Final Accounts

These are financial statements compiled by businesses at the end of a particular accounting
period. Such as at the end of a fiscal or a trading year. These include transactions, revenue
and expense.
Final account are for the following reasons : To show the financial capability/performance
to the stakeholders.

Stakeholders are of two types : 1. Internal (employees, shareholders, Managers ) 2. External

(government, financers, customers, suppliers, competitors, financers. )

Internal stakeholders:

1. Shareholders: They are interested because they need to be assured weather

their investment is profitable and is it efficient to invest capital in the company
in other words they assess weather their capital/investment is safe.

2. Managers: They use it to set targets and for efficient strategic planning . They
can use it to judge the performance with respect to other financial years or
within a particular year. They use it to set budgets which will help them
monitor and control expense pattern.

3. Employees : An increase in final accounts could signal 2 things to the

employees, first that their jobs will stay secure and second that they might get a
salary raise or a bonus. But its not compulsory that an increase in account will
result in a pay raise as a result my employees create unions.

External Stakeholders:

1. Customers : By the help of final accounts they can see whether the company
will continue to create the product of their interest and that will result in
weather they can depend on that product. Also if low profitability is observed
 the customers might shift to some other company that is more reliable and
steady.

2. Suppliers : They use the account to negotiate better cash and credit terms. They
can increase their credit limit time or can ask for cash early. If a company has
low profit its ability to repay will be a huge concern for the suppliers.

3. The government : They use it to keep a check on the company to see if they
follow all the accounting rules and regulations also the government checks the
profit and tallies it with the tax paid to ensure the company is paying the right
amount of tax. If the government finds that a company is not doing well it is a
problematic situation as it means that there is or will be higher unemployment
which is not good for the countries economy

4. Competitors : business will compare its accounts to those of its competitors to

ensure their stand and position in the market. The competitors will find
answers for two questions, first is the competitor making more profit and
second is how do the sales revenue compared to theirs.

5. Financers : these are generally the bank and they carefully look at your
accounts to see whether the company will be able to repay the loan with
interest.

6. Local People: They want to check whether the business has growth potential
(to create jobs.

The Main Final Account

Profit and Loss Account:

It is also called income statement and shows all the income and expenditure of a company
over a given period of time. After a business establishes weather they have created profit or
loss the account gets divided into 3 parts, which are :
1. Trading account
2. Profit and loss account
3. Appropriation account
1. Trading account :

It shows the difference between the sales revenue and the production of cost. This provides
the company with the gross profit . The formula for which is :

● Sales Revenue: Income earned by selling of goods or services over a particular

period of time.
● Cost of sales(COGS): It is the direct cost of producing or purchasing of goods
that were sold over that particular period. The formula for COGS is :
2. The profit and loss account :

The gross profit comprises of interest tax and other indirect costs like : Administration cost,
rent, salary, insurance, etc so the use of this segment is to find the cost after tax, interest,
expenses.
SO for this process there are 3 steps :
1. Net Profit before tax and interest
2. Net Profit before tax
3. Net Profit after tax and interest
Formula for three are as follows:

3. The appropriation account :

This is the final part of the account is calculated how the money left after the payment of
tax and interest is divided. The money can be divided in 2 ways, first it can be given as
dividends to shareholders and it can be taken back as retained profit by the company.
Formula for retained profit :

Layout of Profit and Loss Account:

Balance sheet:
It's also called statement of financial position, it is based on a simple equation that is : Assets
= Liabilities + Equity. This sheet shows that how much a company owns and how much
does it owe. It is used to find a company's financial position.

Assets​: These are the resources that a company owes or are owed to. Assets are divided in
two: Fixed and current Assets

Fixed Assets : These are the assets that the company will own for a longer period of time i.e
is for more than 12 months the example for the same are : Land, Machine, Equipment,
Vehicle. Some of the fixed assets go through depreciation and therefore to find their value
the rate of depreciation needs to be subtracted from the cost of fixed asset to get net fixed
assets.

Current Assets ​: These are the services or goods that a company owes that lasts for less than
12 months. These include cash, debtors and stocks (stocks include: raw material, semi
finished goods and finished goods. Raw materials are also called inventory. )
Liability : These are a firm's legal debt that they owe to firms, institutions and individuals.
These are generally for the operations and funding of the firm. They are classified into 2 :

1. Long term
2. ​Current Liabilities

1. Long term include: bank loans and mortgages that are for more than 12 month.

2. Current Liabilities include: Creditors , Suppliers, Bank Overdrafts and Tax.

Once the company knows its liabilities it can calculate its working capital or the Net
Assets these are the costs that are required for the day to day working of the company.
It is calculated in the following way:

After this Total assets less liabilities is calculated and the formula is :

After this Net assets are calculated and for that long term liabilities are subtracted
from the Total Assets less current liabilities.

​Equity​ : It includes 2 aspects that are : share capital and retained profit

Share capital: It refers to the capital obtained from Shares that were bought at the start
of the business by the shareholders. It is a permanent source and does not include the
daily buying and sale.

Retained Profit : As per the profit and loss account (mentioned above)
Formula for the same is :

Note : Equity is always equal to Net assets

Blueprint for balance sheet :

 Depreciation (HL)

This is the decrease in value of fixed asset over time. It is calculated in the Profit and loss
account to find the net profit. Depreciation is a non cash expense. It is calculated for 2
reasons :

1. Wear and Tear

2. Obsolescence

The 2 methods to find depreciation are : A.) Straight Line B.) Reducing Balance

A.) Straight Line Method :

This is a very simple method in which the cost is spread over time. This is a fixed cost
that is reduced every year throughout the lifespan of the product. Generally it’s reduced
per annum. The following things are required for the calculation:
1. The expected useful life of the asset
2. The original cost of the product
3. Residual or scrap value of the product
With the help of the above information depreciation can be calculated:

Example for straight line depreciation are :

Advantages of Straight Line method:
1. It is simple to calculate
2. It is good for less expensive items and for assets whose lifetime is predictable.
(furniture).

Disadvantages of Straight Line method:

1. It is not suitable for for expensive or lage assets like machine or plant as
ignores other costs.
2. It sometimes inflates the value of products that lost a larger value in the
first years.
3. It doesn’t cater to the fast environmental and technological changes.

B.) Reduce Balance Method :

This method applies a percentage of depreciation rate over the useful life of the asset.
It adopts an acceleration depreciation technique in which the rate of charge is reduced
every year. Higher is charged at start and less at the end.To calculate ever years
depreciation the formula is :

Advantages of Reducing Balance method:

1. It is more realistic
2. It is more accurate as compared to straight line
3. It consider many different non cash expenses that affect the rate.
​Disadvantages of Reducing Balance method:
1. More complex method
2. Charges more rate of depreciation in the start which may not be true for
cheaper assets.
3. The formula is subjective (due to lack of residual value)
4. It lowers the profit
5. It will defer Tax payment for later years.

Formula and example is :

The End
 Chapter 3.5 Profit and Liquid Ratios

This is an analysis tool that is used for interpretation and assessment of a firm's financial
statement. It is used to evaluate firm's finances by analysis its strengths and weaknesses and
assessing it by comparing it. It is used for decision making of the company by making inter
organisation comparisons and by analysis past ratios and ratios of competitors.
The types of ratios are :
1. Profitability Ratio
2. Efficiency Ratio
3. Liquidity Ratio

Profitability Ratio

They interpret the firm's performance on their profit making ability. There are 2 ratios :
1. Gross Profit Margin (GPM)
2. Net Profit Margin (NPM)

Gross Profit Margin (GPM) :

It is calculated by dividing the gross profit by sales revenue. And then the answer is
multiplied by 100 because GPM is expressed in percentage. Formula :
Strategies that can improve GPM :
1. The company can increase their prices in markets where the consumer are
less price sensitive. In such a market the company can increase their sales
revenue. Also in markets with less competition.
2. Reduction in the costs of raw materials.
3. Aggressive promotion strategies to persuade people to buy their product.
4. Reduce direct labour cost, influence labour to sell/ create more units also the
employees that are not productive need to be shed off.

Net Profit Margin (NPM) :

It is calculated after all costs are removed from the sales revenue i.e NPBIT is divided by
sales revenue and then multiplied by 100 as NPM is expressed in percentage.
Formula and example for NPM is :
Strategies that can improve NPM :
1. Reduce indirect cost and thereby reduce unnecessary expenses.
2. The firm can negotiate with some stakeholders to reduce their fees.
(eg: Ask landlord to reduce rent)

Efficiency Ratio

This ratio assesses how well a firm utilizes its assets and liabilities. This also analyses how
is the performance of the firm. One such tool is called :​ Return On Capital Employed
(ROCE).

Return On Capital Employed (ROCE):

This ratio measures a firm's profitability as well as efficiency as it measures what is the
return from the capital invested. It is calculated by :

This then helps in the calculation of ROCE:

Strategies that can improve ROCE :

1. A firm should try and reduce their Loan capital while ensuring that their
profits remain the same.
2. By providing additional dividends to shareholders this will reduce the
retained profit and increase the ROCE.
The example of ROCE:

Liquidity Ratio

This ratio measures the company’s ability to pay off short term debts. Business need it to
meet their day to day bills. Liquidity means how fast can a company convert their asset into
cash. Two important ratios are :
1. Current Ratio.
2. Acid test Ratio.

Current Ratio
It is obtained by comparing a firm's assets by liabilities.
Example and explanation :

Strategies that can improve CURRENT RATIO :

1. Reduce bank overdrafts which will reduce short term liabilities.
2. Sell long term assets for cash. This will also increase working capital.

Acid Test Ratio

It is a more stringent indicator of how well the company be able to meet its short term
demands as it removes stocks from current liability.
Formula :
Example and explanation :

Strategies that can improve ACID TEST RATIO :

1. Sell stock on discount for cash to increase liquidity.
2. It might increase credit period from debtors to purchase more stocks on credit.

The End
 Chapter 3.6 Efficiency Ratios Analysis [HL]

As indicated in the above unit these ratios assess the utilization of a firm's resources in
terms of assets and liabilities . There are more efficient tools :
1. Stock Turnover
2. Debtors Days
3. Creditors Day
4. Gearing Ratio

Stock Turnover Ratio:

This ratio measures how fast a firm's stock is sold and replaced in a given period. There are
two ways to calculate. First is in terms of how many times does the stock update and second
in how many days does the stock update, formula for both is :
First : (Number of times):-

Another approach is by calculating the no of days in which you can sell your stocks and the
formula for that is :
Example for the above method is :

Explanation for the ratio:

Strategies that can improve Stock Turnover Ratio :

1. Slow moving or obsolete goods should be disposed.

2. Firms with a wide range of products need to narrow down the products.
 3. Keep low level of stock.
4. Try and adopt the JIT or just in time method (Supply <- Demand ) .

Debtor’s Day Ratio:

This Ratio measures the number of days in which the company collects their money from
customers or other debtor’s to whom the company has given money on credit. The formula
to find out is :

Example of Debtors day with explanation:

Strategies that can improve Debtor’s Day Ratio :

1. Provide offer or discount to the debtors to make them pay early.

2. Put penalty for late come Debtors.
3. Stop further business with those debtors (doesn't always work).
4. Use legal Actions such as court to deal with late comers.
Gearing Ratio:

This measures the extent to which the companies capital employed is from loan capital.
As loan capital is a long term liability it i mesured how much of it is utilized into the capital
employed. The formula for which is :

An example and explanation for the above ratio:

Strategies that can improve Creditor’s Day Ratio :

 1. Seek alternative source of finance i.e rather than Loan capital
2. Decrease or forbid the declaration of dividends to shareholders to increase
retained profit.
Creditor’s Day Ratio:

This measures how quickly can a firm repay their suppliers or other creditors the formula to
calculate the Creditors ratio is:

An example and explanation for the above ratio:

Strategies that can improve Creditor’s Day Ratio :

1. Having good relations with the creditor and negotiating to provide extra credit
period.
2. Effective Credit control will improve the ratio.

The End
 Chapter 3.7 Cash Flow

Cash is the most liquid asset of a company and any kind of cash transaction in the company
is called as cash flow of the company it is measured over a particular period of time. There
are two types, first : ​cash inflow​ refers to all the money that enters the organisation and
cash outflow ​is the money paid by the business over a period of time.
Cash Flow is a key indicator for a company's ability to fulfill their financial obligations. A
positive cash flow will result in a firm's smooth day to day expenses.

Profit vs cash flow :

Profit is obtained by subtracting total cost from total revenue. To explain the concept of
profit vs cash flow there is an example :

There are two alternatives in which cash flow and profits differ, such as :
1. More profit less cash flow
 2. More cash flow less profit

1.) More profit but less or no cash flow :

This kind of situation is called INSOLVENCY and it can be a result of :

a. Poor collection of funds.
b. Paying suppliers early and leaving no cash for day to day work.
c. Purchasing capital equipment or many non current asset at the same time.
d. Purchasing too much stock by cash = Overtrading.
e. Servicing loans with cash.

2.) More cash flow but less or no profit :

a. Source of cash can be bank loans.

b. Obtained from firms fixed assets.
c. Obtained from shareholders funds.

The working capital cycle.

Working Capital = Net current assets
The working capital is calculated by:

● For a good working capital current assets should be more than current liabilities.
● If the case is visa versa then the company can face insolvency or liquidity crisis.
● The business will then be considered illiquid business.
● And if the business doesn’t improve it’s condition it will be liquidated .
● This cycle is a period of time between payment of goods and receiving cash for the
goods sold.
● It is recommended that the cycle is short to maximize working capital
● The gap between the inflow and outflow
should be as much as possible so to
accommodate any kind of lag or delay.
Cash Flow forecast :

These are future predictions o a rms cash inflows and outflows over a given period of time.
This is in the form of a financial document that shows expected month-by-month receipts
and payments of a business that have not yet occurred. Examples of likely cash inflows
include cash sales from selling goods or business assets, payments from debtors, cash
investments rom shareholders, and borrowing from banks. Cash outflows include
purchasing materials or xed assets or cash, cash expenses such as rent, wages and salaries,
paying creditors, repaying loans, and making dividend payments to shareholders.

How to construct a cash flow forecast :

To construct a forecast 5 things are required :

1. Opening Balance
2. Cash inflows
3. Cash outflows
4. Net cash flow
5. Closing Balance (Becomes the opening balance of next month)
Blueprint and example of a cash forecast also explanation :
Benefits of cash flow forecast :
1. Useful planning document to start a business.
2. It is a great support for business if applying for loan.
3. It helps managers to forecast where is the help needed in the coming months.
4. Helps in the management of cash flow.

Relation between cash flow investment and profit :

Strategies to deal with cash flow problems :

Reducing Cash Outflow:

1. Negotiate with suppliers or creditors to increase the credit period. This will
result in more working capital.
2. Purchase of fixed assets can be delayed so to keep cash on the business.
3. Reduction in costs that don't affect the production. Like : Promotion costs.
4. Find a cheaper suppliers as well as cheaper materials (in terms of cost).

Reducing Cash Outflow:

1. Business may request customers to pay by cash to avoid late credit payment.
2. Offer discount for early payment.
3. Company can provide different products to diversify customers and potential
increase of sales.

Additional Financial Sources :

1. Sale of Fixed Assets

2. Arranging a bank overdraft
3. Leaseback of assets
4. Debt factoring
5. Grants and subsidies

Limitations of cash flow forecasting :

1. Unexpected change in economy

2. Poor Market Research
3. Difficulty in predicting competitors behaviour
4. Demotivated employees
5. Unforeseen Machine Failure

The End
 Chapter 3.8 Investment Appraisal

● Investment appraisal refers to the quantitative techniques used in evaluating the

viability or attractiveness of an investment proposal.

● It attempts to assess and justify the capital expenditure allocated to a particular

project. It therefore aims to establish whether a particular business venture is worth
pursuing and whether it will be profitable.

● Investment appraisal also assists businesses in comparing different investment

projects.
● The methods that we will look into are:
1. Payback Period
2. Average rate of return
3. Net Present value

The Payback Period :

It calculates how fast will the business return the net investment or the cost outlay. It can be
calculated by :

Two types of examples for the above method :

Advantages of Payback Period :

1. It is simple and fast to calculate

2. It is useful in rapid changing industries as can tell how fast the money can be
gained back.
3. It can help with cash Flow problems (company selects the project that pays
faster)
4. Less inaccurate for long term forecasting.
5. Managers can easily use and comprehend this data.

Disadvantages of Payback Period :

1. Doesn’t consider the cash earned after the payback period.

2. Ignores overall Profitability as it only focuses on the initial return.
3. Doesn’t consider the external factor that might influence the payback period.

The Payback Period :

This method measures annual net return of an investment in percentage of its capital cost.
It is also called accounting rate of return. It can be calculated by the following formula :

The example and explanation for the above method is

Advantages of Average Rate of Return (ARR) :

1. It's measures the profitability of a business over a particular period of time.

2. It considered all the cash flow of the business.
3. It provides a better comparison with other potential investments.
4. A company can check its criteria and compare it to ARR to check its validity.

Disadvantages of Average Rate of Return (ARR) :

1. It is less reliable in predicting for long term investments.

2. Doest consider Time as a factor of return.
3. Doesn’t consider the value of time in money .

Net Present Value (HL):

The End
 Chapter 3.9 Budget [HL]

Importance of budgets in an organisation :

1. Planning​ : It helps to set targets, provides a direction to the manger and helps
in anticipating future problems and solutions.

2. Motivation:​ Budget holders who are responsible for budgetary control feel a
sense of empowerment and trust which increase their productivity and loyalty.

3. Resource Allocation : ​Budget helps in prioritizing the needs of the firm and
hoow will the resources be used in the firm. Generally firms require a lot of
resources and budget sets a boundary for the expense on that resources.

4. Coordination​ : Budget brings all the people of different departments together

for the common budget and to meet the common targets.

5. Control​: Budgets acts as a monitor for the firm it evaluates that all the
departments are in the budget and are spent in the right direction.

To be able to divide revenues the different parts of the business are divided into two groups:
1. Cost centers
2. Profit Centers

Cost centres:

These are the centres where cost is collected and recorded. Example is electricity, wages,
ads, etc. These centres can be divided on the following criterias:

1. By department ( H.R , Operations, Marketing )

2. By Product (Company with several products like samsung )
3. By geography (Coca cola is situated in different places and all are cost centres)
Profit centres:

They check how much profit does the company make by collecting and recording the cost
as well as the sales revenue. This allows the company to check which of their centres are
making a profit.
Similar to the above centres they are divided into 3.

Role of Cost and Profit centres:

1. Helps in decision Making

2. Better Accountability (Responsibility)
3. Helps in tracking Problem areas
4. Helps In increase in motivation
5. Helps in comparison and benchmarking the company.

Problems of Cost and Profit centres:

1. It is difficult to allocate indirect costs

2. External costs are not considered
3. Centre conflicts
4. This creates staff stress

Variance Analysis :

● Variance refers to the difference in the budget figure fixed and the actual budget

figures. It is calculated at the end of the budget period.

● This can be done for both cost and sales revenue budgets.

● It can be either FAVOURABLE or ADVERSE.

● (F ) is when the difference is positive and in favour of the company.

● (A) is when the difference is negative and bad for the company.
Example for variance :

Adv. of using Budget and variance in strategic planning :

1. Control revenue and expenditure
2. Budgets provide SMART targets
3. Helps in coordination of different department
4. Variance helps in the analysis of the company's performance
5. It helps in finding out any deviations of the budget .
6. Quantifies the appraisals of budget holders.

Dis-adv. of using Budget and variance in strategic planning :

1. Does Not support flexible budgets that may change (externally)
2. Larger difference can result in the loss of credibility of the tool.
3. Long term gains can be ignored
4. Underspend budget can unjustify wasteful management by manager
5. It can affect the motivation levels of people.

The End