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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 businessGross profit does not make any allowance for overhead costs or expensesIn 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 TOTALThe 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 timeThe 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 businessFixed 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 businessLong-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 debtsWorking capital = Current assets – Current liabilities

Net assets = Fixed assets + Working capitalThese 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 companyShare capital – is the money put into the business when the shareholders bought newly issued sharesProfit 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 performingThe 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 formulaReturn on capital employed (%) = Operating profit/Capital employed * 100This 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 formulaGross profit margin (%)= Gross profit / Sales turnover * 100

GO BACK TO PERFORMANCE RATIOS

NET PROFIT MARGIN

This is calculated by the formulaNet profit margin (%)= 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 RATIOand ACID TEST or LIQUID RATIOGo back to “Ratio analysis of accounts”

CURRENT RATIO

This is calculated by the formulaCurrent ratio = Current assets / Current liabilities

GO BACK TO LIQUIDITY RATIOS

ACID TEST or LIQUID RATIO

This is calculated by the formulaAcid 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