BM Unit 3.5 Final Accounts

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IB Business and Management (Standard Level)
All material taken from the IB Business and Management Textbook:
"Business and Management", Paul Hoang, IBID Press, Victoria, 2007

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BM Unit 3.5 Final Accounts

  1. 1. Unit 3.5 Final AccountsLesson 1: Income statementspp. 389-398 <br />IB Business and Management<br />
  2. 2. 1. Think about it…<br />“Nothing speaks move eloquently than money.” – French proverb<br />Everyone knows a “picture is worth a thousand words”…money talks as well. <br />How does this money “talk”?<br />In the form of income statements and balance sheets.<br />…<br />
  3. 3. 2. An overview<br />All businesses need to keep records of their finances.<br />In the majority of countries around the world it is a legal requirement.<br />These records are also used to have better financial planning and control.<br />Final reporting also acts as a way to account for all monies made by the firm.<br />All companies must produce a set of final accounts in the form of three statements:<br />1. Profit and loss account (shows your position at the end of the accounting period)<br />2. Balance sheet (shows assets and liabilities)<br />3. Cash flow statement (shows cash inflows and outflows)<br />Now, lets take a look at the purpose and users of final accounts….<br />Remember: incorporated businesses are legally obliged to produce final accounts, which ensure transparency in the use of their funds.<br />…<br />
  4. 4.
  5. 5. 4. Trading, Profit & Loss Accounts <br />Also know as: an income statement.<br />Main purpose of an income statement is to show the amount of profit or loss that a business has made in a trading period.<br />As stated earlier, the different stakeholders will have different uses for the income statement of a firm.<br />It is also used to assess the profit quality of a business.<br />Example, firm’s that sell inferior products at a high price will have LOW profit quality.<br />There are three sections in an income statement:<br />1. the trading account (gross profit)<br />2. the profit and loss account (profit statement; operating and net profit)<br />3. the appropriation account (shows how the net profit is distributed)<br />…<br />
  6. 6. 5. Trading Account (gross profit) <br />Represents the top section of a Profit & Loss account.<br />Shows the difference between:<br />sales revenue and <br />direct cost of trading.<br />So…<br />Sales revenue – Cost of goods = GP<br />Cost of goods sold (COGS):<br />Cost of sales = opening stock + purchases – closing stock (in blue)<br />The cost of goods actually sold.<br />How can you improve gross profit?<br />Use cheaper supplies<br />Increase sales price<br />Use marketing strategies<br />Remember: Gross profit is NOT the profit a business gets to keep.<br />
  7. 7. 6. Profit and Loss Account (operating profit and net profit) <br />Shows the operating and net profit or loss of a company.<br />Operating & net profit = Gross profit – expenses.<br />The Net profit or operating profit is the surplus if any.<br />This is the actual profit made from trading / doing business.<br />So how can we reduce expenses?<br />Rent fees could be re-negotiated.<br />Fuel consumption could be reduced.<br />Administration costs could be reviewed.<br />Some P&L accounts might show non-operating income.<br />Income from other activities, such as collecting rent, interest from savings, etc.<br />This would show as profit before interest and tax…text page 395.<br />
  8. 8. 7. Appropriation Account <br />Shows how the net profit is distributed into:<br />Taxation (goes to government)<br />Dividends (goes to shareholders)<br />Retained profits (kept by the business)<br />All three parts combined and termed the Profit and Loss Account.<br />There is no set format on how a firm reports their P&L accounts. <br />Go online and practice reading from several different Ltd. Companies.<br />Yahoo finance is a great resource for financial statements of public companies.<br />
  9. 9. 8. Limitations of the P&L Accounts<br />Shows the historical performance of a business.<br />No guarantee that future performance will be any better.<br />Window dressing: legal manipulation of the account to make the company look financially attractive can take place.<br />This means the true figures are hidden.<br />No standardized format for producing a P&L account.<br />This can make it difficult to compare the profit and losses of different firms.<br />…<br />
  10. 10. 9a. Balance Sheets<br />They are annual financial statements that companies are legally required to produce for auditing purposes.<br />It is a record of a company’s financial position at the end of the trading year.<br />The balance sheet will contain an organization’s:<br />Assets<br />Liabilities<br />Capital invested by the owners<br />It also shows the capital employed (firm’s sources of finance) and the assets employed (where the money has been spent).<br />Three very important parts of a balance sheet are:<br />1. Assets: Fixed; tangible, intangible and investments.<br />2. Liabilities: long term and current.<br />3. Capital and reserves: share capital, retained funds, and reserves.<br />Let’s take a look at these in more detail….<br />…<br />
  11. 11. 9b. Assets<br />Items owned by or to a business that are valuable. <br />Fixed assets:<br />Asset that is bought for business use.<br />Tangible (physical): machinery, property, etc.<br />Intangible (non-physical): brand names, trademarks, copy rights, etc.<br />Investments: medium to long term,.<br />Current Assets: cash or any liquid asset that can be turned into cash within 12 months. <br />…<br />
  12. 12. 9c. Liabilities<br />The amount of money owed by the business.<br />The business is legally responsible to repay its lenders.<br />Long-term Liabilities(accountspayable):<br />Debts due to be repaid after 12 months.<br />Current Liabilities(Creditors):<br />Debts that must be settled within one year.<br />…<br />
  13. 13. 9d. Capital & Reserves<br />Appear at the bottom either as shareholder’s funds or owner’s equity.<br />There are usually three parts to this section.<br />Share capital: money raised through the sale of shares.<br />Retained profit: an amount of net profit after interest, tax, and dividends have been paid.<br />Reserves: any proceeds from retained profits from previous years.<br /> Capital and reserves show the internal sources of funds for a business. <br />See the example on page 401<br />…<br />
  14. 14. 9e. Balance sheet Recap<br />Shows the difference between current assets and current liabilities.<br />Shows us the net current assets or the working capital (unit 3.3).<br />The short term liquidity position of the business.<br />Shows the amount of money for day to day operation of the business.<br />Asset structure can be analyzed. <br />Increase in fixed assets may indicate an expansion.<br />Increase in value of stocks might suggest overtrading.<br />Capital structure can be used to see the sources of finance.<br />Shareholder capital, debentures, and current liabilities.<br />Capital employed gives us an indication of it’s the firm’s size. <br />Higher the firm’s capital employed, the greater its market value might be.<br />Are static documents<br />Value of capital and reserves can change from day to day.<br />The figures given in the balance sheet are “accurate” estimates.<br />Market value vsbook value, we won’t know the true value until the asset is sold.<br />No specific format required to produce a balance sheet.<br />Not all assets are included in a balance sheet.<br />Intangible, human capital etc.<br />Used for several purposes:<br />The limitations:<br />
  15. 15. 10. Window Dressing <br />Also know as creative accounting <br />The legal manipulation of accounting statements based on the accounting principles, practices and rules of that country in order to make the numbers look more pleasing.<br />Some examples:<br />Show an overdraft that is repayable after 12 months as a long term liability.<br />Will improve the working capital figure of the business.<br />How a firm values its intangible assets.<br />Using sale or leaseback just before the final accounts are due, will show the liquidity position of the company.<br />Outstanding loans and other bills paid later<br />Declared sales revenue for items paid on credit, this will boost the profit figures of the company.<br />…<br />
  16. 16. 11. Limitations of Final Accounts<br />Must use a set of final accounts to get the full picture of the financial well being of a business. Also look for trends over time periods.<br />Human resources are totally ignored in these accounts.<br />Final accounts do not reveal anything about the organization’s non-financial matters.<br />Qualitative factors can be equally important when making decision.<br />For examples, does the company practice CSR?<br />There needs to be access to the accounts of other businesses.<br />Must be lawfully produced…watch out for creative accounting.<br />Are a historical account of the financial position of a company.<br />…<br />
  17. 17. End<br />

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