Users of Accounts (Cambridge International IGCSE Business)

Internal users of accounts

Spec point — "e.g. owners (sole traders, partnerships, shareholders), managers, employees"

Internal users of accounts

• The financial accounts of a limited liability business need to be submitted to Companies House each year

  • Public Limited Companies need to have their accounts audited before they publish them

• A range of internal stakeholders use business accounts for different purposes

Business owners

• Sole traders and partners use financial accounts for several reasons

  • To check if the business is making enough profit
  • To see if the business can pay short-term debts
  • To plan for growth or reduce costs

• Shareholders also use accounts to discover

  • How profitable the company is, compared to the investment they have made
  • To decide whether to sell or keep their shares
  • To assess whether the company is in a position to pay dividends

Managers

• Financial accounts and ratio analysis are crucial to help managers:

  • Measure business performance and set future targets
  • Make decisions, such as whether to cut costs or invest in new products
  • Identify problems early (e.g. falling liquidity or high debts)
  • Compare with competitors or past performance

Employees

• Employees are also interested in the information within financial reports to

  • Judge the business’s financial health to check that they have job security
  • See if the business is profitable or liquid enough to award pay rises or bonuses

Exam Hint Don’t assume accounts are only for owners – examiners expect you to recognise other users such as employees, banks, suppliers, and government, each with different information needs

External users of accounts

Spec point — e.g. suppliers, government, lenders/banks

Suppliers

• Suppliers can use financial accounts to determine if the business can pay its bills on time

  • They consider the current ratio to see if a customer has enough cash or short-term assets to cover what they owe

• If the business is struggling, suppliers may

  • Ask for payment in advance
  • Refuse to give trade credit

Government

• Governments will use accounts and ratio analysis to check that

  • The business is paying the correct amount of tax
  • The business is following laws such as those for financial reporting

• They will also, on a broader level, monitor business size and performance for economic planning, such as the ability to create new jobs

Lenders and banks

• Lenders, including banks, often look very closely at financial accounts to determine

  • Whether to approve a loan
  • Whether the business can repay a loan

• They use liquidity ratios, like the current ratio, and profitability ratios, like RoCE, in their decision-making

  • A business with weak liquidity or falling profits may be seen as risky and would likely be refused lending

Using financial accounts to make decisions

Spec point — "how users of accounts may use financial information to help make decisions, e.g. whether to lend to or invest in a business"

Using financial accounts to make decisions

• Financial accounts and ratio analysis can be used to support strategic decisions

  • Investment or divestment decisions
  • Determining the most profitable option given the level of capital employed

• Using these tools gives a clear, factual picture of the business’s performance and financial health

  • Financial accounts show real profit, sales and costs data
  • Ratios turn these numbers into useful tools for comparing and spotting problems or strengths
  • They make it easier to compare performance from year to year or with other businesses of a similar size

Worked Example Faced with increasing costs, Kent & Medway Properties Ltd* *is looking to close one of its three high-street estate agency branches.

The table below shows some key data for each of the branches.

Branch	Capital employed	Profit before interest and tax
Sevenoaks	£2.4m	£0.37m
Whitstable	£3.1m	£0.57m
Rochester	£2.9m	£0.51m

Calculate the return on capital employed (RoCE) for each branch and recommend which branch, in profitability terms, should close.

(4)

Step 1: Apply the formula to calculate the RoCE for each branch

RoCE = (Profit before interest and tax)/(Capital employed) x 100 > > RoCE Sevenoaks = (\pounds 0.37 m)/(\pounds 2.4 m) x 100 = 15.42 %****[1]**

$> \text{RoCE} \text{Whitstable} = \frac{\pounds 0.57 \mathrm{m} }{\pounds 3.1 \mathrm{m} } \times 100 = 18.39 \%$** [1]

$\text{RoCE} \text{Rochester} = \frac{\pounds 0.51 \mathrm{m} }{\pounds 2.9 \mathrm{m} } \times 100 = 17.59 \%$****[1]**

Step 2: Identify the least profitable branch for closure

• Sevenoaks is the least profitable branch with a RoCE of 15.42% and should be the branch selected for closure** [1]

Limitations of using accounts and ratio analysis

• While financial accounts and ratios are useful in decision-making, they are not perfect for several reasons

They use past data

• Financial accounts show what has already happened
• Ratios are based on past performance, not future results
• Conditions can quickly change (e.g. new competitors, economic shocks), so past data may not help predict what will happen next

They do not show the full picture

• Accounts do not explain why figures changed

• Ratios cannot measure non-financial factors such as

  • Employee motivation
  • Customer satisfaction
  • Product quality

• Important business problems may be missed if only financial data is used.

Data can be manipulated

• Businesses might make their accounts look better than they really are by delaying payments or hiding debts
• Decisions based on false or adjusted data can lead to poor outcomes