BALANCE SHEETS AND

ANALYSIS OF ACCOUNTS

Chapters 24 and
25
 Financial Documents
 Accounts – the financial records of
a firm’s transactions
 Accountants – the professionally
qualified people who have
responsibility for keeping accurate
accounts and for producing the
final accounts
 Financial Documents
 Final Accounts – are produced at the
end of the financial year and give
details of the profit or loss made over
the year and the worth of the business
 Purchase Orders – these are
requests for goods or materials sent
to suppliers
 Financial Documents
 Delivery Notes – these are used by
the suppliers to confirm that the goods
have been received. This must be
signed by the buyer.
 Invoices – these are sent by the
supplier to the customer as a request
for payment for the goods delivered
 Methods of Payment
 Cash
 Credit
 CreditCard
 Debit Card
 User of Accounts
For tax purposes
Government

Companies
Accounts Creditors
For profit, tax, To prompt
technology, etc. payment of
Shareholders principal +
interest
For dividend +
growth of money
 Final Accounts

Manufacturing Trading Account

Accounts Retail Enterprise
Production companies

Both lead to…

Profit & Loss Account

Then comes…

Balance Sheet
 Trading Account
 Revenue Sales/Incomes – the
revenue (money) earned by a
business from selling its products
during a period
 Trading Account – shows how the
gross profit of a business is
calculated
 Trading Account
 Cost of Goods Sold (COGS) – the
cost of production or buying, in the
goods actually sold during a period
of time.
 Gross Profit – is made when sales
are more than cost of goods sold
(GP = Sales – COGS)
 Profit and Loss Account
 Profit and Loss Account – shows
how the net profit and retained profit
of a business is calculated
 Net Profit – made by a business
after all indirect expenses or
overhead costs have been deducted
from gross profit, giving the actual
profit
 Profit and Loss Account
 Retained Profit – the net profit
reinvested back into a company, after
deducting tax and payments to owners,
such as dividends
 Profit and Loss Appropriation Account –
extension of Profit and Loss Account,
which shows how the profit is distributed
as dividend retained in the business
 Profit and Loss Account
 Depreciation– reduction in the
value of any asset due to usage or
wear and tear
 Balance Sheet
 Balance Sheet - statement of balances
which show the value of assets and
liabilities on a particular date
 Balance Sheet
 Assets – the things owned by the
business for its use. They may be:
– Fixed: Land
– Current: Inventory
– Tangible: Vehicle, furniture
– Intangible: Goodwill, trademark,
copyrights.
– Fictitious: Discounted shares,
promotional expenses etc
 Balance Sheet
 Fixed Assets – Assets that are kept for
the use or the business rather than
resale. They will be kept for more than
12 months. (e.g. land, buildings,
machinery, vehicles, etc.)
 Current Assets – Assets which can be
converted in to cash within 6-12 months.
(e.g. cash, bank, debtors, stock, etc.)
 Balance Sheet
 Tangible Assets – Assets that can be
seen or felt. (e.g. goods, land, etc.)
 Intangible Assets – Assets which
cannot be seen or felt. (e.g. services,
goodwill, etc.)
 Fictitious Assets – Imaginary assets.
 Balance Sheet
 Liability
– are the values or the
obligations owed by the business.
They may be:
– Long Term
– Current
– Contingent
 Balance Sheet
 Long Term Liability – the loan which can work
for 5 to 6 years. (e.g. bank loans, debentures,
etc)
 Current Liability – Obligations of a business to
be paid in 6-12 months. (e.g. creditors, bank
overdraft, bills payable, etc.)
Contingent Liability: A potential obligation that
may be incurred depending on the outcome of
a future event. (eg: lawsuit for infringement of
a patent)
Important:

Net Profit should be added to the capital because

it is the property of the Share holders or the
owners or the company as it was generated from
the funds generated from them. On the other
hand it is treated as liability (to bo shown in
liabilities side) because it should be distributed to
the share holders(Dividend) or the the owners of
the company.
 Balance Sheet
 Working Capital – the capital which is
required by any organization for day-to-
day operations of as business (also
known as Net Current Assets)
Assets
 WC = Current Assets – Current
Liabilities
 Net Assets=Fixed
Assets Assets–Depreciation
=Fixed(or)Assets+WC
How are Assets Financed?

Assets

Shareholder’s Long Term

funds Liabilities
 Shareholder Funds
 Shareholder funds – shares issued
by a company that are bought by
individuals, (they are called
Shareholders)
Shareholders
 Shares
 Shares – Total capital of a
company that is divided into
innumerable lots, each portion is a
share
 Share Capital – the money put into
a business when the shareholders
bought newly issued shares
Understanding Shares
Share

Share
Capital
 More Shareholder Information
 Profitand Loss Reserves – retained
profit from current and previous
years. This profit is owned by
shareholders but hasn’t been paid as
dividends.
 Capital Employed
 Capital Employed = Shareholders’
funds + Long term Liabilities
(or)
 Capital Employed = Net Assets
 Shareholder (Owner) Funds
 Equity Shares
 Preference Shares
 Profit & Loss Account
 Reserves / Surplus
 Undistributed Profit
 Equity and Preference Shares
 Equity Shares – ordinary
shareholders’ class of share which
doesn’t carry any preferential rights
 Preference Shares – those class of
shares which carries 2 preferential
advantages
 Preferential Rights
 To claim dividend ahead of equity
shareholders
 To claim capital ahead of equity
shareholders
Published Accounts
Are made to find the

Financial Strength
Which tells about the

Performance
Is found using

Financial Tools
One example is

Ratio Analysis
 Ratio Analysis
 Ratio Analysis – comparing 2 figures
from the accounts of a business which
can be represented on “percentile”
basis and “number of times” basis
 Ratios are used to compare other
(inter-firm) businesses and the
businesses between years (intro-firm)
 Ratios
 These ratios access performance and
financial strength:
– Gross Profit Ratio
– Net Profit Ratio
– Operating Profit Ratio
– Current Ratio
– Acid Test/Liquidity Ratio
– Return on Capital Employed Ratio
 Gross Profit Ratio (%)
 Gross Profit Ratio – calculated upon
the net sales of the company. It tells
you the amount of profit earned
before the indirect cost/overheads
 Ratio = Gross Profit
X 100
Net Sales
 Must-Know Info.
 Gross Profit = Sales – COGS
 COGS = Opening Stock + Net
Purchases + Direct Cost – (Net Sales +
Closing Stock)
 Net Sales = Sales – Sales Returns
(Inwards)
 Net Purchases = Purchases – Purchase
Returns (Outwards)
 Net Profit Ratio (%)
 Net Profit Ratio – calculated upon
the net sales of the company. Used
to calculate the net profit before tax
is paid.
 Ratio = Net Profit
X 100
Net Sales
 Must-Know Info.
 Net Profit (before tax) = Gross Profit +
Indirect Incomes - Indirect Expenses
 Indirect Incomes – I.e. rent,
commission received, discount
received, etc.
 Indirect Expenses – I.e. salary,
commission paid, discount allowed,
advertising, depreciation, etc.
Operating Profit Ratio (%)
 Operating Profit Ratio – taking the
non-operating expenditures, and
non-operative income into account.
This profit tells the operating
efficiency.
 Ratio = Operating Profit
X 100
Net Sales
 Must-Know Info.

 Operating Profit = Net Profit + Non-

operating Expenses – Non-
operating Incomes
 Must-Know Info.
 Non-operating Income – I.e.
interest received, rent received,
dividend received
 Non-operating Expenses – I.e.
interest paid, rent paid, dividend
paid
 Current Ratio (#)
 Current Ratio – calculated to find
the short-term solvency
 Solvency – assets are more than
liabilities
 Ratio = Current Assets

Current Liabilities
 Must-Know Info.
 Theideal current ratio is 1.5 and 2.
Less than 1 means cash flow
problems are occurring.
Acid Test/Liquidity Ratio (#)

 Acid Test/Liquidity Ratio – calculated

to check the liquidity of the business
 Ratio = Current Assets-Closing Stock
Current Liabilities
(or)

Liquid Assets
Current Liabilities
 More-Know Info.
 Liquidity – Cash should be
sufficient
 The ideal liquid ratio is 1. Less than
1 means danger to the business
 Return on Capital Employed Ratio
(%)

 Return on Capital Employed Ratio–

Ratio
calculated to know the efficiency of
the business in getting the returns
on the capital invested in business
 Ratio = Operating Profits
X 100
Capital Employed
 Higher results mean more efficiency
 Disadvantages of Ratio
 Calculates past results
 Affected by inflation
 Different methods of accounting