Unit 4 Managing 2

Accounting Monitoring the BusinessUnit 4 Managing 2ObjectivesThe following topics from Unit 4 of the syllabus are covered in this chapterWhy monitor the business?Who is interested in the financial position of an enterprise?How important is financial information to a business?The final accountsRatio analysisAccounting ratiosMonitoring a businessHow do we judge the success of a business?Profit?Sales?Reputation?Size of company?Number of employees?History?Potential?Financial ControlsThe financial controller in a business is responsible for ensuring that proper financial controls and procedures are in place.

Final AccountsThe financial controller also prepares the final accounts and balance sheet of the business.

1. Trading Account2. Profit and Loss Account3.Balance SheetTrading AccountPurpose of the trading account is to find the gross profit or gross loss over a period.

Trading Account for year end 31-12-11Sales600,000Less cost of salesOpening Stock20,000Purchases150,000Cost of goods available for sale:170,000Less closing stock(30,000)Cost of Sales(140,000)Gross Profit460,000

Profit and Loss AccountThis shows the net profit or net loss made by the business in the trading period.

P&L account for year end 31-12-11Gross profit460,000Add gainsRent received10,000470,000Less expensesWages and salaries100,000Rent and rates20,000Insurance50,000Telephone5,000Depreciation20,000Advertising20,000215,000

Net Profit255,000Advantages of Profit and Loss AccountIt measures the success of the business compared to previous years.It can help obtain loans of finance from banks.It enables owners and managers to plan ahead. It shows all the expenses and highlights where any increases have occurred.Balance SheetBalance sheet as on 31-12-11Fixed assets:Land 400,000Buildings70,000Current assetsStock55,000Debtors20,000Bank15,00090,000Less current liabilitiesCreditors16,000Dividends due50,00066,000Working capital36,000Total net assets506,000Financed byOrdinary shares150,000Retained earnings255,000Term loan101,000Capital employed506,000Balance SheetStatement of a businesss financial position at a point in time.Current Assets: Assets that will shortly be turned into cashCurrent Liabilities: Amounts owed by a business that must be paid in the near future.Working capital = CA CLIf CAs are greater than CLs, working capital is positive and the firm is said to be liquid.If CLs are greater than CAs, working capital is negative and the firm has a liquidity problem and to be overtrading, i.e. It cannot pay its debts as they fall due.Ratio AnalysisRatio analysis involves examining the relationships between financial figures in the accounts and expressing them as ratios or percentages.

1. Profitability RatiosThese ratios show how successful the management was in making profit in the business.The profitability ratios are:Return on Capital Employed/Return on InvestmentGross Profit Percentage/MarginNet Profit Percentage/MarginReturn on Capital Employed/ROIGross Profit Percentage/MarginNet Profit Percentage/MarginExampleThe following information relates to the accounts of N.Martin Ltd, a boutique owner in Galway.

For 2004 and 2005 calculate the gross profit margin, the net profit margin and the return on investment.Analyse these profitability trends and discuss how shareholders might use them in making decisions.

20042005Sales700,000550,000Gross Profit210,000110,000Net Profit140,00082,500Capital Employed500,000440,0002. Liquidity RatiosLiquidity is the ability of a business to pay its short-term debts as they arise. It is measured by subtracting the current liabilities from current assets

Current Assets Current Liabilities = Working Capital

If working capital is positive, the firm is said to be liquid. If working capital is negative, the firm is said to be overtrading and cannot pay its debts as they arise.Current RatioAcid Test Ratio3. Debt-equity ratioThis shows the relationship between the debt capital and the equity capital in a company

Debt Capital = Long-term debtEquity Capital = Ordinary Share Capital + Reserves

Debt Capital: Equity CapitalDebt - equity ratioDebt < Equity = Low gearingThe business has borrowed less than the amount invested by shareholdersDebt = Equity = Neutral gearingThe business has borrowed the same amount as invested by shareholdersDebt > Equity = High gearingThe business has borrowed more than the amount invested by shareholders

Advantages of low gearingA greater amount of the capital of the company is provided by the owners.More profit available for Dividends.Easier to borrow in the future.Easy to sell shares in the futureConsequences of high gearingHigh interest payments on borrowings.Difficult to sell shares in the future because of poor dividends.Difficult to borrow in the future.Low dividends low share price.2009 Higher Level Question

2004 Higher Level Question