IGCSE BUSINESS STUDIES CHAPTER 7 – BUSINESS ACCOUNTING

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INDEX WHAT ARE ACCOUNTS AND WHY ARE THEY NECESSARY FINANCIAL DOCUMENTS INVOLVED IN BUYING AND SELLING METHODS OF MAKING PAYMENT WHO USES THE FINAL ACCOUNTS OF A BUSINESS THE TRADING ACCOUNT THE PROFIT AND LOSS ACCOUNT BALANCE SHEETS EXPLANATION OF BALANCE SHEET TERMS ANALYSIS OF PUBLISHED ACCOUNTS RATIO ANALYSIS OF ACCOUNTS

WHAT ARE ACCOUNTS AND WHY ARE THEY NECESSARY 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. 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.

FINANCIAL DOCUMENTS INVOLVED IN BUYING AND SELLING Purchase orders – these are requests for products or services sent to suppliers. Delivery notes – these needs to be signed by the customer to confirm that the order has been received. Invoices – these are the requests for payment sent by the supplier. Credit notes – these are issued if a mistake has been made. Statement of account – a statement that each month the supplier will send to his customers. Remittance advice slips – these are slips issued to make sure the customer isn’t charged again for the invoices he has already paid. Receipts – a copy of the invoice that is kept by the customer

METHODS OF MAKING PAYMENT Cash – the most common method of payment used for most small amounts. Cheque – instructions to a bank to transfer a certain sum of bank balance to a specific person. Credit card – this allows customers to buy goods and services and letting them pay in the future. 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.

WHO USES THE FINAL ACCOUNT OF A BUSINESS Shareholders – they have a big interest in knowing how big the profit of loss of the company is. Creditors – they have a big interest in knowing whether the company can pay back a loan. Government – the government and the tax office will want to know bow much tax the business should pay. Other companies – they will want to compare their business to other businesses to see how their business is performing.

THE TRADING ACCOUNT It shows the difference between the COSTS OF GOODS SOLD and the SALES REVENUE The difference is called GROSS PROFIT 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

THE PROFIT AND LOSS ACCOUNT It shows how the NET PROFIT is calculated It begins with the gross profit calculated from the trading account All other expenses and overheads of the business are subtracted DEPRICIATION is the fall in the value of a fixed asset over time THE PROFIT AND LOSS ACCOUNTS FOR LIMITED COMPANIES

THE PROFIT AND LOSS ACCOUNT FOR LIMITED COMPANIES It follows exactly the same principals as the PROFIT AND LOSS ACCOUNT . The main differences are: Corporation tax paid on company profits will have to be shown Results from the previous year have to be included The final section of the profit and loss account is called the APPROPRIATION ACCOUNT

BALANCE SHEETS They are very different from the profit and loss account. 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 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 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 BALANCE SHEET TERMS

EXPLANATION OF BALANCE SHEET TERMS Working capital (aka as net current assets). It is used to pay short term debts Working capital = Current assets – Current liabilities 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 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 Capital employed = Shareholders’ founds + long term liabilities CAPITAL EMPLOYED = NET ASSETS

ANALYSIS OF PUBLISHED ACCOUNTS LIQUIDITY is the ability of a business to pay back it’s short term debts It is important to choose more than one figure from the accounts when trying to find how a business is performing. Comparing two features from one account is called RATIO ANALYSIS

RATIO ANALYSIS OF ACCOUNTS There are two main types of ratios : PERFORMANCE RATIOS and, LIQUIDITY RATIOS Disadvantages of ratio analysis

PERFORMANCE RATIOS These are used to see how the business is performing The three most common performance ratios are: RETURN ON CAPITAL EMPLOYED GROSS PROFIT MARGIN NET PROFIT MARGIN Go back to “Ratio analysis of accounts”

RETURN ON CAPITAL EMPLOYED 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

GROSS PROFIT MARGIN This is calculated by the formula = Gross profit / Sales turnover * 100 GO BACK TO PERFORMANCE RATIOS

NET PROFIT MARGIN This is calculated by the formula = Net profit before tax / Sales turnover * 100 GO BACK TO PERFORMANCE RATIOS

LIQUIDITY RATIOS These measure the ability of a business to pay back it’s short-term debts Two common liquidity ratios are: CURRENT RATIO and ACID TEST or LIQUID RATIO Go back to “Ratio analysis of accounts”

CURRENT RATIO This is calculated by the formula Current ratio = Current assets / Current liabilities GO BACK TO LIQUIDITY RATIOS

ACID TEST or LIQUID RATIO This is calculated by the formula Acid test or Liquid ratio = (Current assets – stocks) / Current liabilities GO BACK TO LIQUIDITY RATIOS

DISADVANTAGES OF RATIO ANALYSIS Ratios are based results collected on the past and therefore will not be able to show how a business might perform in the future Accounting results over time will be affected by inflation Different companies might use slightly different accounting methods GO BACK TO RATIO ANALYSIS OF ACCOUNTS