Hello guys, today we are going to study the accounting part of business. This involves making records and calculating a firm’s transactions. This includes calculating its profit, loss, assets, liabilities etc. All these terms will be made clear to you by the end of the lecture.
So before we go directly to accounting, I will explain the terms break-even point and budgets for you. Now break-even point, as the word suggests is the point where profits equal losses. In other words, it is the level of sales at which total costs equal total revenue.
Break-even charts are diagrams used to show the break-even point. These charts have numerous advantages. i.e :
- They show the level of sales that must be achieved in order to compensate all losses
- It also shows the total revenue made by producing a certain number of products. In this way it helps determine the prices a firm charges for its products or services.
- By redrawing the graph a manager can see how the price or the level of sales affect each other.
Hence, we can say that break-even charts are really very helpful to businesses. Now let’s move onto budgets. A budget can be defined as a plan for the future containing numerical or financial targets.
A budget is very helpful for a business in that it gives the business a purpose, a target for which the business strives. Another very important benefit is that it allows a business to analyse its efficiency by measuring its current performance and comparing it with that ordained by the budget. This type of analysis is known as variance analysis.
Well, I hope that made it clear. So as I mentioned before accounts are the records of financial transactions made by a business. All of you must have heard the word accountant. Well an accountant is that person who keeps and records final accounts of a business. That is just one job of an accountant.
Final accounts, these accounts are published at the end of the financial year, thus, the word ‘final’. They give details of the profit or loss made over a period. The first account included in final accounts is TRADING account. This tells us about the Gross Profit. Before I explain further, let me tell you that a Gross Profit is the difference between the cost of goods and the price which they are sold for. So a trading account looks something like this:
Trading Account for year ending 31/4/2009
Total stock available
Less closing stock
Total stock sold
Okay, so now that we showed you the trading account, its time to move onto Profit and Loss Account
Non Trading income
From this we can conclude that a profit and loss account shows the Net Profit or the profit made after deducting all expenses from the Gross profit.
This should give you guys a fair idea of what final accounts are. Now we will move onto balance sheet, a balance sheet gets more tricky. It shows the value of a business’s assets and that of its liabilities. Assets are those items that can br sold by a business to make money, and liabilities are those debts which a business owes to its stakeholders.
There are two types of liabilities, current or short-term liabilities and long-term liabilities.
( Balance Sheets diagram)
Assets can also be characterized as fixed(long term) and current(short-term). Long-term assets last for very long periods. Examples of these are land, buildings, machinery. Short-term assets are those that last for onlya short period of time i.e. not more than one year.
These formulas I sm going to tell you are very important so please listen closely:
- Working Capital = Current assets-Current liabilities
- Net assets= Fixed assets + Working capital
Fixed assets+(Curr. Assets-Curr. Liabilities)
Capital employed= Shareholder’s funds + Long term liabilities.
These formulas are very important in analyzing the performance of a business. But without the performance ratios these formulas are of little use.
The common performance ratios are:
- Return on Capital employed %= Operating profit *100
This performance ratio measures the efficiency of a business in making profits out of the capital put into it by the shareholders.
- Gross Profit Margin%= Gross Profit * 100
This shows the profit made on every good sold, a very good measure of gross profit indeed.
- Net Profit margin= Net Profit before tax * 100
This shows the success rate of managers in making profit from sales.
These were the performance ratios, now I know all of you would be cursing me for fitting so much in just one lecture but, before I end it, I would coclude the topic by mentioning the liquidity ratios. These ratios show the ability of a business to pay back its debts.
- Current ratio=Current Assets/current liabilities
- Acid Test ratio= (Current assets- stock)/ liabilities
Okay guys that’s it for today see you next time. Bye.