St Augustine’s CE High School

Level 3

BTEC Nationals in Business

Unit 5

An Introduction to Accounting

Student Handbook

Unit 5 – An Introduction to Accounting

Understanding how a business operates and what makes it successful requiresknowledge of the accounting process. This unit will introduce you to the purpose ofaccounting and its role in the management of a business organisation.

Accounting involves the recording of business transactions, and this in turn, leads tothe generation of financial information, which can be used as the basis of goodfinancial control and planning. Inadequate record-keeping and a lack of effectiveplanning ultimately lead to poor financial results. It is vital that owners and managersof businesses are able to recognise the indications of potential difficulties. Remedialaction can then be taken. This unit should give learners the skills and knowledgeneeded to understand and manage finances.

The unit is divided into two distinct parts. The first is an understanding of theaccounting processes necessary to provide accurate and relevant financialinformation. The second part is the practical aspect of carrying out those accountingactivities.

You will be introduced to accounting terminology as you study the purpose andfunction of accounting and consider the various categories of business income andexpenditure. It is important to know the sources of an organisation’s income and thenature of its expenditure as this clarifies the basis of its profitability and enablesmore effective control of the business. This control begins with the planning processand you will study the use of a cash flow forecast which requires managers to setcash flow targets that can be monitored and adjusted on a regular basis. You will consider the effective management of cash flow and the implications of cashflow problems. The link between business failures and cash flow problems will behighlighted.

The measurement of an organisation’s financial performance and position requires anunderstanding of a basic profit and loss account and balance sheet. Thisunderstanding permits the analysis of profitability, liquidity and efficiency of theorganisation through the application of ratio analysis. Analysis will always requirecomparison of current figures with those from a previous accounting period or thoseof a similar business organisation. You will discover the method of carrying outratio analysis as well as the meaning and implication of the figures.

Learning outcomes

On completion of this unit you should be able to:

  • Understand the purpose of accounting and the categorisation of business income and expenditure
  • Be able to prepare a cash flow forecast
  • Understand profit and loss accounts and balance sheets
  • Be able to review business performance using simple ratio analysis.

Task 1 – The Purpose of Accounting (P1)

Please refer to the PowerPoint presentation entitled “An introduction to Finance & Accounts.ppt” at Task 1.

Write a report titled “The Purpose of Accounting”. Your report should include the following information:

  • A definition of theterm "accounting"
  • An explanation of the difference between "management" and "financial" accounting
  • Three different examples of a financial accounting document. Provide print screens of any relevant examples you have found.
  • An explanation of how each financial accounting document is used, and who uses it.
  • An explanation of the implications of not completingfinancial accountscorrectly
  • Three different examples of amanagementaccounting document. Provide printscreens of any relevant examples you have found.
  • An explanation of how eachmanagement accounting document is used, and who uses it.
  • An explanation of the implications of notusing managementaccountscorrectly
  • Research at least one news story which highlights theimportanceof a businesskeeping an accuraterecord of finances

Task 2 – The Difference between capital and revenue income and expenditure (P2)

Please refer to the PowerPoint presentation entitled “Revenue and Capital Spending.ppt” at Task 2.

Complete the following tasks:

  1. Explain the difference between revenue and capital income.
  2. Imagine you run a mini-cab service from Kilburn High Road. Identify some potential sources of revenue and capital income.
  3. Explain the difference between revenue and capital expenditure
  4. How can poor management ofrevenue and capitalexpenditure lead to cash flow problems?
  5. What are the implications of poor cash flow for a mini cab firm?

Task 3 – Cash flow forecasts

P3 - Prepare a 12 month Cash flow forecast to enable an organisation to manage its cash.

M1 - Analyse the cash flow problems a business might experience

D1- Recommend and justify actions a business might take when experiencing cash flow problems

Hamilton Construction Limited, a small house building and restoration company, forecast the following cash flows over the next 12 months commencing in January.

Turnover of £16,000 per month from January to March inclusive and wages of £3,000 per month; £28,000 per month from April to August inclusive and wages of £5,000 per month; and £14,000 per month from September to December and wages of £2,500 per month. All work is undertaken strictly on one month’s credit.

The company had a cash balance of £17,000 at the beginning of January. Materials which are paid for on one month’s credit are estimated at £5,000 per month from February to May, £10,000 per month from October to December. Current creditors total £25,000 for supplies bought in December, where debtors are £12,000.

A £20,000 investment in new equipment is anticipated in May. Corporation Tax is estimated at £2,000 per quarter. Miscellaneous expenses are estimated at £2,500 per month.

  1. Prepare aprofessional looking 12-month cash flow forecast for the companyusing Spreadsheet softwaresuch as Microsoft Excel
  2. Comment on any trends or actions which the company may need to take to control its cash flow.
  3. Use your spreadsheet to consider the impact on the figures if...
  • Wages and materials increased by 10%
  • Sales improved by 20%

Task 4 – Profit & Loss Account & Balance Sheet

P4 – Explain the component parts of a profit and loss account and balance sheet of a given organisation

Profit & Loss Account for JD Sports Ltd

  1. Copy and paste the above Profit & Loss account for JD Sports from Task 4 into a Word document. Label and explain the following component parts:
  • Revenue
  • Cost of Sales
  • Gross Profit
  • Operating profit
  • Profit before tax
  • Income tax expense
  • Profit for the period
  • Basic earnings per ordinary share

Balance Sheet for JD Sports Ltd:

  1. Copy and paste the above Balance Sheet for JD Sports into your Word document, and label and explain the following key components:

  • Assets
  • Intangible assets
  • Non-current assets
  • Current assets
  • Liabilities
/
  • Current liabilities
  • Non-current liabilities
  • Capital and reserves
  • Total equity/Net Assets

Task 5 – Ratio Analysis

P5 - Perform Ratio Analysis to measure profitability, liquidity and efficiency of a given organisation

M2 - Analyse the performance of a business using suitable ratios

D2 - Analyse the financial performance of a business using ratio analysis

Profitability Ratios

Ratio / Calculation / Comments / Indicators
Gross profit margin (%) / (Gross profit/revenue) * 100 / This ratio tells us something about the business's ability consistently to control its production costs or to manage the margins its makes on products its buys and sells. Whilst sales value and volumes may move up and down significantly, the gross profit margin is usually quite stable (in percentage terms). However, a small increase (or decrease) in profit margin, however caused can produce a substantial change in overall profits. / This depends on the industry – for a retailer, 20-40% is good, 10-20% satisfactory, under 10% is unsatisfactory.
Operating Profit Margin (%) / (Operating profit/revenue) * 100 / Assuming a constant gross profit margin, the operating profit margin tells us something about a company's ability to control its other operating costs or overheads.
ROCE (Return on Capital Employed) / (Profit before tax/Total assets) *100 / ROCE tells us what returns management has made on the resources made available to them before making any distribution of those returns. / 20% is very good – the bigger the better!

Liquidity Ratios

Ratio / Calculation / Comments / Indicators
Current Ratio / Current assets/current liabilities / A simple measure that estimates whether the business can pay debts due within one year from assets that it expects to turn into cash within that year. / 2 is very good, less than 1 is a serious cause for concern
Acid test ratio / Cash and Cash equivalents/current liabilities / Not all assets can be turned into cash quickly or easily. Some - notably raw materials and other stocks - must first be turned into final product, then sold and the cash collected from debtors. The acid test therefore adjusts the Current Ratio to eliminate all assets that are not already in cash (or "near-cash") form. / A ratio of less than 1 is a cause for concern

Efficiency Ratios

Ratio / Calculation / Comments / Indicators
Asset turnover / Sales revenue/net assets / This measures the productivity of the business (i.e. how many pounds worth of sales revenue can be generated from the assets employed?). A figure of 1.6 will mean that for every £1 of net assets, the business generates £1.60 of sales revenue. / Clearly the higher the answer, the better. It is normal for service industries (e.g. supermarkets) to have a much higher asset turnover ratio than manufacturing industries, since service industries generate very high sales in relation to their net assets.
Stock turnover ratio / Cost of sales/Inventories (stock) / This measures the number of times in a 12-month period that a business sells its stock. A figure of 4 would mean that the business would turn its stock over (i.e. sell the lot and order some more) four times per year, or every 91 days on average. / Care must be taken when comparing the stock turnover ratios of different businesses, since a supermarket, for example, is likely to have a much higher stock turnover (especially for vegetables, fruit and other perishables) than a retailer such as 'Dixons' (for televisions, washing machines, etc).

Tasks:

  1. Calculate each of the ratios in the table for JD Sports using the information in the profit and loss account and balance sheet from task 4. Please use the Profitability/Liquidity/Efficiency sub-headings. (P4)
  1. For each ratio you have calculated, explain what the result indicates and what it means for the business. i.e. will they have to reduce costs? Increase sales? Streamline operations? (M2)
  1. With full reference to the ratios, explain how well you think JD Sports performed in 2008. You will need to compare the ratios to previous year’s results and other businesses’ performance in the same market. (D2)

Reading List

Brammer J, Cox D, Fardon M and Penning A — Active Accounting (Osborne Books,

2002) ISBN 1872962378

Cox D — Business Accounts (Osborne Books 1999) ISBN 1872962580

Dyson JR — Accounting for Non-Accounting Students (FT Prentice Hall, 2003)

ISBN 0273683853

Fardon M — Finance (Osborne Books, 1992) ISBN 1872962351

Journals

Accounting Technician (Centurion Publishing Group)

PQ Magazine (PQ Publishing)

Websites

- Association of AccountingTechnicians Online

Accounting Web - for news andanalysis

- Business education websiteincluding learning materials andquizzes

- Support for teachers and learners

Edexcel Level 3 BTEC National Certificate in Business Studies

Mr R Gordon