Accounting - Business Revision Notes

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Accounting 4

The Profit and Loss Account 4

Typical Profit and Loss Account 4

What is the Importance of the Profit and Loss Account? 4

The Balance Sheet 5

Typical Balance Sheet 5

Assets 5

Liabilities 5

What is the Importance of the Balance Sheet? 6

Ratio Analysis 6

Profitability Ratios 6

Liquidity Ratios 8

Overtrading 9

Causes 9

How to Prevent Overtrading 9

Gearing 9

Debt/ Equity Ratio 9

Limitations of Ratio Analysis 10


The Profit and Loss Account

  • The profit and loss account calculates how much profit or loss a business makes in a year. The net profit of a company is its gross profit (money made) minus expenses.

Typical Profit and Loss Account

Sales 90,000

  • Cost of Sales 30,000

Gross Profit 60,000

  • Expenses 40,000

(heat, wages etc)

Net Profit 20,000

What is the Importance of the Profit and Loss Account?

  • Decision Making: the size of the net profit can help the manager decide if the business can afford to give out a dividend to its shareholders. It can also indicate if the business will have to borrow and how much if it wishes to expand.
  • Costs may be too high: if the business has a low gross profit this could indicate to the manager that the business may be paying too much for raw supplies. The manager can then look for a cheaper supplier.
  • Incorrect Pricing: a low gross profit can also indicate the business needs to start charging more for its product. This would lead to an increase in profits if the quality of the product matches its price.
  • Expenses may be too high: a low net profit can indicate that the business’s expenses are too high. The manager can then plan where cutbacks to expenses can be made to increase profits.

The Balance Sheet

  • The purpose of the Balance Sheet is to provide the financial position of the business. It shows the value of assets and l...

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