ROCE= Net profit
* 100
Average capital
Average Capital = opening capital = closing capital
Performance Ratios
Assesses the performance of the company and gives a prediction of how much it costs a company to make sales and how hard its assets are working with its credit controlling. For all these ratios the higher the percentage number, the more effective the company is operating.
- Stock turnover
- Debtors collection period
- Creditor days
- Asset turnover
Stock Turnover
This measure the number of times in one year a company turns of its stock up for sale. The ratio can also can be used to record the amount of days it takes a company to to hold its stock. This is the ratio:
Stock turnover = Cost of goods sold
Average stock
Average stock = Opening Stock + Closing Stock
2
Debtor’s collection period
This ratio is used to find out how long it I taking its customers to pay back the outstanding amount of money back to the company. An efficient company, means that its customers pay their outstanding amount within the time period, and if the length is increased then there will be implications put on the company. This is how the ratio is worked out:
Debtors collection period (days) = Debtors * 365
Sales
Creditor Days
This ratio is to determine how good other companies are at paying their suppliers on time. This is critical to decide whether or not to offer any credit, for how long and how much. This is how its worked out:
Creditor days = Creditors * 365
Purchases
Asset Turnover
This measures, how effective assets of the company are, in generating sales and how effective the sales staff are in generating sales.
Asset Turnover= Turnover
Sales
Solvency Ratios
This is used to investigate the stability of a company, by looking at its assets and liabilities. There are two main types of ratios which consider the stability of a company. These include:
- Current ratio
- Acid test ratio
Current ratio
The current ratio looks at the relationship of current assets and current liabilities, and the ratio examines the liquidity of the company. The ideal figure for the current ratio is between 1.5:1 or 2:1 a figure below the expected means that the company is experiencing problems to pay short term debts, and a figure above means that the company has too much money tied up in productivity. The ratio is calculated as such:
Current ratio= Current assets
Current liabilities
Current assets = working capital + current liabilities
Acid test ratio
The acid test ratio also measures the relationship between current assets and current liabilities; however, it subtracts stock from the calculation. The reason for this is that stock is the most illiquid current asset and is the hardest to turn into cash without a loss in its value. This is why stock is subtracted from the calculation to give further accurate information, of a company’s liquidity position. Moreover, the ideal figure ratio must be between 1 and 1.2.:1. If the figure is below, then it may experience problems in paying short term debts, and if the figure is greater then its not using its money effectively. The calculation for this ratio is:
Acid test = Current assets - stock
Current liabilities
Make Decisions
As you can see from above, the ratio analysis is very important in providing information of a company such as SPA Ltd. This is because the ratio analysis will give a precise indication of how a company or SPA Ltd may be generating profit, its liquid position, controlling credit and debit periods etc… The ratios used can give an overview of what a company may need to do to improve the efficiency. This is why it is important that accurate finance information is correct, as the financial figures will be used in all aspects to see how well a company is doing. In the case, if there is a wrong figure it may provide wrong evidence which may result in wrong decisions on the company.
Using the financial documents of a company or SPA Ltd, the documents will have to be assessed. This is undergone through a procedure where, checks are made through previous years to see if there is any improvement of the company or SPA Ltd. The financial information received will be cross referenced with all documents such as, profit and loss, balance sheets, cash flows and ratio analysis from past years. After checking the accuracy of the financial data, it will provide a solid outcome of the situation of the company or SPA Ltd, and what needs to be improved on. In addition, the documents of finance may be cross referenced with other competing company’s that have the same aspects and basis of SPA Ltd or any other company. The cross reference procedure will provide the stakeholders or managers and directors of SPA Ltd and overview of what needs improving and changing to increase the stability and chances of surviving in the market. Furthermore, it also shows why it is important to have accurate financial information, perform at high standards and keeping up with potential competition.
Furthermore, SPA Ltd or any other company must undergo to follow legal requirements, where importance of accurate financial records is vital in keeping stakeholders of the company informed. Every limited company whether public or private is required by law to produce financial statements which are available for the public to inspect if they so wish. The law which stated that these legal requirements must be fulfilled is the Company Act 1985. The financial statements required by the companies act are:
- Profit and loss account- mentioned above
- Balance sheet-mentioned above
- Directors report- the directors report mentions;
-Review of the activities of the company
-directors name and shareholdings
-proposed dividends
-policies and actions mad
They mainly responsible for preparing the accounts.
- This is basically where the auditor criticises and makes comments on the company’s accounts and questions whether or not the accounts are true or fair.
When producing these statements, SPA Ltd and other companies must follow the procedure of the accounting practise and financial reporting standards.
Under the legal requirements, it is stated that:
- Final accounts must be published which is publicised at companies house.
- Accounts must be produced to protect creditors and investors, who may not get their money back if the business fails.
- Accounts are produced for shareholders to see if the directors of the company are doing their job properly and not just wasting money.
- Accounts must be produced as it can have a great influence on the local community, to find jobs.
The consequences maybe if, the accounts are not correct are:
- Taxation is not paid appropriately where legal action may be taken by Inland Revenue or the government.
- Incorrect information may be provided to the shareholders which means a wrong prediction of the company position.
- Wrong invoices sent to a customer, which means an effect on the financial records and unsatisfied customers.
Moreover, the legal requirements of producing payrolls based on employees must be provided and given to the Inland Revenue for justifying how many people work at the company, and their wage rate must be included. Further as mentioned earliaer a quartile report must be submitted to custom’s and excise for VAT purposes, but where as if a business is small, it will have to produce only a yearly report. In addition following these procedure, SPA Ltd and other company’s will have to produce accurate financial data at the end of the year, to which it will be listed at the company’s house, where it will be made publicised.
For any company to survive it must make sure its business is running smoothly and efficiently. It must also consider, ways in which it may raise finance to keep its business competing in the market. This process is where company’s such as SPA Ltd will try to raise finance through different procedures. These will include:
- Trying to get new shareholders to try and invest their money into the business to increase its value and efficiency.
- Try to get loans, mortgages and overdrafts off the bank by presenting positive results of the company.
- Maybe trying to attract a variety of sponsors, to help them be sponsored and well known, to increase sales of the company.
These are few of many ways a company such as SPA Ltd may well try to raise finance to increase the potential of the business and the efficiency to get more revenue.
E5/A2
This is where I will be analysing and evaluating the different types of business formats that are operated in the market today. There are four main types of businesses which are situated, and they are all different from each other, of how they operate and there finance is carried out. These include:
- Sole trader business
- Partnership business
- Limited companies
-Private limited
-Public limited.
Sole traders
A sole trader mainly consists of one person who runs the business overall. This is usually the area where a small amount of finance is dealt and operated. Sole traders often employ waged employees but alone will have to provide all the finance, and will have to carry all the risk involved in the business venture. In return sole traders have all the control of the business and enjoy all the yearly profits obtained.
The legal structure of a sole trader is that it faces unlimited liability for the debts which may be incurred, and this is referred to an unincorporated- this means that there is no legal difference between the business and the owner.
To open a business as a sole trader it is necessary that finance is provided through savings and bank loans which are taken out.
The financial statements which are used by a sole trader business is the basic of:
- T-accounts
- Trial balance
- Profit and loss
- Balance sheet
- Cash flows
Finally as an unincorporated business, the owner/sole proprietor is seen legally as inseparable from the business, and this can not limit their liability in respect of debts of the business. The nature of the sole trader provides therefore certain advantages and disadvantages which are listed:
Partnership Business organisation
Many partnership businesses are set up from a sole trader business, where it has expanded to become involved with an association of individuals with a variety of skills. This mainly consists of about 2-20 people, and many partnership businesses are often in the related sector of solicitors, accountants, surveyors etc…
Each member of the partnership is responsible for the debts of the business and therefore critical decisions are needed when drawing up agreement on the responsibilities and rights of each partner. Many partnerships face a unlimited liability for their debts, but the exceptions are that limited partnerships, that may wish to raise additional finance, but does not wish to take any new active partners. To overcome this problem, the partnership may tale on sleeping partners where they provide investments into the business, but do not have any role of the operations of the business. The sleeping partners face unlimited liability for the debts of the business and it may also be considered like a sole trader where it is an unincorporated business. Moreover, it may be in the interest of partners to draw up an agreement of how the partnership will operate, and what roles and responsibilities each partner shall take on, this agreement is referred to as a Deed of Partnerships. The Partnership Agreement or Deed of Partnership covers the following:
- Division of profit and losses
- Partners salaries
- Interest allowed on capital
- Interest charged on drawings
The above elements of the agreement determine how the profit and losses of the partnership are appropriated. When the final accounts of a partnership are drafted and the net profit from the trading has been determined, then an appropriation account is prepared. The final accounts of a partnership are similar of those of a sole trader, except that there is more then one owner. There are additional sections which need to be covered; these include profits and ownership of capital.
Final accounts include:
- An appropriation account: final section of profit and loss account showing how profits are divided.
- A capital account: this is not changed by profits or drawings, but is fixed showing the original capital invested.
- A current account for each partner on the balance sheet: this shows the profits, to which each partner is entitled and any drawings taken.
Here are the layouts of the accounts, which will be included on the balance sheet:
Partners Capital Account
X Y X Y
£ £
1 Jan Cash 5,000 10,000
Appropriation account
31 Dec share of profit 31 Dec net profit b/d 10,000
Current account
X 5,000
Y 5,000
10,000 10,000
Partners’ Current Accounts
X£ Y£ X£ Y£
1 Dec Drawings 3,000 4,000 31 Dec share profit 5,000 5,000
Balance c/d 2,000 1,000
5,000 5,000
5,000 5,000
1 Jan Balance c/d 2,000 1,000
As for other business organisations, there are many advantages and disadvantages to them. For partnership accounts, these include:
Advantages
- Additional skills- anew partner may have abilities which the sole trader does not possess. These can help to strengthen the business, perhaps allowing new product or services to be offered, or improving the quality of existing condition.
- More capital- a number of people together can inject more finance into the business than one person alone.
- Expansion- with the new skills, increased labour and greater capital a partner brings. The business will have an increased potential for future growth.
Disadvantage:
- Sharing profit- the financial benefits derived from running the business will have to be divided up between the partners according to the partnership agreement made on formation. This can easily lead to disagreement about fair distribution of work loads and profits.
- Loads of control- multiple ownership means that no individual can force an action on the business decision making, but must be shared.
- Unlimited liability- it is one thing to be unlimitedly liable for your own mistakes (sole trader) far more worrying, surely to have unlimited liability for mistakes of your partners. This problem hit many investors in the Lloyds insurance market in the 1990’s. Certain partnerships lost millions of pounds from huge insurance claims. Some investors lost their life savings.
Differences
As you can see from the two types of business organisations and sole traders and partnership organisations, there is a big difference of the way the companies are set up and financed. For a sole trader it is specifically a single venture, where as a partnership firm may include up to as 20 people who own the company. As you can see this contradicts that a partnership will be made up of people with a variety of skills, where a sole trader will only include one person with the responsibility of carrying out all the tasks. The investment of a sole trader and the capital generated is up to the single person alone to provide the finance and the start up costs of the business, whereas on the other hand an investment from all the partners involved with the partnership will invest a small amount which is needed. Moreover, in a sole trader business, it is considered the decision of the single person on how the business operates and runs, and for the partnership it is up to all the partners of the business to decide of how to run it efficiently. This coincides with the agreement of the partnership of deeds which must be signed by all partners when starting the business, so that agreements can be made from the partners. Both the sole trader and the partnership organisation all incur unlimited liability, which means they are responsible for there debts. To conclude, the final accounts produced by sole traders are of basic form, where profit and loss and balance sheet are included. In the case of partnership business, additional accounts must be prepared; these include the appropriation, capital, current accounts to sufficiently fulfil the balance of partners’ incomes.
Limited companies
All limited companies are incorporated, which means they can sue or own assets in their own right. There owners are not personally liable for the firm’s debts which are limited liability. The ownership of a limited company is divided into equal parts called shares. Whoever owns one or more of these is called a share holder. A public
Limited Company (PLC) can sell its shares on the Stock Market, while a Private
Limited Company (LTD) cannot. Unlike a sole trader or a partnership, the owners of a Limited Company are not involved in the running of the business, unless they have been elected to the Board of Directors.
To become a limited company, applicants have to submit a Memorandum of Association, which states the business’ name, address and main purpose. I also describe the liability and amount of capital invested. The internal workings of the company including the number of directors, how they are elected and what there roles are described in the Articles. This also decides how profits will be divided.
When the Memorandum of Association has been submitted the Registrar of Companies issues a Certificate of Incorparation which allows a limited company to begin trading. A public Limited Company first has to raise the sufficient capital, through selling its shares to the public. It has to produce a prospectus, which explains how the business is run and what it intends to do in the future. Once all this has been done, the registrar includes a Trading Certificate, which allows newly formed PLC to start trading.
Public and Private limited Companies
Both types of company must audit their accounts, and have them available for inspection. They must indicate their status in their name, usually by using their abbreviation PLC or LTD. This warns their traders that their liability is limited and that debts cannot be recovered from the personal funds of the company shareholders.
Private Limited Companies
Public Limited Companies
By law, for limited companies it is required by the private and public sector of companies to keep records. A limited company is legally required to:
- Keep statutory books
- Prepare annual accounts
- Complete an annual return
Statutory Books
The statutory books, a company must keep are registers of:
Members
Contents- details of shareholders showing name, address, date of ownership of shares, number and type of shares held. On total disposal of a person’s shareholding the entry would be closed off by inserting the date he ceased to be a member.
Directors and Secretary
Contents- personal details (name and address, nationality, details of other directorship.)
Debenture holders
Contents- details of debenture holders showing name, address and amount of holding.
Mortgages and charges
Contents- details of charges on the companies assets. Certain creditors of the company will have advanced money to the company. One condition of such loans is often some security being given by the company.
Statutory accounts
At least once in every year the directors must arrange before the company in general meeting a profit and loss account and balance sheet made up to a date within seven days of an accounting reference date. This must be done not more than seven or ten months (for public and private limited companies respectively.) for the end of the accounting period which ended on the relevant accounting date. The interval may be extended by three months is the company gives notice to the registrar that it caries on the business or has interest abroad. Within the same time limits all companies (other then exempt unlimited companies) must deliver the copies of the accounts to the registrar.
Members, debenture holders and auditors are to receive a copy twenty-one days before the general meeting.
Annual return
A company is required to deliver to the registrar of companies once a year the annual return. The return should be delivered within 28 days of a return date.
If the company has a share capital its return contains the following information:
- The address of the registered office and, if the register of members or the register of debenture holders is not kept at that office, the address (e.g. of a professional registrar) at which it is kept.
- A summary of authorised and issued share capital which consideration received for issued shares and other details.
- A list of members (made up to the return date) showing individual shareholdings and changed which occurred during the year. However, to avoid the annual submission of a lengthy list, companies may submit a full list once every three years and particular of changes in the intermediate years.
- Particulars of directors and secretary taken from registrar. The annual return must be signed by one directors and the secretary.
In addition it is required be the limited companies to produce a deduction of corporation tax, proposed dividends and share capitals at the end of the year balance sheet.
Balance Sheet as at 31 December £
Net assets 454,600
Creditors:
Corporation tax (70,000)
Proposed Dividends (9,900)
Called up share capital 75,000
This is the end requirement to a balance sheet which a limited company must ensure they have. This shows how much corporation tax, dividends need to be subtracted from the sales and much the price of share capital is at.
E6
Nowadays in the year 2004, there are many companies that need to deal with their accounts and financial situation of the business. The process for preparing the accounting system for the business in a manual step which is a long and time consuming process, where skilled accountants are required. However, these days many companies are trying to lay down the manual approach and go into the computerised system to work out the accounts and finance of the business.
I think that many companies are taking steps to computerise their accounting system because, we are now in the millennium which means everything is based around computers, and companies will have to keep up with time and technology. Since we are in the increase of technology and time, there are many advantages and disadvantages which come along the process of using computerised systems. These include:
Advantages:
- Computerised system of accounting is much quicker at producing outcomes which means that results can be presented at any time to see the financial position a business. Moreover, it will save man hours as there is no need for employing an accountant to wok out the finances and position.
- The system of computerised accounts is much more accurate without mistakes, and leads to accurate information presented to stakeholders.
- Unlike the manual system, it may be inevitable that mistakes may be spotted. However, in this case of computer accounting, mistakes are clearly shown by the computer and it can be dealt with.
- The computer system is much more reliable as it will produce the right result all the time, unless an error is made by the person inputting the information.
- Unlike the manual system, there is much paperwork involved and a storage place must be kept. In this case the files of the accounts may be saved on the computer, or a back up is made and kept. This process will mean that there is no need to have lots of storage space.
- With this process there is regular updates of accounts that can be made at any time.
- The computerised system will also allow you to produce a well presented report.
- The reports and documents are easily accessible.
- Alterations can be made at any time if necessary.
These are many of the advantages of using a computerised system to work out the accounts of a business. As you can see there is many advantages, which suggests that the process of using software packages is more reliable then the manual process of accounting. It has completely revolutionised the way accounting works. It has made businesses and companies change there approach and has made the business more efficient and accurate. However, there are many disadvantages to using computerised systems to work out accounts. These include:
Disadvantages:
- Unlike the manual system, the process of using computer systems is that it is very costly. On its own, the cheapest range software packages reaches around £1,400, and not only the package price you have to be aware of there is the running of the computer running time.
- Moreover, if the software is used then there will have to and additional staff training program which will have to undergone. This is because if there is no one that knows how to use the program then there will be mistakes in the process.
- In addition, there is the chance of loosing critical information. This can occur when the computer freezes, which means that the entire or some data will be lost. Also there is the chance that computer viruses may arise and ruin the system which means that the initial data will be lost. Moreover, there is a chance of computer hackers getting into the system and altering the accounts or copying the system for other uses.
A1
Accounting Concepts
Accounting concepts are of which an aid, which may be relevant when final accounts are produced to provide relevant and reliable information to be comparable and understandable to the reader. There are many accounting concepts which help to make the information more reliable and understandable; this can be put into a diagram:
Business Entity
This refers to the fact that the financial accounting information relates on to the activities of the business and not the activities of the owner. In the basic terms it provides information of the records and reports of one particular business and do not include personal assets and liabilities.
Materiality
The concept of materiality states that accountants should not include such low value items, which is not worth recording them separately. This is because these items are not material and misleading. These include;
- Small expense items grouped as sundry expenses
- Small end of year stocks of office stationary not valued for the purpose of final accounts.
- Low cost fixed assets being charged as expense in the profit and loss account.
Going Concern
This presumes that the business to which accounts relate will continue to trade in the foreseeable future. E.g. there should be no purpose of trying to reduce the size of the business or to liquidate it. However, if the business is not a going concern, its assets could be worth less and the balance sheet will be affected considerably.
For example financial statements are drawn up on the assumption that there is no intention of the business liquidating.
The reasons for which going concern should not be justified is where;
- Business is likely to liquidate
- Where there is a possibility that the business will fall into liquidation.
- Where there is a possibility that the business will fall short of finance, which will have an affect on the business.
Accruals and matching concept
The accruals or matching concept states that costs and revenues should be matched one with the other and dealt with in the accounting period to which they relate.
The accruals state that revenue should be recognised when it is earned and not when the money is received.
The matching concept states, that in calculating the profit the revenue should be matched against the expenditure incurred in earning it.
For example in Jane trading profit and loss and balance sheet it should be considered that closing stock, accruals and pre-payments should be accounted whilst adjustments are made to the final accounts.
Closing stock
At the end of the financial year a business must stock take, where all the stock is valued at cost price. However, the value of the stock may vary during the year. At the end of the year it is normally that, the cost price which is considered is the FIFO (first in first out) this is where the oldest stock is issued first, so that at the end of the year the stock will be reflected at the most recent cost prices.
Accruals
This is an amount due in the accounting period which is unpaid at the end of that year.
In the final accounts an accrued expense is:
- Added to the expense, shown in the Trial balance, before listing it in the profit and loss. E.g. this shown in the trial balance for Jane where it is listed in the trial balance it is listed. Before inputting the expense I have added the accrued expense.
- This is shown as an accrual in the balance sheet in the current liabilities, at the section of year end. On the balance sheet for Jane it shows this as accruals at the current liabilities.
Pre-payments
This is where a payment is made in advance of the accounting period to which it relates.
This is therefore the opposite of an accrual. In the final accounts, a prepaid expense is:
- Deducted from the expense, in the trial balance before it is inputted in the profit and loss. E.g. in Jane pre-payments are deducted from the expense amount, which is then listed in the current assets of the profit and loss.
- This is shown at the year end balance sheet under current assets.
Prudence
This requires that final accounts should always, when there is any doubt report a conservative figure for profit or the valuation of assets. To this end, profits are not to be anticipated and should only be recognised when they are reliably measured.
For example in the prudence concept, this is where the liability has been estimated between £500 to £600, the accountant will take the highest estimate on the grounds of prudence.
The areas which cover the prudence concept is depreciation and the treatment of bad debts.
Depreciation
To provide a more accurate view of the financial state of the business, the depreciation is recorded as follows in the final accounts:
- The amount of depreciation over the years is recorded as an expense in the profit and loss, to reduce the net profit.
- The fixed asset value in the balance sheet is reduced to reflect of the amount depreciated since assets were bought.
Treatment of bad debt
This is where invoices, statements, letters has been given to the debtor to pay. If this is a small amount then there is point. If all means fail then this is called a bad debt. The way to remove debts from the business is:
- This should be put into the expense in the profit and loss as a bad debt.
- Then a deduction should be made from debtors in the balance sheet.
Consistency
This requires that, when a business adopts particular accounting methods, it should normally continue to use such methods consistently. Changes can be made for any good reason for doing so, and a note or explanation included in the financial statements.
For example in the case of a depreciation of a fixed asset, there is more then one method it is conducted. Under the consistency concept, it is essential for a business to choose which method to approach and stay with this idea. If there is any changes then there should be notes applied.
Other accounting concepts:
Money measurement
All items are expressed in common denominator of money, only by using money can items be added together to give profit and loss or balance sheet.
Historical costs
Assets and liabilities recorded in final accounts at historical costs.
Dual aspects
Each accounting business transactions are recorded by means of two opposite accounting entries, e.g. debit and credit but equal values.
Realisation
Business transactions are recorded in the final accounts at the same time as payment is made.
Objectivity
The presentation of final accounts should be objective rather then subjective. This should not be influenced by the owner’s expectations.
It is the same in the case for legal requirements of financial accounts statements procedure. For each step it needs to be considered by each person in the diagram, that an accurate set of data is represented and this checked. The final amendments and procedure of final accounts is undergone by the directors of the business where, then external auditors examine the financial statements and provide an image of the companies performance and position.
Business companies must undergo to follow legal requirements, where importance of accurate financial records is vital in keeping stakeholders of the company informed. Every limited company whether public or private is required by law to produce financial statements which are available for the public to inspect if they so wish. The law which stated that these legal requirements must be fulfilled is the Company Act 1985. The financial statements required by the companies act are:
- Profit and loss account
- Balance sheet
- Directors report- the directors report mentions;
-Review of the activities of the company
-directors name and shareholdings
-proposed dividends
-policies and actions mad
-They are mainly responsible for preparing the accounts.
- This is basically where the auditor criticises and makes comments on the company’s accounts and questions whether or not the accounts are true or fair.
When producing these final statements, business companies must follow the procedure of the accounting practise and financial reporting standards.
Under the legal requirements, it is stated that:
- Final accounts must be published which is publicised at companies house.
- Accounts must be produced to protect creditors and investors, who may not get their money back if the business fails.
- Accounts are produced for shareholders to see if the directors of the company are doing their job properly and not just wasting money.
- Accounts must be produced as it can have a great influence on the local community, to find jobs.