Unit 5 - Introduction to Financial Statements
5.1 Sole trader
Sole trader - a business owned and operated by one person.
Advantages
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Profits are not shared.
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Easy to establish and manage.
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Decision making is speedy.
Disadvantages
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Difficult to raise capital.
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Owner bears all the responsibility.
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Unlimited liability.
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Importance of preparing income statements and statements of financial position:
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Helps decision making.
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Used to compare performance of business from previous years.
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Trading business - Sells tangible goods. E.g. grocery store, furniture store.
Service business - Sells intangible goods. E.g. cleaning, event planning.
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Income statement & Statement of financial position:
5.2 Partnership
Partnership - a business owned by two or more people to make profits.
Advantages
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More capital and resources available.
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Easy to establish and manage.
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More skills, knowledge.
Disadvantages
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Unlimited liability.
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Must share profits.
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Responsibilities are shared.
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Importance of appropriation account:
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Shows how net profit is distributed between partners.​
Current account - To show the value of investment they currently have in the business.
Capital account - To show the main investment they have in the business.
5.3 Limited companies
Limited company - a legal entity which has a separate identity from its shareholders, whose liability for the company’s debts is limited.
Types:
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Public limited company - may offer its shares to the public.
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Private limited company - not allowed to offer its shares to the public.
Advantages
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Limited liabilities
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Easier to raise capital
Disadvantages
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Expensive to set up, many legal formalities
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Profit is shared
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Accounts must be made
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Limited liabilities - you can only risk what you’ve invested into the business.
Equity - the total amount of money invested in the company by shareholders.
The capital structure of a limited company consists of: Preference share capital, Ordinary share capital, General reserve & Retained earnings.
Issued share capital: The amount of capital issued to shareholders.
Called-up share capital: Part of the issued share capital, where the company asks for payment from shareholders.
Paid-up share capital: Part of the called-up share capital, where payment has been received.
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Share Capital
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Preference shares -
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Enable the shareholders of a company to get dividends before the equity shareholders. No voting rights.
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Ordinary shares - Total funds provided by shareholders. Have voting rights.
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Loan capital
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Debentures - Long term loan, with fixed rate of interest. No voting rights.
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Statement of changes in equity:
5.4 Clubs & societies
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Ensures profit is not overstated in the year.
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Prudence principle​​
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Receipts and payments accounts
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Shows money received and paid.
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Shows the balances of cash/bank.
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No adjustments.
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Income and expenditure accounts
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Shows income and expenses.
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Shows the surplus/deficit.
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Includes adjustments (accrual, prepaid)
5.5 Manufacturing account
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Direct costs - Expenses that directly go into producing goods or providing services.
Indirect costs - General business expenses that keep you operating.
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Direct material - Resources used to make a product.
Direct labour - People whose labour is directly producing the output.
Prime cost - Costs that are directly related to the purchases and handling of goods. It changes as the amount of goods produced changes.
Factory overheads - Expenses to produce the company’s product.​​
5.6 Incomplete records
Statement of affair - summary of the financial position of a business on a certain date.
Disadvantages of not maintaining a full set of accounting records:
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Trial balance cannot be made.
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Difficult to compare with previous years.
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DIfficult for decision making.
Profit = Closing capital – Opening capital + Drawings – Capital Introduced
Measuring gross profit as a percentage:
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Mark-up = Gross profit ÷ cost of sales x 100
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Margin = Gross profit ÷ sales x 100
