, why would you not take it into account in a profit and loss account ?

The book says "The level of profit determines the standard of living, capacity to invest, borrowing capacity, etc.." but if you're not taking a repayments into account then how can it determing your borrowing capacity ?

Sorry, if these are very basic questions, but any help would be appreciated !!!

Profit and loss refers to the business you carry on and the revenues and costs in that business for a particular trading period(usually a year)
Capital repayments is repaying loans or other finance that is part of the businesses capital structure ,the changes in capital accounts is nothing to do with the everyday operations/trading of the business and just tell you how the companies operations were financed and the nature of the companies capital and equity etc on an ongoing basis.
the p&l is all about the profit or loss you made as part of the business for a particular trading period,capital repayments etc arent usually part of the companies normal trading/business and are dealt with in balance sheet.

your profits determine your borrowing capacity as they represent your ability to repay the borrowings. banks will look at how much of your profits will be taken up by repayment of loans and interest.

deadl0ck

OK - Thanks for that.

I understand what you are saying, but I don't see how you can ignore capital repayments when you look at profit and loss...

If my profit (minus loan repayment) is 1000 per month, but the company has a loan to pay back of 700 per month, how can you say you that this isn't taken into account for your borrowing capacity - arou saying my borrowing capacity is based on 1000 p/m as opposed to 300 p/m ? It just doesn't make financial sense to me......Of course, I could be totally misunderstanding this

ronbyrne2005

deadl0ck wrote:

OK - Thanks for that.

I understand what you are saying, but I don't see how you can ignore capital repayments when you look at profit and loss...

If my profit (minus loan repayment) is 1000 per month, but the company has a loan to pay back of 700 per month, how can you say you that this isn't taken into account for your borrowing capacity - arou saying my borrowing capacity is based on 1000 p/m as opposed to 300 p/m ? It just doesn't make financial sense to me......Of course, I could be totally misunderstanding this

Sorry i should have said the interest element of any repayments is allowable when determining profit and loss but the capital repayment is not. so if the interest is 700 and your profit before taking away the interest is 1000 you will have a net profit of 300.only the interest element of repayments is allowable as an expense when calculating profit or loss

kluivert

Learning accountancy from a book is very hard.

Practice experience makes it easier + the book for guidlelines.

You need to always think DOUBLE ENTRY when doing accounts.

Am assuming you understand this.

Loan Repayments: Captial Commitment

Credit: Bank Account (Balance Sheet)
Debit: Loan Account (Balance Sheet)

The transaction is not reflected on the p+l.

Interest Charged on loan: Servicing of Finance

Credit: Loan Account (Balance Sheet)
Debit: Interest Charged (Profit and Loss)

slave1

Your capital IS refected in the Profit & Loss - or as it is now known the Income Statement - through depreciation/amortisation, which is an accounting way to spread Capital investments in assets across the economic life of that asset.
This is part of the matching principal which is a fundamental accounting concept, this attempts to match revenues with costs associated with that revenue stream.
Another approach to help make this easier for you is that I think you are confusing cash flows. The income statement reflects CHARGES whereas you are thinking cash flows.
Your loan payment is 100% cash, where the interest portion is an allowable charge in the Income Statement and the principal is charged through depreciation.
Depreciation does not have to equal principal payments, in fact rarely does.

deadl0ck

Thanks guys - I understand what you are saying, but, I'm saying it doesn't seem to make financial sense to me - At this point I'm just looking for a plain english explaination of why this is - I understand that Capital Repayments are not taken into account (but interest is).

Can you expalin if I have a loan (capital repayments) of 700 p/m (forget about interest to make it easier - 0% interest for this example) and I only have profit of 1000 per month, how is my borrowing capacity is based on 1000 p/m ?

Surely, if I have 1000 p/m, but 700 of that has to go to repay a loan, I only really have 300 per month and my borrowing capacity should be based on that ?

Like I said, I understand that you don't count the capital repyaments - I'm just wondering why (based on my above example)....

slave1

Going back to a point in my reply, you seem to be concered with cashflow not profits.
A firms's loan capability will be based upon their cashflow history and projections NOT their Income Statement.
Profitable companies go under in their first years of trading due to cashflow mismanagement even though they are making profits.
In the company I work for, we have not made a profit in 5/6 years and will not do so for at least another 2/3, yet we have no problem servicing our loans and getting new ones because we have good positive cashflow.

Therefore the 1000 profit can be largely irreevant if that is a reflection of revenues streams booked e.g. credit sales and costs charged e.g. depreciation, none of which have cashflows.

Stop thinking Profits and start thinking from a Cashflow perspective and I think you will be able to answer your own question.

kluivert

Profit is after tax and interest.

Loan capacity is based on Profits - Not a good basis in my opinion.

You are talking about two different things near, I agree with slave.

Your thinking about repayments therefore you should look at a Cashflow Statement, this will take into account Loan Repayments.

deadl0ck

Guys - I feel thick as sh*t here.
You are still talking in accounting terms which I'm not comfortable with.

Can you explain, in plain english, why the 700 repyament (in my example) is NOT talken into account when looking at my borrowing capacity.

From my basic viewpoint :

I make 1000 profit p/m according to my P&L accounts, so by borrowing capacity is based on this - Is this correct ?

However, if I have to pay 700 per month back on a loan, do I not really have only 300 p/m to "play with" ????

At this point I don't care about P&L and Cashflow, I just don't get it from a common sense point of view - How can my borrowing capacity be based on money I don't have ?
If I have 1000 profit, I can in theory borrow the equivalent of 500 p/m (for example) - but wait; I'm now paying back 700 + 500 p/m and I only make 1000 profit per month - Am I not 200 quid short every month now ????

Sorry if I don't get this - but you keep answering as if I were talking to an accountant and I should get it - the concept just doesn't make sense.

Do you know what I'm getting at ??

Sorry again for dragging this on - maybe I'm destined not to get it !!

chump

Ok this is how I believe it goes.
Assuming purchase car used for selling&distrib for €1000
It will be depreciated over 8 years, on a striaght line basis, 125€ a year.
So the €125 every year for the next 8 year is an expense under Selling&Distribution.
If you took a loan out to buy this car, the interest element of the payback (ie. a repayment constitutes capital+interest) is also accounted for in the income statement.

If you pay for the item outright (no loan) you gain an asset and lose cash(reserves).
If you get a loan, you gain an asset but similtaneously gain a liability. The liability will be diminished every year when you make a loan payment whcih will extract money from cash. This cash is for 2 elements, capital repayment (lessen outstanding liability), and interest charge (noted in income statement, ie. p&l).

Carb

deadl0ck wrote:

Guys - I feel thick as sh*t here.
You are still talking in accounting terms which I'm not comfortable with.

Can you explain, in plain english, why the 700 repyament (in my example) is NOT talken into account when looking at my borrowing capacity.

From my basic viewpoint :

I make 1000 profit p/m according to my P&L accounts, so by borrowing capacity is based on this - Is this correct ?

However, if I have to pay 700 per month back on a loan, do I not really have only 300 p/m to "play with" ????

At this point I don't care about P&L and Cashflow, I just don't get it from a common sense point of view - How can my borrowing capacity be based on money I don't have ?
If I have 1000 profit, I can in theory borrow the equivalent of 500 p/m (for example) - but wait; I'm now paying back 700 + 500 p/m and I only make 1000 profit per month - Am I not 200 quid short every month now ????

Sorry if I don't get this - but you keep answering as if I were talking to an accountant and I should get it - the concept just doesn't make sense.

Do you know what I'm getting at ??

Sorry again for dragging this on - maybe I'm destined not to get it !!

Why do you keep referring to profit and borrowing capacity. Banks can read balance sheets also. The profit figure is just that, a figure. Most of the time the profit figure will bear no resemblence to available cash. ie a 300 euro profit does not mean that you have an extra three hundred in your bank. The capital repayment doesn't go into the P&L, as the original expenditure was used to buy/pay for an asset on the balance sheet. You are deemed to gain some economic benefit from this asset which has a limited life. Therefore, to make sure the cost is written off over the life of the asset, depreciation is used. The simplest way of looking at it is this: If you take out a five year loan to buy a van (10k). The van is deemed to have an economic life of five years, so each year 2k gets wrote of to the P&L as depreciation. After five years, the full 10k will have been wrote off to the P&L. If the capital element of the repayment had been put to the P&L instead, the impact overall would have been the same, but depreciation is used as the economic life of the asset will not always agree to the laon term. ie the loan could have been three years.

deadl0ck

Thanks Carb - makes more sense.

Why do you keep referring to profit and borrowing capacity. Banks can read balance sheets also.

It all stems from these 2 statements, in the intro to accounting I'm reading :

Capital repayments are not taken into account

and

The level of profit determines the standard of living, capacity to invest, borrowing capacity, etc..

That's why I was referring to profit and borrowing capacity.

And thank you all for putting up with all my questions !

kluivert

You should learn the accounting concepts first or read FRS18 Accounting Principles.

Carb has explained it best there in my opinion.

Its called the matching concept as stated above.

The repayments are not taken into account but you are written off the asset (depreciation) at the same rate as the loan, therefore the repayments are reflected in the depreciation which is shown in the P & L.

www.accountancystudents.co.uk or something like that is very helpful.

deadl0ck

Cheers.

Thanks again everybody for all the help on this!