Chapter 7 Business Accounting By the end of this chapter, candidates will be able to : To understand why businesses keep accounting records and how they use them To analyze the needs of the different users of business accounts To understand the construction of simple balance sheet To understand the construction of simple profit and loss accounts To analyze business accounts using ratios

What is a “Profit and Loss account”? An account that records business sales revenues, all costs and expenses, and any loss/profit made during the year. Often it is referred to as “ Trading Account” ABD Traders Ltd - Profit and Loss Account for year ending 31/9/04 Amount ( $) Item 12000 Sales turnover 4000 Cost of goods sold 8000 Gross Profit -3000 Overheads 5000 Net Profit

What is a “ Sales Turnover”? The value of sales in a certain period of time. Often is referred to as Sales Revenues Product Unit Price Quantity Sold Sales Turnover ( Revenues)l $ 150 4 Units $ 600

Sales Turnover ( Revenues)l Gross Profit Profits after subtracting the cost of sales from sales turnover. Products Quantity Sold Unit Price Sales Turnover ( Revenues)l 4 Units $ 150 $ 600 Products Quantity Sold Unit cost Cost 4 Units $ 80 $ 320 $ 280 GROSS PROFIT

Net Profit Profit after subtracting all expenses/ overheads from gross profit. Products Fixed $ 80 Cost Total Cost = $ 130 X 4 Units = $ 520 Variable $50 Total Sales = $ 150 X 4 Units = $ 600 Net Profit Total Sales Total Cost $ 80 Total Sales = $ 150 X 4 Units = $ 600 Total Cost = $ 130 X 4 Units = $ 520

Corporation Tax Tax on a company’s NET PROFIT. Assuming that a company is making $ 5000 NET PROFIT, and that the ratio of tax imposed by the government is 25%, then, the company will pay (as a corporation tax) the amount of $ 1250. $ 5000 X 25 / 100 = $ 1250

What is DIVIDENT? DATA G 11 Ltd consists of 5 shareholders Partner 1: $ 5000 Partner 2: $ 5000 Partner 3: $ 5000 Partner 4: $ 5000 Partner 5: $ 5000 DATA G 11 Ltd consists of 5 shareholders 2012 records showed $ 25000 NET PROFITS Total company capital is $ 1 M Shareholders financed the capital on 20% contract. Distribution of DIVIDENTS (shares) on shareholders:

The fall of value of fixed assets over time. Depreciation The fall of value of fixed assets over time.

Liquidity (CURRENT RATIO) The ability of the business to convert its assets into cash and pay off short-term debts.

Return on capital employed (%) “ROCE” To deduct certain amounts of profits, over a defined period of time to collect back the value of a fixed capital. Calculations: Net Profit / Capital Employed X 100 = Ration of ROCE

Retained Profit. ( RESERVES) Profit made after payment of tax and dividends. It is reinvested back into the business.

Formula Formula Term Gross Profit/Sale Turnover X 100 Gross Profit Margin (%) Net Profit/Sale Turnover X 100 Net profit Margin (%) Current Assets --------------------- Current Liability Current Ratio (COMPANY LIQUIDITY) Current Assets - Stock ------------------------------- Asset Test Ratio Net Profit -------------------------- 100 Capital Employed Return on capital employed (%)

Working capital The capital (MONEY) needed by a business to finance its day-to-day needs.

Fixed Vs Current Assets Fixed Assets are owned by a business that expects to keep and use for more than one year. (Buildings – cars – machines – equipment – furniture … etc. ) Current Assets are Assets that the business will use up or turn into cash within one year. (Stocks, debtors, cash.)

Current liabilities Loans and debts of the business that will be repaid within one year. (Bank overdraft and creditors.)

Balance sheet An account that records all business assets and liabilities and the value of shareholders' funds.

Long-term Liabilities The money value of debts that do not have to be repaid in one year.

Shareholders’ Funds Finance provided by shareholders - share capital or retained profits. Share capital is from sale of shares. Retained profits are called reserves.

Capital Employed Total value of business's long-term finance. Long-term liabilities plus shareholders' funds.

Table 1: Financial information about City Café Ltd. ($000) 1- State and explain two ways in which the owners of City Café Ltd might use the net profits of the business. (identifying the uses of net profit AND briefly explaining each use.) 2- Using figures from Table 1 and a ratio, analyze the liquidity of the company. (Define liquidity, then write down the formula.) 3- Using the figures in Table 1 and ratio analysis, evaluate the performance of the City Cafe Ltd between 2004 and 2005. (Company Performance is measured by how much net profit is won. ) 2004 2005 Sale Revenues 200 250 Net Profit 25 15 Current Liabilities 20 Current Assets 50 Capital Employed 300