Business Accounting

1. Business Accounting GCSE Business Studies tutor2u™ Revision Presentations 2004

2. 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

3. Who Uses Accounts? • Shareholders use accounts to monitor a company’s 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.

4. 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

5. 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

6. 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

7. 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

8. 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

9. 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

10. 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

11. 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)

12. Net Profit • Calculated as gross profit less overheads • Final profit of business from its normal activities

13. 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

14. 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

15. 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)

16. 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

17. 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

18. 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

19. Current Liabilities • Creditors – money owed by business in short term • Bank overdraft – amounts due within next 12 months

20. 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.

21. 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

22. 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

23. 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.

24. 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