Finance and Accounting Fundamentals
Core concepts
Accounting records, classifies and summarises transactions, then communicates results. Know the accounting equation: assets equal liabilities plus equity. Understand the dual aspect concept, accrual versus cash basis, the matching principle, going concern and consistency.
Master the three core statements. The income statement shows revenues less expenses over a period. The balance sheet shows assets, liabilities and equity at a point in time. The cash flow statement classifies flows into operating, investing and financing activities. Understand the treatment of depreciation, capital versus revenue expenditure, and the difference between profit and cash.
Ratio analysis is heavily tested. Learn liquidity (current ratio, quick ratio), solvency (debt-equity), profitability (gross margin, net margin, return on capital employed) and activity (inventory turnover, receivables days) ratios, and what each reveals. Also know working capital, the operating cycle, and basic capital budgeting ideas such as payback and net present value.
Traps in questions
- Profit is not cash: a profitable firm can fail for lack of liquidity.
- Capital expenditure is capitalised; revenue expenditure is expensed.
- The quick ratio excludes inventory, so it is lower than the current ratio.
- A high current ratio is not automatically good; idle stock or slow receivables may inflate it.
Rule of thumb
Every transaction has two effects. Before answering, identify which accounts move and in which direction.
Worked example
Current assets are 500, inventory is 200, current liabilities are 250. Current ratio equals 500 divided by 250, or 2.0. Quick ratio equals (500 minus 200) divided by 250, or 1.2. Both are healthy, but the gap shows heavy reliance on inventory.