Final Accounts (Junior Cert Business Studies): Revision Notes

Analysis of Final Accounts

Introduction - how businesses use final accounts

When a business completes its final accounts, these documents become powerful tools for understanding the company's financial health. The information contained within these accounts allows businesses to assess several key areas of their performance.

Final accounts help businesses understand:

• How their performance has changed compared to previous years (is profit growing or declining?)
• How they compare to their competitors in the same industry
• Whether they are operating efficiently and where improvements could be made

This financial information becomes the foundation for making crucial business decisions. For example, understanding profit levels helps owners decide how much money to keep in the business versus how much to distribute as dividends to shareholders.

Stakeholders and their interests

The financial position shown in final accounts matters to many different groups of people connected to the business.

Shareholders have a direct financial interest since they receive dividends from any profits made. They want to see strong, consistent performance.

Employees care about the business's success for job security. When a company performs well, workers feel more secure and may receive profit-sharing bonuses.

Suppliers need assurance that the business can pay its debts, especially when providing goods on credit terms.

Government agencies monitor performance to ensure correct tax payments are made.

Financial institutions like banks use this information when considering loan applications, as lending decisions depend on a business's financial strength.

Local communities benefit when businesses in their area perform well through increased employment opportunities, local investment, and community sponsorship.

Financial analysis techniques

Businesses can use several calculation methods to analyse their final accounts and gain deeper insights into their performance:

Rate of stock turnover

This calculation requires first determining the average stock level throughout the year. This is calculated by adding the opening stock value to the closing stock value, then dividing by two.

The stock turnover rate uses this formula:

$\text{Stock turnover} = \frac{\text{Cost of sales}}{\text{Average stock held}}$

Different types of businesses will have varying stock turnover rates. For example, a fresh produce supplier like Fyffes would have much higher stock turnover than a luxury car dealership, since fruit must be sold quickly while cars can remain on the forecourt for months.

Profitability analysis

Three key profitability ratios help assess different aspects of business performance:

Gross profit percentage measures the profit margin on sales before considering operating expenses:

$\text{Gross profit \%} = \frac{\text{Gross profit}}{\text{Sales}} \times 100$

Net profit percentage shows the final profit margin after all expenses:

$\text{Net profit \%} = \frac{\text{Net profit}}{\text{Sales}} \times 100$

Return on capital employed (ROCE) demonstrates how effectively the business uses invested capital to generate profits:

$\text{ROCE \%} = \frac{\text{Net profit}}{\text{Capital employed}} \times 100$

Liquidity assessment

Maintaining good liquidity protects a business's credit reputation and prevents cash flow problems. Two ratios help assess liquidity:

Working capital (current) ratio compares current assets to current liabilities:

$\text{Working capital ratio} = \text{Current assets} : \text{Current liabilities}$

The ideal working capital ratio is 2:1, meaning the business has twice as much in current assets as it owes in current liabilities. When current liabilities exceed current assets, the business faces liquidity problems and may struggle with overtrading.

Acid test (quick) ratio provides a stricter liquidity test by excluding stock from current assets:

$\text{Acid test ratio} = (\text{Current assets} - \text{Closing stock}) : \text{Current liabilities}$

This ratio tests whether a business can pay current debts without having to sell stock first. The ideal acid test ratio is 1:1.

Solvency evaluation

$\text{Solvency} = \text{Total assets} : \text{External liabilities}$

A business remains solvent when its total assets exceed its external liabilities. If external liabilities become greater than total assets, the business faces insolvency and potential bankruptcy.

Gearing analysis

$\text{Gearing} = \text{Debt capital} : \text{Equity capital}$

Debt capital represents long-term borrowing from financial institutions that must be repaid with interest. Equity capital comes from share capital and retained profits.

High gearing means heavy reliance on borrowed money, which increases financial risk due to interest obligations. Low gearing indicates financing primarily through equity, which is generally safer but may limit growth opportunities.

Low-geared businesses often attract investors more easily since they carry less debt risk and offer potentially higher returns.

Limitations of financial analysis

While final accounts provide valuable insights, they have several important limitations that businesses must consider:

For example, an Irish restaurant might show excellent financial results on paper but be facing serious staff shortages or negative online reviews that could significantly impact future performance.