A report on the need for accounting within business and why it exists

1. Unit 2 Assignment 4
Lewis Appleton 1 Mr McColgan
Freedom Fashion Ltd
Trading, Profit and Loss Account for year ended 30 April 2010
£ £
Sales 411,529
Less Cost of Sales
Opening Stock 34,993
Purchases 128,129
Less Closing Stock 21,445
Cost of Sales 141,672
Gross Profit 269,852
Less Expenses
Expenses
Rent and Business Rates 37,554
Wages and Salaries 96,221
Telephone and Postage 1,359
Distribution 31,593
Advertising 15,579
Miscellaneous 28,452
Depreciation 17,848
Total Expenses 228,696
Revenue Income 0
Net Profit before tax 41,246

2. Unit 2 Assignment 4
Lewis Appleton 2 Mr McColgan
Balance Sheet for Freedom Fashion Ltd as at 30 April 2010
Cost
Accumulated
Depreciation
NBV
£ £ £
Fixed Assets 218,000 28,800 189,120
Premises 38,500 15,800 22,700
Fixtures and Fittings 19,500 19,500 0
Vehicles
Current Assets
Stock 34,294
Debtors 21,455
Cash at bank 0
Cash in hand 381
56,130
Current Liabilities
Creditors 17,881
Overdraft 12,389
30,270
Working Capital 25,860
Less Long Term Liabilities
Bank Loans 50,998
Net Assets 186,682
FINANCED BY:
Capital 60,000
Retained Profit 126,682
Capital Employed 186,682

3. Unit 2 Assignment 4
Lewis Appleton 3 Mr McColgan
Purpose of accounting
Businesses need to use accounting to get good statistics on their profits and losses that they have. The accounts are
used to record sales, costs and the profit that the business has acquired over a period of time which is usually a
year. Using accounts businesses are able to evaluate their line of management internally and the accounts can be
used by investors and creditors externally. The business can decide whether to offer trade credit from evaluating
their accounts.
Tradingaccount
Components
Trading accounts are used by businesses to find out the trading reports on their business. There are four main
components of this account. There is the sales opening stock, which is what the business has worth of stock to try
and sell over the annual.The second component of the trading accounts reports is purchases, which is the amount
spent on the maintenance of the business. The third component of the account is the closing stock, which is the
value of the stock they have remaining at the end of the financial year. The final component of the account is the
cost of goods sold, which is defined as the actual value of the stock that was sold over the year to generate sales.
How cost of goods sold are calculated
The cost of the goods sold is calculated using the opening stock, the purchases and the closing stock. The way it is
calculated is that the opening stock value is added to the value of purchases made by the business. Then the closing
stock value is taken away from the sum of these two components. To shorten the calculation;
Opening stock + Purchases - Closing stock = Cost of goods sold
Gross profit
The gross profit is calculated using the sales and the cost of goods sold. The sales are calculated from how much
they have made from selling their products and services to the customers. The sales that they have made are

4. Unit 2 Assignment 4
Lewis Appleton 4 Mr McColgan
recorded as a value then the cost of the goods sold is taken away from this to see how much profit they have made
with the products being originally bought to the price sold for. This is called the gross profit. Gross profit in simple
terms is the surplus that is calculated from the sales costs being deducted from the sales amount.
Profitand Loss Account
Expenses
Some expenses that businesses may have to pay out can include taxes and rent at higher priorities then after that
they will move on to pay out the costs for their insurance and machinery. They will also need to pay out money to
their employees.
Net profit before tax
In a profit and loss account the expenses are subtracted from the gross profit which then adds up to make the net
profit before taxation. The expenses is everything the business has had to pay out for over the years, this includes
rent, wages, bills, advertising space, distribution of their business awareness. The total expenses are taken away
from the gross profit, which is the cost of the sales taken away from the sales amount. This then adds up to the net
profit before tax, this is the overall profit they have made before the taxes have been applied.
BalanceSheet
Purpose
A balance sheet is a frozen evaluation of the businesses net worth and usually is carried out towards the end of the
financial year. It has to summarise the assets that the business owns and also what it may owe in terms of
liabilities, to summarise a balance sheet it is an evaluation that reveals what the business is really worth. The
standard business balance sheet has three main components which are assets, liabilities and ownership.
Format
Balance sheets can be formatted either vertically or horizontally, businesses can decide how they want to present it
based on what they are showing. The most common format is to present a balance sheet vertically. The first half of
a balance sheet is the calculation of what a business owns and what it owes. The second half of the sheet queries
how it is financed which shows the capital employed. This is the total amount tied in businesses from profits they
have retained and investments.

5. Unit 2 Assignment 4
Lewis Appleton 5 Mr McColgan
Fixed assets
Fixed assets are those that are owned by the business and are highly unlikely to be sold for at least a year. These
can include the all the required items to run the business such as vehicles and buildings. Reducing the amount of
assets each year can be used to find the depreciation. The historic cost minus the residual value then divided by the
live expectancy finds out the yearly depreciation. The historic cost is the purchase cost, the residual value is the
resale value and the expected life is how long the asset is expected to be used within the business.
Current assets
Current assets are those owned by the business which can be sold off at any moment. The value is also variable as it
can change regularly. These types of assets can include the stock, debtors, and cash in the bank and cash in hand.
The stock is the value of all of their products held at one time. The debtors are the people that owe money to the
business. The current assets are evaluated according to how easy it can be to change them into cash; these ways
will be prioritised and will be done when the business is having money problems.
Current liabilities
Current liabilities are those that the business actually owes such as overdrafts and creditors. These should be paid
back within a year so that the business does not get bad recognition and neither does it go into a debt spiral.
Working capital
Working capital is very important to businesses because it is a representation of the likelihood of the business
paying back short term debts on time. A business needs to have enough current assets to cancel out the costs of the
current liabilities; if they do not have enough then it can be disastrous for the business. Therefore a business may
have to result to selling a fixed asset to pay off their liabilities. Working capital is current assets minus current
liabilities.
Net assets
Net assets are what represent the value of everything the business owns against the value of the liabilities it has.
Therefore the calculation for this is; (fixed assets + current assets) – (current liabilities + long term liabilities).

6. Unit 2 Assignment 4
Lewis Appleton 6 Mr McColgan
Financed by
The last section of the balance sheet works out the capital employed and it does this by adding the capital and the
retained profit. For the balance sheet to be balanced then it means that the net assets are equal to the capital
employed.
Ratios
Ratios allow accounts to be analysed and they can be compared within and outside the business; inter-firm and
intra-firm.
Solvency ratios
Current ratio
This ratio is calculated as current assets / current liabilities
This ratio when calculated shows the amount of assets against the amount of liabilities. For example if a business
had £2 worth of assets for every £1 worth of liabilities then the ratio would be 2:1 and the ratio will be accepted as
the business is not in any danger. If the business had more worth of liabilities than assets then it can put the
business in jeopardy.
Acid test ratio
This ratio is calculated as (current assets – stock) / current liabilities
This is similar to the current ratio as it still shows the relation between current assets and current liabilities but in
contrast this ratio does not include the prices of stock. The reasoning for this is that the hardest asset to quickly
turn into cash is stock because there may not always be a high demand for the supplies.
Profitability ratios
Gross profit percentage
This ratio is calculated as (gross profit / sales turnover) x 100

7. Unit 2 Assignment 4
Lewis Appleton 7 Mr McColgan
This ratio is calculated in order to find out the percentage of sales turnover. It shows that for every certain amount
made in sales the remaining value left as gross profit. For example if a supplier sold a shop a certain product for
25p and the shop went on to sell it for £1 they have made a gross profit of 75p. This would mean that the gross
profit percentage is 75%.
Net profit percentage of sales
This ratio is calculated as (net profit / sales turnover) x 100
This ratio is calculated to find the net profit as a percentage of the sales that they have made. This shows how
much is left over when sales are made after all of the expenses have been taken into account. Once again this ratio
is measured by every £1. A net profit percentage of 50% means that every £1 of sales made results in 50p being left
as net profit. Businesses try to keep this high so that they do not have to reduce their expenses, although before
any actions can be taken the accountant(s) must find the cause of the negative growth.
Return on Capital Employed
This ratio is calculated as (net profit before interest and tax / capital employed) x 100
This ratio is calculated to show the return that a business gets from its capital that is used to generate the return
they have received. The way this is measured is that for every £1 invested the percentage of what is being
generated in profit is shown. A percentage of 10% means that every £1 invested is going to generate 10p.This ratio
can also be compared by businesses with the interest rates that banks offer and from this they can see if they are
making the better choice or whether storing the money within a bank will generate more revenue.
Determiningperformance
Debtors’ payment period
This ratio is calculated as (debtors / credit sales) x 365
This ratio is calculated to show the average amount of time it is going to take for the debtors to pay and this is
measured in days. Businesses may have different payment periods such as 60 days which means it will take around
two months for goods or services to be purchased on credit from the debtors. This period will be decreased by
businesses that are having problems with cash flow. Businesses can also offer different payment terms.
Rate ofstock turnover
This ratio is calculated as (average stock / cost of goods sold) x 365

8. Unit 2 Assignment 4
Lewis Appleton 8 Mr McColgan
The average stock is calculated as (opening stock + closing stock) / 2
This ratio is calculated to show the average period of time that an item is stored within a business and is measured
by a value of days. For example if a business has a stock turnover of 10 then it means that on average each item is
stored within the business for 10 days. The nature of the business is what affects this ratio as well as the
supply/demand.

9. Unit 2 Assignment 4
Lewis Appleton 9 Mr McColgan
Ratio Working Out Answer What it shows
Current Ratio
CurrentAssets
CurrentLiabilities
11,438
17,731
0.6450848795894196604
8164232135807
0.65:1 For every £0.65 of
currentassetsthe
businesshas£1 of
currentliabilities.
Acid Test Ratio
CurrentAssets – Stock
CurrentLiabilities
11,438 – 3,162
17,731
0.4667531442107044159
9458575376459
0.47:1 For every £0.47 of
currentassetsthe
businesshasthey
have£1 of liabilities.
GrossProfit Percentage
Gross profit
Sales Turnover x 100
8.3044755543155372470
499417373751
5,060
60,931 x 100 =
8.3% For every £1 of sales
made£0.08.3 is left as
grossprofit.
Net Profit Percentage
Net Profit
Turnover x 100
6.2546158769755953455
548078974578
3,811
60,931 x 100
6.25% For every £1 madein
sales thereis 6.25p
left as netprofit.
Return OnCapital Employed
Net Profitbeforeinterest and tax
Capital Employed x100
8.7935323383084577114
427860696517
3,535
402
8.8 For every £1 used
within thebusiness
there is a return of
8.8p.
Debtor CollectionPeriod
Debtors
Credit Sales x 365
1653.6992221261884183
232497839239
10,484
2,314 x 365
1653.7 This meansthatthe
averageamountof
time it takesdebtors
1653 daysto pay for
the purchases.
Asset Turnover
Sales
2.0978859661203690951
659551026029
60,931
2 The averagetime it
takesthe businessto
sell its stockis 2 days.

10. Unit 2 Assignment 4
Lewis Appleton 10 Mr McColgan
Total Assets 35,337 + 11,438 – 17,731