FINANCIAL ACCOUNTS

IB Business & Management – A Course Companion (2009),

p165-178

FINAL ACCOUNTS

• Final accounts are financial statements that inform stakeholders about the financial profile and performance of the business. There are various accounts including:

The Trading Account: this covers sales revenue, the cost of buying stock and gross profit.

The Profit & Loss Account: Most features of the trading account, plus all other expenses, taxes and interest paid, net profit and the appropriation of funds.

Balance Sheet: this covers what the business owns (assets) what it owes other people (liabilities) and how it has funded this situation (the capital employed) – its net assets (assets less liabilities).

The Trading Account - Example• The trading or manufacturing account looks at the cost of

production. It is possible to determine how efficient this side of the business operation is. Note that labour costs in making the goods could also be included as a cost of sales.

CORPX LIMITED $000 $000

Sales Revenue 1500Opening Stock (at start of year)

340Additional Purchases (during the year)

950Less Closing Stock (as at the end of the year)

(290) Cost of Sales 1000Gross Profit (or contribution)

500

The Trading Account - Example

• In the CorpX example, gross profit $500,000, represents about 33.3% of sales revenue or to put it another way, cost of sales is 66.5% of revenue.

• Fore every $1 of revenue, 66 cents goes on costs and that leaves 34 cents as gross profit.

• CorpX would compare this with previous years figures and also with competitors results as a way of gauging its production efficiency.

The Profit & Loss Account

• The Profit & Loss account presents the sales revenue of the company for a given period of time.

• It also shows the related costs in making that sales revenue and finally its shows how the resulting profit is used or `appropriated`.

$000

Sales Revenue(money received from cash/credit sales)

1,500

Costs of Sales(cost of buying-making- the actual good/service we sell)

1,000

Gross Profit 500

Expenses(electricity, phone, wages, rents, advertising, etc)

250

Net Profit before interest & tax 250

Interest 15

Tax 45

Net Profit after interest and tax 190

Dividends (share of company profits paid to shareholders)

95

Retained Profit 95

PROFIT & LOSS ACCOUNT FOR THE CORP-X FOR THE YEAR ENDED 31ST MAY 2008

The Appropriation Account

• The appropriation account is part of the profit & loss account and examines how the profit is distributed or appropriated. There are four use of profit:

Interest payable to lenders Corporate tax owed to the Government Dividends for shareholders Retained Profits – what isn’t given out can remain

in the business for future investment needs.

The Appropriation Account How profits are used:

• The first two uses of profits (taxes & interest payable to lenders) are usually non-negotiable.

• However, how much to give to shareholders and how much should be retained for investment or expansion can be determined by the business every year and will vary.

• When the business has made very small profits there may be no dividend payments to shareholders.

CALCULATION EXERCISE – THE PROFIT & LOSS ACCOUNT$000

Sales Revenue(money received from cash/credit sales)

3,000

Costs of Sales(cost of buying-making- the actual good/service we sell)

?

Gross Profit 1500

Expenses(electricity, phone, wages, rents, advertising, etc)

?

Net Profit before interest & tax 455

Interest 155

Tax 120

Net Profit after interest and tax ?

Dividends (share of company profits paid to shareholders)

80

Retained Profit ?

The Balance Sheet

• The Balance Sheet tells us on a specific day what the business owns (assets) and what it owes others (liabilities) and what are the net assets (assets – liabilities)

• It also tells us how the next assets were funded, or in other words, what the capital employed is.

• The capital employed will always equal the net assets, and this helps to explain why the account is called a balance sheet.

The Balance Sheet

• The Balance Sheet also gives an indication of the worth or value of a business on particular day.

• However, the value is a very approximate estimation of value, because, after all, the worth of a business depends on what a buyer is prepared to pay and in many cases this is well in excess of the net value as presented in the accounts.

BALANCE SHEET TERMSFixed Assets or Non Current Assets

• These are long term assets and remain in the business for more than 1 year. This could include:

equipmentcars or delivery vehicles fixtures and fittings land & or premises (if owned by the business) patents & brands (known as intangible assets

because we cannot hold them)

BALANCE SHEET TERMSCurrent Assets

• These are assets that remain in the business for up to one year, hence `current`.

This includes: inventory (stock), debtors (people who owe us money)cash

These are all transitory items and are part of theworking capital cycle.

BALANCE SHEET TERMSCurrent Liabilities

• These are the short-term debts that the business owes, that are payable within one year. This could includes:

creditors (people we owe money to – goods & services we have purchased on credit from other companies)

bank overdraft (money owned to the bank for short term borrowing)

short term borrowing

BALANCE SHEET TERMSNon Current Liabilities

• These are long term debts that the business owes. They are repayable over many years, perhaps, 5, 10, 15 or 30 years. It includes:

long term borrowing (a bank lent us money to buy the premises, a motor vehicle or some other significant assets).

NOTE: In the IB Accounting framework, Non Current Liabilities are not identified under Liabilities section. Rather the term Loan Capital is used under Share Capital.

BALANCE SHEET TERMSShare Capital

• This is money invested in the business by the shareholders and will include the original start-up funding and any subsequent investment by shareholders, perhaps for an acquisition or for purchasing new premises.

• Note: This has nothing do with the buying and selling of existing shares on the stock market, which brings no additional capital into the business.

BALANCE SHEET TERMSLoan Capital

• This is the long term finance (for more than 1 year) from a bank or other lender.

• Loan capital is not a negative thing for a business.

• It helps share the burden and risks of funding the business.

• However, interest payments will take a share of the profit.

BALANCE SHEET TERMSRetained Profit

• This is the profit over the years that has remained in the business and has been used to fund its development.

• Retained profit will be represented in the other half of the balance in an asset category such as land and buildings, equipment or even cash.

$000 $000

Fixed Assets 1500

Current Assets

Stock / Inventory 32

Debtors 60

Cash 5

Total 97

Current Liabilities

Creditors 37

Short –Term Borrowing 8

Total (45)

Net Assets 1552

Share Capital 1000

Loan Capital 350

Retained Profit 202

Capital Employed 1552

CORP X BALANCE SHEET AS AT 31ST

MAY 2008

How are accounts used by stakeholders?SHAREHOLDERS

• Accounts inform shareholders of how efficient the organization is at investing their capital and making a good return.

• Shareholders would look at the profitability and the level of dividends.

• They would also be interested in how safe their investment is or if the investment is likely to fail.

• The role of directors and whether or not they are performing would be issue. The directors may need to be replaced or re-incentivized.

How are accounts used by stakeholders?DIRECTORS, MANAGERS & EMPLOYEES

• Accounts inform these people about the financial viability of their employer and it may be useful to them or their trade unions to have profit figures when negotiating salary changes.

How are accounts used by stakeholders?CUSTOMERS

• Some customers are highly dependent on their supplier. If the supplier struggles so might they.

• By reviewing the accounts customers can appreciate whether their supplier is in trouble and what the effects might be on them.

• They might also be able to use this information to negotiate better discounts from their supplier or simply move to someone else to safeguard supply of materials.

How are accounts used by stakeholders?SUPPLIERS

• Suppliers can check up on the financial profile of customers and use to negotiate better terms.

• Eg: A supplier might not have realized that it was such a significant supplier for a particular business and yet the supplier has always had to wait 90 days for payment.

How are accounts used by stakeholders?CITIZENS OR RESIDENTS

• Citizens can use this information to better understand the financial strength or weakness or the local business.

• They might be interested in questions such as: Is the business likely to close and leave a lot of people

out of work? Is it performing well and so able to support local

community projects and charities?What expansion plans are likely and will they, for

example, bring any noise or other environmental problems?

How are accounts used by stakeholders?COMPETITORS

• Businesses will use published accounts to try and see how well their competitors are doing.

• Are competitors struggling or are their sales rising more quickly than their rivals?

How are accounts used by stakeholders?BANKERS

• They will want to know how safe their loans are and that the business can continue to pay both the interest and capital back.