Chapter 7: Business Accounting: What Are Accounts and Why Are They Necessary?
Chapter 7: Business Accounting: What Are Accounts and Why Are They Necessary?
Chapter 7: Business Accounting: What Are Accounts and Why Are They Necessary?
Accounting
What are accounts and why are they necessary?
Every end of the year, a final accounts must be produced which gives details of:
Limited companies are bound by law to publish these accounts, but not other
businesses.
Accountants use various documents that are used for buying and selling over the
year for their final accounts. They can help the accountant to:
keep records of what the firm bought and from which supplier.
Delivery notes: These are sent by the firm when it has received its goods. It
must be signed when the goods are delivered.
Invoices: These are sent by the supplier to request for payment from the
firm.
Credit notes: Only issued if a mistake has been made. It states what kind of
mistake has been made.
Receipts: Issued after an invoice has been paid. It is proof that the firm has
paid for their goods.
Credit card: Lets the consumer obtain their goods now and pay later. If the
payment is delayed over a set period then the consumer will have to pay
interest.
Debit card: Transfers money directly from user's account to that of the
seller.
Businesses usually use computers to store their transactions so that they can be
easily accessed, calculated and printed quickly.
Shareholders: They will want to know about the profit or losses made
during the year and whether the business is worth more at the end of the
year or not.
Creditors: They want to see whether the company can afford to pay their
loans back or not.
Government: Again, they want to check to see if correct taxes are paid.
They also want to see how well the business is doing so that it can keep
employing people.
This account shows how the gross profit of a business is calculated. Obviously, it
will contain this formula:
Note that:
Only calculate the cost of goods sold, and forget the inventory.
The profit and loss account shows how net profit is calculated. It starts off with
gross profit acquired from the trading account and by deducting all other costs it
comes up with net profit.
Depreciation is the fall in value of a fixed asset over time. It is also counted as an
indirect cost to businesses.
As for limited companies, there are a few differences with the normal profits and
loss account:
It needs to have an appropriation account at the end of the profits and loss
account. This shows what the company has done with its net profits, in
other words, how much retained profit has been put back into the
company.
Balance sheet
The balance sheet shows you a business's assets and liabilities at a particular time.
The balance sheet records the value of a business at the end of the financial year.
This is what it contains:
Fixed assets: land, vehicles, buildings that are likely to be with the business
for more than one year. They depreciate over time.
Current assets: stocks, inventory, ash and debtors that are only there for a
short time.
If your total assets are higher than your total liabilities, then you are said to own
wealth. In a normal business, wealth belongs to the owners, while in a limited
company, it belongs to the shareholders. Hence the equation:
Working capital: is used to pay short-term debts and known as net current
assets. If a business do not have enough working capital then it might be
forced to go out of business. The formula:
Net assets: Shows the net value of all assets owned by the company. These
assets must be paid for or finance by shareholders' funds or long term
liabilities. The formula:
Shareholders' funds: The total sum invested into the business by its
owners. This money is invested in two ways:
Without analysis, financial accounts tell us next to nothing about the performance
and financial strength of a company. In order to do this we need to compare two
figures with each other. This is called ratio analysis.
The most common ratios used are for comparing the performance and liquidity
of a business. Here are five of the most commonly used ratios.
Gross profit margin: If this rises, it could mean that either they are
increasing added value or costs have fallen.
Net profit margin: The higher the result, the more successful the managers
are. This could be compared with other businesses too.
Ratios used for analysing liquidity: This is too see how much cash a business has
to pay off all of its short-term debts.
Current ratio: This ratio assumes that all current assets could be converted
into cash quickly, but this is not always true since stock/inventory could
not be all sold in a short time. Generally, a result of 1.5 to 2 would be
preferable, so that a business could pay all of its short-term debts and still
have half of its money left.
Acid test or liquid ratio: This type of analysis neglects stocks, but it is
similar to the current ratio analysis.
It must be remembered that a ratio on its own will give you nothing, but when it
is compared with ratios from the past and other businesses it will tell you a lot of
things.
Only shows past results, does not show anything about the future.
Comparisons between businesses could be difficult since each has its own
accounting methods.