Business Accounting

Chapter 7

  • Accounts can help:
    keep track of how much money is owed
    how much raw material needs to be ordered
    keep a check on the money supply
    calculate profit and loss
    calculate how much tax is to be paid
    tell about the performance of the company
    tell about financial strength of company
    calculate liquidity
    estimate share/market value
  • Final accounts are produced at the end of the financial year and give details of profit and loss as well as the worth of the business. They:
    keep record of what has been bought and from which supplier
    keep records of what been sold and to which customers

Financial Documents

Purchase OrdersRequests for the goods or materials sent to the supplier
Delivery NotesUsed by the supplier to confirm the goods have been received by the purchaser
InvoicesSent by the supplier to the customer as a request for payment for the goods delivered
Credit NotesCredit provided if a mistake has been made
Statements of AccountTotal value of deliveries made each month
Remittance Advice SlipsIndicate which invoice is being paid
ReceiptsGiven by the supplier when the purchaser pays an invoice


Methods of Payment

  • Cash
  • Check
  • Credit card
  • Debit card

Who Uses the Final Accounts of a Business?

Shareholdersto know the worth of the business
Creditorsto see if the company can pay them back
Governmentto charge taxes accordingly and know how it will affect the economy
Other Companies/Competitorsto compare their own companies and to see if takeover or merger should be considered


Components of a Final Account

AccountFeaturesCalculation Method
Trading AccountGross profit (does not include overhead costs or expenses)Sales Revenue – Cost of Goods Sold
Profit and Loss AccountNet profit and retained profit (the net profit invested back into a company after deducting tax and dividends)Gross Profit – Expenses (depreciation and taxes included)
Appropriation Account

(Part of P&L Acc.)

Shows profit after tax is distributedProfit- Tax
Balance SheetValue of the business’s assets and liabilities (owner’s wealth)Total Assets – Total Liabilities



Depreciationfall in value of a fixed asset over a period of time
Retained Profitnet profit reinvested into a company after deducting tax and payments to owners
Liquiditythe ability of a business to pay back its short-term debts


Formulae [Ratio Analysis]

Cost of Goods SoldOpening Stocks + Purchases – Closing Stocks
Owner’s WealthTotal Assets – Total Liabilities
Debtor’s Days[Debtors/ Sales Turnover] * 365
Creditor’s Days[Creditors/Cost of Sales] * 365
Working CapitalCurrent Assets – Current Liabilities
Capital EmployedShareholder’s Fund + Long-term Liabilities
Dividend YieldDividend per share/ market value of share

Performance Ratios [Profitability Ratio]

Operating ProfitGross Profit – Expenses
Return on Capital EmployedOperating Profit / Capital Employed
Gross Profit MarginGross Profit / Sales Turnover
Net Profit MarginNet Profit Before Tax / Sales Turnover
Share YieldDividend/ Market Price of Share

Liquidity Ratio [Cash Position]

Current RatioCurrent Assets / Current Liabilities
Acid Test RatioCurrent Assets- Stocks / Current Liabilities
Stock/Sales TurnoverCost of Sales / Average Stock
Net AssetsWorking Capital + Fixed Assets


Disadvantages of Ratio Analysis

  • May not indicate how a business will perform in the future
  • Inflation is not considered
  • Different companies use different methods of accounting


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