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IGCSE BUSINESS

STUDIES
CHAPTER 7 BUSINESS ACCOUNTING

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INDEX

WHAT ARE ACCOUNTS AND WHY ARE THEY NECESSARY

FINANCIAL DOCUMENTS INVOLVED IN BUYING AND SELLING

METHODS OF MAKING PAYMENT

WHO USES THE FINAL ACCOUNTS OF A BUSINESS

THE TRADING ACCOUNT

THE PROFIT AND LOSS ACCOUNT

BALANCE SHEETS

EXPLANATION OF BALANCE SHEET TERMS

ANALYSIS OF PUBLISHED ACCOUNTS

RATIO ANALYSIS OF ACCOUNTS

WHAT ARE ACCOUNTS AND WHY ARE


THEY NECESSARY

There is a very big difference between accounts and


accountants:
ACCOUNTS are the financial records of one or more
transactions.
ACCOUNTANTS are the people who have the responsibility of
keeping the accounts as accurate as possible.

Accountants, at the end of every financial year, need to


produce the FINAL ACCOUNTS of the business. These tell
business main financial results, and also how much the
business is worth at that period of time. Limited companies
also need to publish their final account.

FINANCIAL DOCUMENTS INVOLVED IN


BUYING AND SELLING

Purchase orders these are requests for products or services sent to


suppliers.

Delivery notes these needs to be signed by the customer to confirm that the
order has been received.

Invoices these are the requests for payment sent by the supplier.

Credit notes these are issued if a mistake has been made.

Statement of account a statement that each month the supplier will send to
his customers.

Remittance advice slips these are slips issued to make sure the customer
isnt charged again for the invoices he has already paid.

Receipts a copy of the invoice that is kept by the customer

METHODS OF MAKING
PAYMENT

Cash the most common method of payment used for most


small amounts.

Cheque instructions to a bank to transfer a certain sum of


bank balance to a specific person.

Credit card this allows customers to buy goods and


services and letting them pay in the future.

Debit card these work the same way as credit cards but
instead of credit being accumulated, the money is
transferred directly to the the sellers account.

WHO USES THE FINAL


ACCOUNT OF A BUSINESS

Shareholders they have a big interest in knowing how big


the profit of loss of the company is.

Creditors they have a big interest in knowing whether the


company can pay back a loan.

Government the government and the tax office will want


to know bow much tax the business should pay.

Other companies they will want to compare their business


to other businesses to see how their business is performing.

THE TRADING ACCOUNT

It shows the difference between the COSTS OF GOODS SOLD and the
SALES REVENUE

The difference is called GROSS PROFIT

IMPORTANT:
Cost of goods sold does not have to be the same as the total value of
goods bought by the business
Gross profit does not make any allowance for overhead costs or expenses
In a manufacturing business the direct labor cost and the direct production
costs will be deducted from the gross profit before arriving at the GROSS
PROFIT TOTAL
The gross profit is not the final profit of the business as all the expenses
have to be deducted

THE PROFIT AND LOSS


ACCOUNT

It shows how the NET PROFIT is calculated

It begins with the gross profit calculated from the trading


account

All other expenses and overheads of the business are


subtracted

DEPRICIATION is the fall in the value of a fixed asset over


time

THE PROFIT AND LOSS ACCOUNTS FOR LIMITED COMPANIES

THE PROFIT AND LOSS


ACCOUNT FOR LIMITED
COMPANIES

It follows exactly the same principals as the PROFIT


AND LOSS ACCOUNT . The main differences are:

Corporation tax paid on company profits will have


to be shown

Results from the previous year have to be included

The final section of the profit and loss account is


called the APPROPRIATION ACCOUNT

BALANCE SHEETS

They are very different from the profit and loss account.

The profit and loss account shows the income and expenses of a business over a
period of time
The balance sheet shows the value or worth of a business at a particular moment in
time

ASSETS are those items of value that are owned by the business
Fixed assets (Land, buildings, equipment and vehicles) they are likely to be kept
by the business for more then a year, most of the fixed assets depreciate over time
Current assets (cash, stocks and debtors) they are only held for a short period of
time

LIABILITIES are the items owed by the business


Long-term liabilities they are long term borrowings (they do not have to be repaid
within one year)
Current liabilities borrowings which must be repaid within one year

BALANCE SHEET TERMS

EXPLANATION OF BALANCE
SHEET TERMS

Working capital (aka as net current assets). It is used to pay short term debts
Working capital = Current assets Current liabilities

Net assets = Fixed assets + Working capital


These assets must be paid for by money but into the business in two ways :
shareholders found and long-term liabilities

Shareholders founds is everything that is invested into the business by the owners
of the company
Share capital is the money put into the business when the shareholders bought
newly issued shares
Profit and loss reserves are retained profits from current and previous years

Capital employed = Shareholders founds + long term liabilities

CAPITAL EMPLOYED = NET ASSETS

ANALYSIS OF PUBLISHED
ACCOUNTS
LIQUIDITY is the ability of a business to pay back

its short term debts


It is important to choose more than one figure

from the accounts when trying to find how a


business is performing.
Comparing two features from one account is

called RATIO ANALYSIS

RATIO ANALYSIS OF
ACCOUNTS

There are two main types of ratios :

PERFORMANCE RATIOS

and,

LIQUIDITY RATIOS

Disadvantages of ratio analysis

PERFORMANCE RATIOS

These are used to see how the business is performing


The three most common performance ratios are:

RETURN ON CAPITAL EMPLOYED

GROSS PROFIT MARGIN

NET PROFIT MARGIN

Go back to Ratio analysis of accounts

RETURN ON CAPITAL
EMPLOYED
This is calculated by the formula

Return on capital employed (%)


= Operating profit/Capital employed * 100
This is how much the business was able to get back
from the capital it had employed

GO BACK TO PERFORMANCE RATIOS

GROSS PROFIT MARGIN

This is calculated by the formula

Gross profit margin (%)


= Gross profit / Sales turnover * 100

GO BACK TO PERFORMANCE RATIOS

NET PROFIT MARGIN

This is calculated by the formula

Net profit margin (%)


= Net profit before tax / Sales turnover * 100

GO BACK TO PERFORMANCE RATIOS

LIQUIDITY RATIOS

These measure the ability of a business to pay back its


short-term debts

Two common liquidity ratios are:

CURRENT RATIO

and

ACID TEST or LIQUID RATIO

Go back to Ratio analysis of accounts

CURRENT RATIO

This is calculated by the formula

Current ratio = Current assets / Current liabilities

GO BACK TO LIQUIDITY RATIOS

ACID TEST or LIQUID RATIO

This is calculated by the formula

Acid test or Liquid ratio


= (Current assets stocks) / Current liabilities

GO BACK TO LIQUIDITY RATIOS

DISADVANTAGES OF RATIO
ANALYSIS
Ratios are based results collected on the past and

therefore will not be able to show how a business


might perform in the future
Accounting results over time will be affected by

inflation
Different companies might use slightly different

accounting methods
GO BACK TO RATIO ANALYSIS OF ACCOUNTS

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