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BUSINESS & MANAGEMENT Unit 3.5 Final Accounts 1/39.

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Presentation on theme: "BUSINESS & MANAGEMENT Unit 3.5 Final Accounts 1/39."— Presentation transcript:

1 BUSINESS & MANAGEMENT Unit 3.5 Final Accounts 1/39

2 Standard Level 2/39 Higher Level Introduction to Final Accounts Profit & Loss Accounts Balance Sheet Window Dressing Depreciation – Straight Line & Reducing Balance Intangible Assets – Patents, Copyrights & etc. Stock Valuation – LIFO & FIFO NB: - Students will not be tested on Manufacturing Accounts or Double Entry

3 Introduction 3/39 Businesses to have some way of knowing where there money is going. Small businesses keep these so they can keep track of profit and spending. Corporations (Private limited liability companies and Public limited liability companies) need to legally keep these for a number of years. In some countries, the period is as long as 7 years so as to facilitate corporate governance.

4 Things that need to be kept by a corporation Profit & Loss Account Balance Sheet Cash Flow Statement 4/39 Explains the trading that took place during a period of time. Assets and Liabilities of a business. Shows money coming in and money going out.

5 5/39

6 Stakeholders who look at the final accounts Shareholders EmployeesManagersCompetitors 6/39 The owners of the company like to see where their money is being spent. They would like to see how secure their job is and to see if they might receive a pay raise. Use the accounts to see how well they are performing and to plan for the future. Other firms will look to see how businesses are performing compared to themselves.

7 GovernmentFinanciers 7/39 Stakeholders who look at the final accounts Tax collectors will make sure that businesses are paying their fair share. Banks, business angels and suppliers will make sure a business is running sound before giving finance or credit.

8 RevenueCostProfit Profit Quality 8/39 Terminology Revenue is money that comes into a business from trading accounts. Cost is the money that flows out of a business for revenue expenditures like rent/mortgage payments, wages (payment to staff), costs of material. Profit is the difference between revenue and costs. Profit quality of a business refers to the long-term prospects of making money for a firm. Businesses with low quality products and high prices will have low profit quality.

9 P&L Account or Income Statement? What information does a P&L Account give? 9/39 Profit & Loss Accounts/ Income Statements P&L Account is used by profit-motivated organizations whereas Income Statements is used by non-profit organizations as there not profit-motivated. Usually works for one year and explains how much profit is being made (or not made).

10 P&L Account comprises of three parts 10/39 Trading Account Profit & Loss Account Appropriation Account

11 Trading Account 11/39

12 Trading Account for HIO $ $ 5,000 3, ________ Sales Cost of goods sold Opening stock Add: Purchases Less: Closing stock Total Cost of Goods Sold Gross Profit 12/39 2,700 2,300

13 Trading account for CBO $ $ ________ _____ Sales Cost of goods sold Opening stock Purchases Closing stock Gross profit 13/39 1,

14 Ways to improve Gross Profit 14/39 Use cheaper suppliers but try not to reduce quality Increase selling price but try to not lose customers Use marketing strategies – promotions and repackaging. This might increase sales but will definitely increase expenses.

15 15/39

16 P&L Account: 16/39 Shows the operating profit and net profit of a business. Operating Profit =Gross Profit - Expenses Expenses are listed on Pg. 393 box 3.5 (1 st Edition) or Pg. 346 box 3.5a (2 nd Edition). The operating profit is the actual profit made by a business

17 List of Expenses Income received by directors for directorship. Director Fees Monthly salaries, commission, incentives & bonuses. Salaries Fees paid to the secretarial firm. Secretary Fees Fees paid to the audit firm. Audit Charges Administration fees charged (e.g. by statutory boards.). Administration Charges Market Research, Market & Sales Promotions, Door Gifts & etc. Marketing Costs Personal Insurance (Life & Term), Fire Insurance for Property & etc. Insurance Premiums Interests incurred from bank loans, hire purchase, overdrafts, & etc. Interest Charges Rental charges (including management fee) of land and property. Rental Pen, paper, ink cartridges, boxes, stapler and etc. Stationery Costs Air & Sea freight, warehousing charges, land delivery charges & etc. Transportation and Distribution Costs Gas, heat, electricity, telephone and water charges. Utility 17/39

18 Profit and loss account for PML $ $ Sales 40,000 Cost of goods sold Opening stock 25,000 Purchases 5,000 Closing stock 16,000 Cost of stock _______ Gross profit _________ Expenses Salaries 3,000 Utilities 6,000 Transportation 2,000 Others 1,000 Total Expenses _________ Operating Profit _________ 18/39 14,000 26,000 12,000 14,000

19 Some basic things businesses do to try and reduce expenses and increase profit 19/39 Try to negotiate for lower rent or move. (this can be dangerous to some businesses.) Reduce using air conditioning and heating. Cutting down on administrative personnel.

20 Non Operating Income 20/39 Examples include interest earned at a bank, rent charged on property owned by business and dividends earned from shares in other companies. These are counted as non-operating income. It is counted after operating profit. Interest payments and taxes are counted after operating profit as well.

21 Profit and loss account for Larrys $ Chinese school Sales Revenue Cost of sales (30000) Gross Profit ________ Expenses (7000) Operating Profit ________ Non-operating income 3000 Net Profit before interest and tax ________ Interest payments (5000) Net Profit ________ 21/39 20,000 13,000 16,000 11,000

22 Appropriation Account 22/39 This shows how profits are distributed between taxes, dividends(money paid to shareholders (shown as a current liability)) and Retained profit (money used by the business to grow(shown as a capital reserve)). Businesses have no choice when it comes to taxation but they make decisions on how much money should be paid in dividends and how much should be kept as retained profits during shareholders meetings. (Most businesses pay out dividends twice a year).

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24 Profit and loss account for __________ $ ________________________________ Sales Revenue ________ Less: Cost of sales __________ Gross Profit ___________ Less: Expenses _________ Profit before interest and tax (Operating Profit) ___________ Add: Non-Operating Income Less: Interest payments Net Profit Before Taxes and Dividends ___________ Less: Tax ___________ Net Profit after interest and tax ________ Less: Dividends _________ Retained Profit _________ 24/39

25 25/39

26 Limitations to Profit & Loss Accounts (P&L) 26/39 Only can show past performance and can be difficult to say what will happen in the future. Window dressing – Some businesses will play with their numbers so that they can make it look more attractive to shareholders. Because of a lack of standards it is hard to compare the profit and loss accounts of different firms.

27 Balance Sheets 27/39 Legally required record of a businesses financial position at the end of the trading year. It shows a businesses assets, liabilities and the capital invested. Basic function of a balance sheet is to show where money comes from and where it goes. Must contain three sections: Assets, Liabilities and Capital & Reserves.

28 Assets 28/39 Money owned by a business or owed to a business. Fixed assets will last for more than a year and will most likely not be sold. Current assets – will be turned into working capital within a year. Cash and liquid assets.

29 Different types of Fixed Assets Tangible Fixed Assets Buildings, equipment, vehicles, etc. Tend to depreciate in value over time. Intangible Fixed Assets Non physical things but they have a value that is hard to determine; e.g. patents, copyrights, trademarks, brand names, etc. Long-term Investments Long-term money that is usually put into other businesses (e.g. stocks, debentures and bonds). 29/39

30 Legal obligations of Liabilities 30/39 Long-term liabilities – paid under accounts payable money that will not be paid back till after a year. Current liabilities – Money that needs to be paid within a year. Shown in the balance sheet under creditors

31 Capital and Reserves (shareholders funds (limited companies)) Owners Equity for other types of businesses 31/39 Share capital – (called up capital) Money raised from the initial sale of shares of a business. (NOT THE CURRENT SHARE PRICE) Retained profit – The net profit that a business has after paying expenses, taxes and dividends. Will match figures from profit loss account. Reserves - proceeds from retained profits in previous trading years. Includes capital gains in the value of fixed assets. (This happens when property goes up in value (revaluation)). Depreciation is not calculated here.

32 Capital and Reserves 32/39 Capital and Reserves are money owed to the owners so it is considered a liability. It is not considered long term or short term liability because there is no set time that it needs to be repaid. It is also considered permanent capital (internal source of finance). Owners of a business own the value of the assets after deducting debt. Many countries require that businesses report their balance sheet for two years. Owners equity = Net Assets – Long term liabilities

33 Differences in Balance Sheet 33/39 Balance sheets of unincorporated businesses (Sole traders, partnerships) will be different from incorporated business (Public and Private) in the following ways: Sources of funds are different (limited business have more options) No shareholders funds for unincorporated businesses Unincorporated businesses pay no shareholders so they may have drawing accounts to use the funds for personal use.

34 Uses of Balance Sheets 34/39 From the Working Capital figure, businesses can see how much money they have to play with. Asset Structure lets a business see if they have an increase in stocks which can mean overtrading. Capital Structure helps to see where capital is coming from. Capital Employed helps a business know how much money they are using.

35 Limitations of Balance Sheets 35/39 Balance sheets do not change if they are not updated; the information or data could be well off. When evaluating stock or other assets it can be hard to predict what the actual value is. Because the real price of something is not known until it is sold. Because businesses run a balance sheet in different ways it can be difficult to compare them. Intangible Assets are very hard to determine the value of. So many things like trained workers are left off a balance sheet.

36 36/39 Show an overdraft that is repayable after 12 months as long-term liability. Giving higher value to intangible assets. Using lease back and straight selling of assets to show a profit. Moving around paying back loans so that the business can show lower profits before reporting income for tax reasons. Declare sales revenue that is sold on credit as if it was paid in cash. Delay declaring depreciation of fixed assets. Using these methods can hide the real value of a firm.

37 37/39 Sets of final accounts are necessary for good analyzing (either intra firm or historical). The skills of the workers are ignored. Qualitative factors are ignored as well as ethical objectives. Need to see the accounts of different businesses to make judgments about performance of the business. Because they are public record many businesses will try to hide as much information as possible in their reports. It can be dangerous to use past information to predict the future. Some managers have trouble keeping this in mind.

38 38/39

39 39/39 Auditing is the process of having outside people go over your books(final accounts). Many countries require this for two reasons: disclosure and accountability of financial matters of a business. Today intellectual property rights (patents and copyrights and trade marks) are extremely important and for some businesses the most important thing they have. Some countries do not recognize the intellectual property rights and this can cause major political problems. Balance sheets are used to help businesses understand their needs day to day. Also these figures will help a business to know when they can expand. Also the final accounts can let shareholders know where their money is being spent. When looking for a balance sheet or other final accounts for a business a good place to start is the annual report.

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