3.5 Financial Accounts

Chapter 22

What are ACCOUNTS?

Financial records of business transactions which provide information to groups within and outside an organization.

Accounts help keep track of assets, liabilities, revenue, and expenses.

ACCOUNTS

Accounts can help up answer business questions:• How much did we buy from a supplier?

• Have they been paid yet?

• How much profit did we make last year?

• Can the business repay a loan?

• How much did we pay in wages last week?

• What is the value of our fixed assets?

Who uses Financial Accounts?

Business Managers Banks Creditors (Trade Suppliers) Customers Governments Investors Workforce Community

Stakeholders Require Account Information

Business Managers• Measure performance of the business and

compare it to last year, last quarter, or to a budget.

• Help make decisions…do we invest in a new product or close branch offices.

• Set performance goals for the future and compare to actual performance in order to remain on target.

Stakeholders Require Account Information

Banks• Decide to lend money

• Increase a line of credit

• Decide whether to continue a loan or line of credit

Stakeholders Require Account Information

Creditors (Trade Suppliers)• Can the company pay off its debts?

• Is the company a good credit risk?

• Should it collect its outstanding debt early?

Stakeholders Require Account Information

Customers• Is the business stable?

• Will I be able to continue buying product in the future? Will it be of same quality?

• Is there be spare parts or service facilities?

Stakeholders Require Account Information

Government/Taxing Authorities• Calculate tax due

• Will the company expand and create more jobs?

• Is the business in danger of closing?

• Is the business adhering to laws and regulations?

Stakeholders Require Account Information

Investors (Shareholders)• Is the business becoming more or less

profitable?

• What share of the profits are the investors receiving?

• Can the business grow?

• Potential investors compare businesses to make an investment decision.

• Investors will decide if they should sell their investment or continue their investment.

Stakeholders Require Account Information

Workforce• Is the company capable of paying wages?

• Is the business likely to expand or reduce in size?

• Are jobs secure?

• If profits are increasing, can higher wages be paid?

• How do wages compare with wages paid to company executives?

Stakeholders Require Account Information

Local Community• Can the company expand? Good for local

economy.

• Is the company losing money? Bad for local economy if the business closes.

Financial Statements

Income Statement• Records the revenue, costs, and profit (or

loss) of a business over a period of time. Balance Sheet

• Records the values of a assets, liabilities, and shareholder’s equity in the business.

Cash Flow Statement• Cash inflows and outflows of the business

used to estimate cash needs.

Income Statement

Detail statements are produced frequently for internal management• Typically once per month

Summary statements are produced for external users. Detail is omitted to avoid revealing strengths and weaknesses.• Typically produced annully

Income Statement

Sales 3060Cost of Sales (1840)Gross Profit 1220

Overheads (580)Net Profit before taxes and interest 640

Interest (80)

Pre-Tax Profit 560

Tax @ 20% (112)

Profit After Tax 448

Dividends to Shareholders (200)

Retained Profit 248

Trading Accounts

Shows gross profit/loss from trading activities of the business. **Sales is the not the same as CASH RECEIVED.

Profit and Loss Accounts

Calculates the Net Profit/Net Loss and calculates the Profit/Loss after taxes are paid.

Appropriation Accounts

Shows how profits after tax are distributed (appropriated) to the owners or shareholders.

Income Statement

Sales 3060Cost of Sales (1840)Gross Profit 1220

Overheads (580)Net Profit before taxes and interest 640

Sales: Revenues generated by the business (also known as sales turnover)

Cost of Sales: Direct costs required to produce the product to sell (also known as cost of goods sold)

Gross Profit: Sales revenue less the cost of sales.

Overhead: Expenses not directly related to producing the item sold.

Sales: Hand made candy bars

Cost of Sales: Chocolate, caramel, nuts, graham crackers

Overhead: rent, wages, utilities

Income Statement

Dividends• Share of profits paid to shareholders as a

return for investing in the company.

Retained Profits• The profit left after all deductions have been

made (including dividends). This is returned to the company as a source of finance.

Income Statement Limitations

Values can be made to look “better” than they really are. Values can be made to look “worse” than they really are.• Low-quality profit: profit that cannot be easily

repeated or sustained (including a large sale that won’t be repeated)

• High-quality profit: profit that can be repeated and sustained.

Balance Sheet

Records the wealth of a business or shareholder equity at one moment in time. (This wealth belongs to the shareholders.)

Shareholder equity is created 2 ways:1. capital invested by the purchase of stock by

the shareholder2. Retained earnings of the company that have

accumulated over time

Balance Sheet Contains the following categories:

• Assets Things the company owns.• Fixed Assets land, buildings, vehicles Tangible items that will be

owned for at least 1 year.

• Current Assets inventory, accts receivable, cash Items that are seen as liquid.

• Liabilities Money the company owes.

• Current Liabilities accts payable, loans, unpaid taxes

• Long-Term Liabilities long-term loans, mortgages, debentures (bonds)Items that will take longer than 1 year to

pay.

• Working Capital Current Assets-Current Liabilities

• Shareholder’s Equity Money paid into company by shareholdersRetained Profits

Balance SheetASSETS

FixedProperty 300Vehicles 45Equipment 67Total Fixed Assets 442

Current AssetsStocks (inventories) 34Debtors (Accts Rcvbl) 28Cash 4

Current LiabilitiesCreditors (Accts Pyble) 42Short-Term Loans 31

Net Current Assets (7)

NET ASSETS 435

Long-Term LiabilitiesLong-Term Loans 125Total Long-Term Liabilities 125

SHAREHOLDER’S EQUITYShare Capital 200Retained Earnings 110Total Shareholder’s Equity 310

CAPITAL EMPLOYED 435

Balance SheetASSETS

FixedProperty 300Vehicles 45Equipment 67Total Fixed Assets 442

Current AssetsStocks (inventories) 34Debtors (Accts Rcvbl) 28Cash 4

Current LiabilitiesCreditors (Accts Pyble) 42Short-Term Loans 31

Net Current Assets (7)

NET ASSETS 435

Fixed Assets: Assets to be kept and used for more than 1 year

Current Assets: Assets that are liquid and likely to be cash by the next balance sheet date

Stocks/Inventories: items ready for sale

Debtors/Accounts Receivable: value of payments to be received from customers who purchased goods on credit

Current Liabilities: Debts that will usually be paid within 1 year

Creditors/Accounts Payable: value of debts for goods bought on credit from suppliers

Net Current Assets: Current Assets - Current Liabilities also known as “working capital”

Balance Sheet

Long-Term LiabilitiesLong-Term Loans 125Total Long-Term Liabilities 125

SHAREHOLDER’S EQUITYShare Capital 200Retained Earnings 110Total Shareholder’s Equity 310

CAPITAL EMPLOYED 435

Long-Term Liabilities: Value of debt that will take more than one year to pay

Long-Term Loans: commercial loans, debentures

Capital Employed: Balances with NET ASSETS