Business Accounting

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Business Accounting
GCSE Business Studies
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Revision Presentations 2004
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What is Accounting?

• There is no one agreed definition of accounting
• Most commentators agree that accounting involves
  the
• Process of identifying, measuring, recording and
  communicating financial information to permit
  informed judgements and decisions by users of the
  information
• Collection monitoring of financial data
  providing information about the activities of
  business

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Who Uses Accounts?

• Shareholders use accounts to monitor a companys
  activities and performance and to decide whether
  to increase, hold or sell their shares
• Managers use accounts to measure performance
  inform decisions e.g. new investment or plant
  closure monitor and control departments set
  targets
• Banks use accounts to decide whether or not to
  offer a loan, increase or withdraw an overdraft
• Creditors use accounts to see if a firm is an
  acceptable credit risk or if they need to press
  for payment
• Customers use accounts to decide if a firm is
  likely to survive into the future and supply
  after sales service
• Government uses accounts to calculate tax payable
  on sales (VAT), profits (Corporation tax) and
  employees (national insurance and income tax
  collected at source (PAYE)
• Staff and the wider community use accounts to
  evaluate if the organisation is stable or likely
  to close.

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Roles of the Accounting Function

• Administrative
• Record financial transactions
• Collect money from sales
• Pay suppliers, salaries and wages
• Management information
• Prepare regular financial information e.g.
  monthly management accounts showing sales, costs
  and profits against budgets, forecasting cash
  flows, cost investigations
• Providing other stakeholders with legal/vital
  information

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Main Accounting Records

• Sales ledger
• Shows how much is owed by customers who have
  bought on credit
• Used to help credit control
• Purchase ledger
• Shows how much is owed by business to suppliers
  who have provided goods and services on credit
• Cash book and bank statements
• Shows all transactions involving cash
• E.g. receipts from customers, payments to
  suppliers, employee wages
• Nominal (or General) ledger
• Used to categorise transactions of a business
  under headings
• E.g. sales of widgets, raw materials,
  electricity, postage

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Financial Statements

• Profit and loss account
• Shows how business has traded for a specific
  period
• Balance sheet
• Shows the assets and liabilities of a business at
  a particular time, and how those assets and
  liabilities have been financed
• Cash flow statement
• Shows how cash has come into business and what it
  has been spent on

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Profit and Loss Account

• Shows whether a business has made a NET PROFIT or
  LOSS over a financial year.
• Describes how profit or loss arose e.g.
  categorising costs between cost of sales and
  operating costs

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Gross Profit and Gross Margin

• Gross profit
• Sales revenue (value of all goods sold) minus
  cost of making these products (cost of sales)
• SALES COST OF SALES GROSS PROFIT
• Gross margin
• A profitability ratio
• Calculated as gross profit divided by sales
• Expressed as a percentage

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Cost of Sales

• Measures the costs directly associated with
  making products e.g.
• Raw materials packaging
• Cost of labour working directly on each product
• Cost of running machines/equipment

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Overheads

• Costs not directly involved in production process
• Cost of premises e.g. rent, insurance, repairs
• Office costs e.g. stationery, postage, computer
  maintenance, staff salaries and wages
• Sales and marketing costs e.g. salaries of
  salesmen, advertising
• Finance costs e.g. bank charges, interest on bank
  loans

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Revenue Expenditure and Capital Expenditure

• Revenue expenditure
• Money spent on goods and services which have been
  or will be consumed
• E.g. Wages, raw materials
• Capital expenditure
• Money spent on long term assets which are used
  over and over again
• E.g. Buildings machinery computer systems
  (hardware)

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Net Profit

• Calculated as gross profit less overheads
• Final profit of business from its normal
  activities

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Ways of Improving Gross Profit

• Change to cheaper raw material suppliers
• Redesign product to use fewer or cheaper
  materials
• Increase selling prices
• Offer fewer discounts to customers

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Ways to Reduce Overheads

• Reduce expenditure on promotional activities
  (e.g. advertising campaigns)
• Move to cheaper premises
• Combine jobs done by administrative staff to
  reduce employee numbers
• Renegotiate cost of overheads such as legal and
  accounting fees

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Balance Sheet

• A snap shot of business at a point in time
  balance sheet date
• Shows what business OWNS, IS OWED and OWES
• OWNS - Assets such as buildings, stock and cash
• IS OWED - Money from debtors
• OWES - Money to creditors and bank
• PLUS owes money to investors/owners of business
  (they own profit)

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Fixed Assets

• Assets that provide a benefit for business for
  more than 12 months
• Assets that business intends to keep
• Land and buildings
• Plant and machinery
• Company cars

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Depreciation

• Assets reduce in value over its useful life due
  to wear and tear and obsolescence
• Depreciation is an estimate of how much the value
  of fixed assets have fallen since they were
  bought
• Reduces original value of an asset by charging an
  amount every year of its useful life to profit
  and loss account

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Current Assets

• Stocks finished goods, work in progress and raw
  materials (note also called inventories)
• Debtors people who owe business money
• Cash in bank and in cash box

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Current Liabilities

• Creditors money owed by business in short term
• Bank overdraft amounts due within next 12 months

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Provisions

• Where business makes a charge against profits for
  something expected to happen
• E.g. charging against profits a reduction in size
  of debtors because it is expected that a debtor
  owing money will fail to pay
• This is called a bad debt.
• A business might also decide to make a provision
  for some kind of claim against business e.g. a
  legal claim for damages.

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Capital

• Amount of long-term money put into business to
  buy assets
• Main forms of capital
• Owners money (share capital)
• Retained profits (profit not paid out as
  dividends)
• Long term bank loans

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Cash flow Statement

• Historical statement that shows movements of cash
  moving in and out of business
• Split into two parts
• Sources of funds
• Where cash has come from (e.g. profits, increase
  in trade credit)
• Use of funds
• How the cash was used (e.g. purchase of assets,
  repayments on bank loans)
• Different from a cash flow forecast which looks
  at future movement of cash

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How Profitable Businesses Can Fail

• A business can make a profit but have a negative
  cash flow.
• Without enough cash to pay employees, suppliers,
  banks and taxes business will go bankrupt.
• A business makes a profit when sales exceed
  costs.
• Positive cash flow arises when payments from
  customers exceed payments to suppliers and
  employees. Cash may not be due from customers
  until next month, but bills and employees may
  have to be paid today.
• This situation can give rise to negative cash
  flow, even though value of sales is greater than
  costs
• Poor cash flow is one of main reasons why new
  businesses fail.

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Accounting Statements Published by a Limited
Company

• Companies Act requires limited companies to
  produce several accounting statements
• Published in the Annual Report and Accounts
• Profit and loss account
• Balance sheet
• Cash flow statement
• Note sole traders and partnerships are not
  required to publish their accounting information
  publicly like companies. However, they will
  still need to produce accounts to show to the
  banks and to calculate tax payments