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3. INDEX
S WHAT ARE ACCOUNTS AND WHY ARE THEY NECESSARY
S FINANCIAL DOCUMENTS INVOLVED IN BUYING AND SELLING
S METHODS OF MAKING PAYMENT
S WHO USES THE FINAL ACCOUNTS OF A BUSINESS
S THE TRADING ACCOUNT
S THE PROFIT AND LOSS ACCOUNT
S BALANCE SHEETS
S EXPLANATION OF BALANCE SHEET TERMS
S ANALYSIS OF PUBLISHED ACCOUNTS
S RATIO ANALYSIS OF ACCOUNTS
4. WHAT ARE ACCOUNTS AND
WHY ARE THEY NECESSARY
S There is a very big difference between accounts and
accountants:
ACCOUNTS are the financial records of one or more
transactions.
ACCOUNTANTS are the people who have the responsibility of
keeping the accounts as accurate as possible.
S Accountants, at the end of every financial year, need to
produce the FINAL ACCOUNTS of the business. These tell
business’ main financial results, and also how much the
business is worth at that period of time. Limited companies also
need to publish their final account.
5. FINANCIAL DOCUMENTS
INVOLVED IN BUYING AND
SELLING
S Purchase orders – these are requests for products or services sent to suppliers.
S Delivery notes – these needs to be signed by the customer to confirm that the order
has been received.
S Invoices – these are the requests for payment sent by the supplier.
S Credit notes – these are issued if a mistake has been made.
S Statement of account – a statement that each month the supplier will send to his
customers.
S Remittance advice slips – these are slips issued to make sure the customer isn’t
charged again for the invoices he has already paid.
S Receipts – a copy of the invoice that is kept by the customer
6. METHODS OF MAKING
PAYMENT
S Cash – the most common method of payment used for most
small amounts.
S Cheque – instructions to a bank to transfer a certain sum of
bank balance to a specific person.
S Credit card – this allows customers to buy goods and services
and letting them pay in the future.
S Debit card – these work the same way as credit cards but
instead of credit being accumulated, the money is transferred
directly to the the seller’s account.
7. WHO USES THE FINAL
ACCOUNT OF A BUSINESS
S Shareholders – they have a big interest in knowing how big the
profit of loss of the company is.
S Creditors – they have a big interest in knowing whether the
company can pay back a loan.
S Government – the government and the tax office will want to
know bow much tax the business should pay.
S Other companies – they will want to compare their business to
other businesses to see how their business is performing.
8. THE TRADING ACCOUNT
S It shows the difference between the COSTS OF GOODS SOLD and the
SALES REVENUE
S The difference is called GROSS PROFIT
S IMPORTANT:
Cost of goods sold does not have to be the same as the total value of
goods bought by the business
Gross profit does not make any allowance for overhead costs or expenses
In a manufacturing business the direct labor cost and the direct production
costs will be deducted from the gross profit before arriving at the GROSS
PROFIT TOTAL
The gross profit is not the final profit of the business as all the expenses
have to be deducted
9. THE PROFIT AND LOSS
ACCOUNT
S It shows how the NET PROFIT is calculated
S It begins with the gross profit calculated from the trading
account
S All other expenses and overheads of the business are
subtracted
S DEPRICIATION is the fall in the value of a fixed asset over time
S THE PROFIT AND LOSS ACCOUNTS FOR LIMITED
COMPANIES
10. THE PROFIT AND LOSS
ACCOUNT FOR LIMITED
COMPANIES
S It follows exactly the same principals as the PROFIT AND
LOSS ACCOUNT . The main differences are:
S Corporation tax paid on company profits will have to be shown
S Results from the previous year have to be included
S The final section of the profit and loss account is called the
APPROPRIATION ACCOUNT
11. BALANCE SHEETS
S They are very different from the profit and loss account.
S The profit and loss account shows the income and expenses of a business over a
period of time
The balance sheet shows the value or worth of a business at a particular moment in
time
S ASSETS are those items of value that are owned by the business
Fixed assets – (Land, buildings, equipment and vehicles) they are likely to be kept
by the business for more then a year, most of the fixed assets depreciate over time
Current assets – (cash, stocks and debtors) they are only held for a short period of
time
S LIABILITIES are the items owed by the business
Long-term liabilities – they are long term borrowings (they do not have to be repaid
within one year)
Current liabilities – borrowings which must be repaid within one year
S BALANCE SHEET TERMS
12. EXPLANATION OF BALANCE
SHEET TERMS
S Working capital (aka as net current assets). It is used to pay short term debts
Working capital = Current assets – Current liabilities
S Net assets = Fixed assets + Working capital
These assets must be paid for by money but into the business in two ways : shareholders’
found and long-term liabilities
S Shareholders’ founds is everything that is invested into the business by the owners of the
company
Share capital – is the money put into the business when the shareholders bought newly
issued shares
Profit and loss reserves are retained profits from current and previous years
S Capital employed = Shareholders’ founds + long term liabilities
S CAPITAL EMPLOYED = NET ASSETS
13. ANALYSIS OF PUBLISHED
ACCOUNTS
S LIQUIDITY is the ability of a business to pay back it’s
short term debts
S It is important to choose more than one figure from the
accounts when trying to find how a business is
performing.
S Comparing two features from one account is called
RATIO ANALYSIS
14. RATIO ANALYSIS OF
ACCOUNTS
There are two main types of ratios :
S PERFORMANCE RATIOS
and,
S LIQUIDITY RATIOS
Disadvantages of ratio analysis
15. PERFORMANCE RATIOS
These are used to see how the business is performing
The three most common performance ratios are:
S RETURN ON CAPITAL EMPLOYED
S GROSS PROFIT MARGIN
S NET PROFIT MARGIN
Go back to “Ratio analysis of accounts”
16. RETURN ON CAPITAL
EMPLOYED
S This is calculated by the formula
Return on capital employed (%)
= Operating profit/Capital employed * 100
This is how much the business was able to get back from
the capital it had employed
GO BACK TO PERFORMANCE RATIOS
17. GROSS PROFIT MARGIN
S This is calculated by the formula
Gross profit margin (%)
= Gross profit / Sales turnover * 100
GO BACK TO PERFORMANCE RATIOS
18. NET PROFIT MARGIN
S This is calculated by the formula
Net profit margin (%)
= Net profit before tax / Sales turnover * 100
GO BACK TO PERFORMANCE RATIOS
19. LIQUIDITY RATIOS
S These measure the ability of a business to pay back it’s short-
term debts
Two common liquidity ratios are:
S CURRENT RATIO
and
S ACID TEST or LIQUID RATIO
Go back to “Ratio analysis of accounts”
20. CURRENT RATIO
S This is calculated by the formula
Current ratio = Current assets / Current liabilities
GO BACK TO LIQUIDITY RATIOS
21. ACID TEST or LIQUID RATIO
S This is calculated by the formula
Acid test or Liquid ratio
= (Current assets – stocks) / Current liabilities
GO BACK TO LIQUIDITY RATIOS
22. DISADVANTAGES OF RATIO
ANALYSIS
S Ratios are based results collected on the past and
therefore will not be able to show how a business might
perform in the future
S Accounting results over time will be affected by inflation
S Different companies might use slightly different
accounting methods
GO BACK TO RATIO ANALYSIS OF ACCOUNTS
