Unit 5:
Business Finance and
Accounting
GCSE Business Studies
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Revision Presentations 2004
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
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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.
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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
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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
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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
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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
2000
£'000
2001
£'000
2002
£'000
10,150
4,250
12,535
4,700
15,100
5,950
Gross profit
5,900
7,835
9,150
Less expenses
4,235
5,675
6,480
Net profit
1,665
2,160
2,670
Gross Profit Margin
58.1%
62.5%
60.6%
Net Profit Margin
16.4%
17.2%
17.7%
Revenue
Less cost of sales
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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
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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
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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
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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)
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Net Profit
Calculated as gross profit less overheads
Final profit of business from its normal activities
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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
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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
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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)
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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
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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
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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
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Current Liabilities
Creditors – money owed by business in short term
Bank overdraft – amounts due within next 12 months
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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.
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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
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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
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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.
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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
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