Presentation dah💪🏽🙏🏽🙏

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By: Hettie & Atang

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 Income Statements
The financial records of a business are called its accounts. They should be
kept up to date & with great accuracy.
This is the responsibility of the accountants working in the Finance
Department.
At the end of each financial year, the accountant will produce final accounts
of the business. These will give details of the profit or loss made over the
year & the worth of the business.

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Profit
Profit is an objective for most businesses. In simple terms, profit is
calculated by:
Profit=Revenue-Total Cost

This simple formula introduces the idea that profit is a ‘surplus’ that remains
after business costs have been subtracted. If these costs exceed the
revenue, then the business has made a loss.
The profit formula also suggests that this surplus can be increased by:
1. increasing revenue by more than costs
2. reducing the cost of making products
3. a combination of 1 & 2

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Importance of profit to private sector
businesses
Why profit is important Explanation
Reward for risk-taking Entrepreneurs have to take considerable risks when they invest capital in a venture,
& profits are a compensation/reward to them for taking these risks(paid in the
form of profits or dividends)

Source of finance After payments to owners, profits are reinvested back into the business for further
expansion(this is called retained earnings)

Indicator of success More profits indicate to investors that the business is worth their time & money, &
they will invest more either in the firm or new firms of their own, in the hopes of
gaining good returns on their investment

Reward for enterprise Successful entrepreneurs have many important qualities & characteristics & profit
gives them a reward for these

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Difference between profit & cash
Profit is the surplus amount after total costs have been deducted from sales.
It includes all income and payments incurred in the year, whether already
received or paid or not yet received or paid respectfully.
In a cash flow, only those elements paid in cash immediately are considered.

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 Analysis of Accounts
Analysis of accounts means using data contained in the accounts to make useful
observations about the performance & financial strength of the business.
Without ‘analysis of accounts’ it is often impossible to tell whether a business is:
• Performing better this year than last year
• Performing better than other businesses
There are many ratios which can be calculated from a set of accounts. This chapter
concentrates on five of the most commonly used. These ratios are used to measure
& compare the profitability & liquidity of a business.

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The concept & importance of profitability
Profit is the amount of money the business has after all costs have been taken off
revenue. However, profitability is different from profit, although it is related. It is
the measurement of the profit made relative to either:
• The value of sales achieved
• The capital invested in the business
Profitability is the measurement of the profit made relative to either the value of
sales achieved or the capital invested in the business. It is measured in % form. It
is a measure of efficiency & can be used to compare the business’s performance
over a number of years. It is important to:
• investors when deciding which business to invest to
• directors & managers of the business to assess if the business is becoming more or less
successful over time, which may lead to a change in the operations of the business to
improve profitability.

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Profitability Ratios
Three commonly used profitability ratios are:
1. Return on Capital Employed (ROCE)
This is calculated by the formula:

The higher the ROCE is, the more successful the managers are in earning profit
from capital used in the business. If this % increases next year, it means that the
managers are running the business more efficiently.

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2. Gross Profit Margin
This is calculated by the formula:

If this percentage increases next year it would suggest that:

• prices have been increased by more than the costs of sales has risen
OR
• costs of sales has been reduced

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3. Net Profit Margin(Profit Margin)
This is calculated by the formula:

The higher this result, the more successful the managers are in making net profit
from sales.

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The concept & importance of liquidity
This measures a very important feature of a business. Liquidity is the ability of a
business to pay back its short-term debts. If a business cannot pay its suppliers for
materials that are important to production or pay its overdraft when it is supposed
to, it is said to be illiquid.
The business it owes money to may force it to stop trading & sell its assets so that
the debts are repaid.

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Liquidity Ratios
Two commonly used liquidity ratios are:
1. Current Ratio
This is calculated by the formula:

This is the basic liquidity ratio that calculates how many current assets are there in
proportion to every current liability, so the higher the current ratio the better (a
value above 1 is favourable)

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2. Acid Test Ratio
This is calculated by the formula:

This is very similar to current ratio but this ratio doesn’t consider inventory to be a
liquid asset since it will take time for it to be sold and made into cash. A high level
of inventory in a business can thus cause a big difference between its current and
liquidity ratios.

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Use & Users of Accounts
User of accounts What they use the accounts for

Managers They will use the accounts to help them keep control over the performance of each
product or division since they can see which products are profitably performing and which
are not.

• This will allow them to make better decisions. If for example, product A has a
good gross profit margin of 35% but its net profit margin is only 5%, this
means that the business has very high expenses that are causing a huge
difference between the two ratios. They will try to reduce expenses in the
coming year. In the case of liquidity, if both ratios are very low, they will try to
pay off current liabilities to improve the ratios.

• Ratios can be compared with other firms in the industry/competitors and also
with previous years to see how they’re doing. Businesses will want to perform
better than their rivals to attract shareholders to invest in their business and
to stay competitive in the market. Businesses will also try to improve their
profitability and liquidity positions each year.

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Shareholders- Since they are the owners of a limited company, it is a legal requirement that they be presented
with the financial accounts of the company. From the income statements and the profitability
ratios, especially the ROCE, existing shareholders and potential investors can see whether they
should invest in the business by buying shares. A higher profitability, the higher the chance of
getting dividends. They will also compare the ratios with other companies and with previous
years to take the most profitable decision. The balance sheet will tell shareholders whether the
business was worth more at the end of the year than at the beginning of the year, and the
liquidity ratios will be used to ascertain how risky it will be to invest in the company- they won’t
want to invest in businesses with serious liquidity problems.

Creditors- these are The balance sheet and liquidity ratios will tell creditors (suppliers) the cash position and debts of
other businesses the business. They will only be ready to supply to the business if they will be able to pay them. If
which have supplied there are liquidity problems, they won’t supply the business as it is risky for them.
goods to the
company without yet
receiving payment
Banks-these may Similar to how suppliers use accounts, they will look at how risky it is to lend to the
have lent money to business. They will only lend to profitable and liquid firms.
the company on a
short- or long-term
basis

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Government The government and tax officials will look at the profits of the company to fix a tax rate
and to see if the business is profitable and liquid enough to continue operations and
thus if the worker’s jobs will be protected.

Workers & Trade They will want to see if the business’s future is secure or not. If the business is
Unions continuously running a loss and is at risk of insolvency (not being liquid), it may shut
down operations and workers will lose their jobs.

Other Businesses- Managers of competing companies may want to compare their performance too or
especially those in may want to take over the business and wants to see if the takeover will be beneficial.
the same industry

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Limitations of using accounts & ratio
analysis
• Ratios are based on past accounting data and will not indicate how
the business will perform in the future.
• Managers will have all accounts, but the external users will only have
those published accounts that contain only the data required by law-
they may not get the ‘full picture’ of the business’s performance.
• Comparing accounting data over the years can lead to misleading
assumptions since the data will be affected by inflation (rising prices).
• Different companies may use different accounting methods and so
will have different ratio results, making comparisons between
companies unreliable.
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Thank you!🙏🏽🙏🏽

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