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Cambridge (CIE) IGCSE Your notes

Accounting
Accounting Ratios
Contents
Profitability Ratios
Liquidity Ratios
Efficiency Ratios
Inter-firm Comparison
Interested Parties
Limitations of Accounting Statements

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Profitability Ratios
Your notes
What are profitability ratios?
Profitability ratios assess a company's ability to earn profits from sales, operations or assets
They compare profits to other values such as revenue, costs and capital employed
The main profitability ratios are:
Gross margin
Mark-up
Profit margin
Return on capital employed

Gross Margin
What is the gross margin?
What is the formula? Gross profit
× 100
Revenue

How should the value be Write as a percentage (X%)

written?

How should the value be Round to two decimal places

rounded?

What does the value mean? The value represents the proportion of the revenue that is turned into
gross profit

How can the ratio be Increase the selling price of the goods
improved?
Buy the goods from a cheaper supplier

If the gross margin decreases then this suggests that:

The goods are being sold at a cheaper price than in previous years
Allowing more trade discounts has the same effect

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The costs of goods have increased but their selling price has remained the same

EXAM TIP Your notes

The gross margin must be less than 100%. If you get an answer bigger than 100% then check your
working.

WORKED EXAMPLE
Kaley is a sole trader. She provides the following information for the year ended 31 December 2023.

Revenue 128 000

Purchases 52 000

Inventory at 1 January 2023 8 000

Inventory at 31 December 2023 6 000

Calculate Kaley's gross margin. Your answer should be correct to two decimal places.
Answer
Calculate the cost of sales
Opening inventory + Purchases - Closing inventory
$8 000 + $52 000 - $6 000 = $54 000
Calculate the gross profit
Revenue - Cost of sales
$128 000 - $54 000 = $74 000
Calculate the gross margin

Gross profit
× 100
Revenue
74 000
× 100 = 57. 8125
128 000
Round to two decimal places
Gross margin = 57.81%

Mark-up

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What is the mark-up?

Your notes
What is the formula? Gross Profit
× 100
Cost of sales

How should the value be Write as a percentage (X%)

written?
This can be bigger than 100%

How should the value be Round to two decimal places

rounded?

What does the value The value represents the percentage of the cost of sales that is added to
mean? the costs to form the selling price

How can the ratio be Increase the selling price of the goods
improved?
Buy the goods from a cheaper supplier

The mark-up is normally a fixed percentage applied to the cost of the goods
The percentage can be raised to increase profits

EXAM TIP
The mark-up can be bigger than 100% so do not worry if your answer is bigger than 100%.

Profit Margin
What is the profit margin?
What is the formula? Profit for the year
× 100
Revenue

How should the value be Write as a percentage (X%)

written?

How should the value be Round to two decimal places

rounded?

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What does the value mean? The value represents the proportion of the revenue that is turned into
profit for the year
Your notes
How can the ratio be Increase the gross profit
improved?
Increase selling prices
Buy goods from cheaper suppliers
Increase income from other sources
Reduce expenses such as staff salaries, marketing or administrative
costs

A decreasing profit margin suggests that:

Gross profit has decreased from previous years
The business is paying more for expenses
The business is not earning as much other income as in previous years

WORKED EXAMPLE
Kaley is a sole trader. She provides the following information for the year ended 31 December 2023.

Revenue 128 000

Gross profit for the year 74 000

Other income 9 000

Expenses 46 000

Calculate Kaley's profit margin. Your answer should be correct to two decimal places.
Answer
Calculate the profit for the year
Gross profit + Other income - Expenses
$74 000 + $9 000 - $46 000 = $37 000
Calculate the profit margin

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Profit for the year

× 100
Revenue Your notes
37 000
× 100 = 28. 90625
128 000
Round to two decimal places
Profit margin = 28.91%

Return on Capital Employed (ROCE)

What is the return on capital employed (ROCE)?
What is the formula? Operating profit for the year
× 100
Capital employed

Capital employed = Equity (or capital) + Non-current liabilities

How should the value be Write as a percentage (X%)

written?

How should the value be Round to two decimal places

rounded?

What does the value mean? The value represents the proportion of the capital employed that is
turned into profits

How can the ratio be Increase the profit for the year
improved?
Increase income
Decrease expenses
Reduce non-current liabilities such as bank loans

A business aims to increase the return on capital employed

The business should consider whether it can use more short-term sources of finance rather than
long-term loans

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EXAM TIP
Your notes
Notice that this profitability ratio uses the operating profit rather than the profit for the year. This
means you need to use the profit before finance costs (loan interest or debenture interest).

WORKED EXAMPLE
The equity and liabilities of Khazam Ltd at 31 December 2023 are listed below.

Ordinary share capital 140 000

General reserve 40 000

Retained earnings 50 000

5% Debentures 30 000

Trade payables 25 000

The profit for the year ended 31 December 2023 was $35 000 after charging debenture interest.
Calculate the return on capital employed for the year ended 31 December 2023. The calculation
should be correct to two decimal places.
Answer
Calculate the debenture interest for the year
5% × $30 000 = $1 500
Calculate the operating profit for the year
Add the debenture interest back onto the profit for the year
$1 500 + $35 000 = $36 500
Calculate the capital employed
Equity (Share capital + Reserves + Retained earnings) + Non-current liabilities
$140 000 + $40 000 + $50 000 + $30 000 = $260 000
Calculate the return on capital employed

Operating profit for the year

× 100
Capital employed
36 500
× 100 = 14. 0384. . .
260 000
Round to two decimal places
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ROCE = 14.04%

Your notes
Evaluating Profitability
How do I evaluate the profitability of a business?
It is best to look at multiple profitability ratios together to get a better understanding
The gross margin might be high but the profit margin might be low
This suggests that gross profit is not an issue
The business needs to look at other income and expenses
The difference between the gross margin and profit margin is the proportion of revenue that is
spent on expenses after deducting other income
A smaller difference indicates that a business has better control of expenses
Consider actions which have a positive and negative effect
For example, if a business finds a cheaper supplier:
The gross margin might increase as a result of lower cost of sales
However, the quality of the goods might not be as good, which could cause customers to
shop elsewhere, reducing sales revenue

How do I compare the profitability of a business between

years?
Compare the ratios to the same ratios from previous years
For each ratio
Make a general comment
State whether it has improved or gotten worse
State the percentages
Give possible reasons for the change
Calculate the difference between the gross margin and the profit margin to see if the business has
gotten better at controlling expenses

WORKED EXAMPLE

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Sana and Taz are business partners. They provide information for the financial years ending 31
December 2022 and 31 December 2023.
Your notes
Year ended

31 December 2022 31 December 2023

Gross margin 32.25% 43.75%

Profit margin 9.43% 10.31%

Return on capital employed 21.08% 10.45%

Comment on the performance of the business over the two years.

Answer
Comment on the gross margin
The gross margin has improved from 32.25% to 43.75%. This could be because Sana and Taz
increased the selling prices of their goods. They could have decreased the cost of sales by
changing to a cheaper supplier.
Comment on the profit margin
The profit margin has improved from 9.43% to 10.31%. This could be due to a higher gross profit, but
it could also be due to an increase in other income.
Comment on the differences between the gross and profit margins
In 2022, the difference between the gross and profit margins was 22.82%. In 2023, this difference
was 33.44%. The difference worsened, which could be because Sara and Taz had worse control over
their expenses.
Comment on the return on capital employed
The return on capital employed worsened from 21.08% to 10.45%. This could be due to an increase
in the capital employed. This may have involved more capital being introduced by the partners or a
long-term loan.

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Liquidity Ratios
Your notes
What are liquidity ratios?
Liquidity ratios are ways to measure how quickly a business can convert assets into cash
They compare the current assets to the current liabilities
The liquidity ratios are:
Current ratio
Liquid (acid test) ratio

Current Ratio
What is the current ratio?
The current ratio is also known as the working capital ratio
Working capital is current assets minus current liabilities

What is the formula? Current assets

Current liabilities

How should the value be Write as a ratio (X : 1)

written?

How should the value be Round to two decimal places

rounded?

What does the value mean? The value represents the amount of current assets available to cover each
$1 of current liability

How can the ratio be Increase current assets by introducing capital or selling non-current
increased? assets
Reduce current liabilities, such as overdrafts and trade payables

A ratio close to 2:1 is generally good

If it is less than 1:1 then the business does not have enough current assets to cover its current
liabilities
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If it is too high then the business could have too much inventory or trade receivables
They need to improve their inventory control Your notes
They need to encourage credit customers to pay faster

WORKED EXAMPLE
Elena and Tom are in a partnership. They provide the following information at 31 March 2024.

Trade receivables 34 000

Trade payables 28 000

Inventory 20 000

Bank 5 000

Other payables 4 000

Calculate the current ratio. Your answer should be correct to two decimal places.
Answer
Calculate the total current assets
Trade receivables + Inventory + Bank
$34 000 + $20 000 + $5 000 = $59 000
Calculate the total current liabilities
Trade payables + Other payables
$28 000 + $4 000 = $32 000
Calculate the current ratio

Current assets
Current liabilities
59 000
= 1 . 84375
32 000
Round to two decimal places and write as a ratio
Current ratio = 1.84 : 1

Liquid (Acid Test) Ratio

What is the liquid (acid test) ratio?
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The liquid ratio is also known as the acid test or the quick ratio
It measures how well current liabilities are covered by the more liquid forms of current assets—cash Your notes
and trade receivables

What is the formula? Current assets − Inventory

Current liabilities

How should the value be Write as a ratio (X : 1)

written?

How should the value be Round to two decimal places

rounded?

What does the value The value represents the amount of cash and receivables available to cover
mean? each $1 of current liability

How can the ratio be Increase current assets, especially cash, by introducing capital or
increased? selling non-current assets
Reduce current liabilities, such as overdrafts and trade payables

A ratio close to 1:1 is generally good

If it is above 1:1 then the business has enough current assets to cover its short-term debts even if
the inventory cannot be sold
If it is too high then the business could be owed too much by trade receivables
They need to encourage credit customers to pay faster

EXAM TIP
You can either subtract the inventory from the total current assets or add up all the current assets
excluding the inventory.

WORKED EXAMPLE
Elena and Tom are in a partnership. They provide the following information at 31 March 2024.

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Trade receivables 34 000

Trade payables 28 000 Your notes

Inventory 20 000

Bank 5 000

Other payables 4 000

Calculate the liquid (acid test) ratio. Your answer should be correct to two decimal places.
Answer
Calculate the total current assets excluding the inventory
Trade receivables + Bank
$34 000 + $5 000 = $39 000
Calculate the total current liabilities
Trade payables + Other payables
$28 000 + $4 000 = $32 000
Calculate the current ratio

Current assets − Inventory

Current liabilities
39 000
= 1 . 21875
32 000
Round to two decimal places and write as a ratio
Current ratio = 1.22 : 1

Evaluating Liquidity
How do I evaluate the liquidity of a business?
The liquid ratio is the best indicator of the liquidity of a business
However, it is helpful to look at both ratios together
The difference between the two ratios tells you about the proportion of the current assets that are
made up of inventory
The current ratio might be good but the liquid ratio might be too low
This suggests the business has a lot of money tied up in inventory

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The ratios might be very similar

This suggests the business does not have a lot of inventory Your notes
This means they might not have sufficient supplies to meet demand
If both ratios are too low then:
The business might not be able to repay short-term debts on time
The business might not have the resources to pay credit suppliers quickly and therefore miss out
on cash discounts
The owner(s) might not be able to take drawings
Pay attention to whether the goods are purchased and sold on credit or cash
If goods are purchased using cash then there will be no trade payables
If goods are sold for cash then there will be no trade receivables
This might not affect the current assets as the bank increases instead of the trade receivables
How do I compare the liquidity of a business between years?
Compare the ratios to the same ratios from previous years
For each ratio
Make a general comment
State whether it has improved or gotten worse
State the ratios
Give possible reasons for the change
Possible reasons for a decrease in the ratios
Less cash or a higher bank overdraft due to
Purchase of a non-current asset
Increase in drawings
Repayment of long-term loans
Decrease in other current assets
Trade receivables
Increase in current liabilities
Trade payables

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Short-term loans
Possible reasons for an increase in the ratios
Your notes
More cash or a lower bank overdraft due to
Sale of a non-current asset
Decrease in drawings
New long-term loans
Increase in other current assets
Trade receivables
Decrease in current liabilities
Trade payables
Short-term loans

WORKED EXAMPLE
Tala is a sole trader and her financial year ends 31 March. She provides the following information.

At 31 March 2023 At 31 March 2024

Current ratio 1.56 : 1 0.94 : 1

Liquid (acid test) ratio 1.03 : 1 0.79 : 1

(a) Suggest two reasons for the change in the ratios.

(b) Suggest two reasons why Tala should aim to increase the ratios.
Answer
(a) State two reasons why both ratios could have decreased. As both have decreased then this
suggests there has not been a decrease in the inventory.
The current ratio has worsened by decreasing from 1.56 : 1 to 0.94 : 1 and the liquid ratio has also
worsened by decreasing from 1.03 : 1 to 0.79 : 1.
One possible reason is that Tala might have purchased a non-current asset for cash which would
decrease the current assets. Alternatively, she might have used a short-term loan to purchase the
non-current asset, which would have increased the current liabilities
Another possible reason is that Tala might have increased the amount of drawings in the form of
cash. This would decrease the money in the bank.
(b) State two reasons why it is better to have higher ratios.
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One reason why Tala should increase her ratios is so that she is able to repay her short-term debts
without incurring late charges or interest.
Your notes
Another reason to increase the ratios is so that Tala has enough funds to pay for the business
expenses without requiring further short-term loans.

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Efficiency Ratios
Your notes
What are efficiency ratios?
Efficiency ratios are ways to measure how efficient a business is at managing processes linked to
buying and selling goods
They compare trade receivables, trade payables and inventory with credit sales and purchases and the
cost of sales
They indicate how efficient a business is at
Receiving payments from customers
Making payments to suppliers
Selling its inventory
The efficiency ratios are:
Rate of inventory turnover
Trade receivables turnover
Trade payables turnover

Rate of Inventory Turnover

What is the rate of inventory turnover?
What is the formula? Cost of sales
Average inventory

How should the value be Write as the number of times per year (X times)
written?

How should the value be Round to two decimal places

rounded?

What does the value The value represents the number of times a business is able to fully sell and
mean? replace its inventory in a year

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How can the ratio be Increase the volume of sales

improved?
Reduce the amount of inventory that is held by the business Your notes

It can be easier to think of the rate in terms of how long it takes for a business to fully sell its inventory
without replacing it
If the rate of inventory is 2 then this means it takes the business half a year to fully sell its inventory
without replacing it
You can divide 365 days by the rate to find the number of days it takes to fully sell the inventory
without replacing it
A business aims to sell its inventory quickly
This prevents the inventory from going out of date or out of season

WORKED EXAMPLE
Omatola runs a small business by herself. She provides the following information for the year ended
29 February 2024.

Sales 40 000

Purchases 25 000

Inventory at 1 March 2023 7 000

Inventory at 29 February 2024 9 000

Calculate the rate of inventory turnover for the year ended 29 February 2024. The calculation should
be correct to two decimal places.
Answer
Calculate the cost of sales
Opening inventory + Purchases - Closing inventory
$7 000 + $25 000 - $9 000 = $23 000
Calculate the average inventory

Opening inventory + Closing inventory

2

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$ 7 000 + $ 9 000
= $ 8 000
2 Your notes
Calculate the rate of inventory turnover

Cost of sales
Average inventory
23 000
= 2 . 875
8 000
Round to two decimal places
Rate of inventory turnover = 2.88 times

Trade Receivables Turnover

What is the trade receivables turnover?
What is the formula? Trade receivables
× 365
Credit sales

How should the value Write as the number of days (X days)

be written?

How should the value Round up to the next whole day

be rounded?

What does the value The value represents the average number of days it takes a business to receive
mean? full payment for goods sold to credit customers

How can the ratio be Encourage credit customers to pay quickly

improved?
Offer cash discounts
Charge interest for late payments
Reduce the amount owed by customers
Enforce a credit limit
Require a cash deposit

A business will aim to receive payment from customers as quickly as possible

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A business might offer credit to customers:

To get ahead of the competitors Your notes
To potentially receive larger orders from customers

WORKED EXAMPLE
Omatola runs a small business by herself. She provides the following information for the year ended
29 February 2024.

Sales 40 000

Trade receivables 11 000

All sales were made on a credit basis.

Calculate the trade receivables turnover for the year ended 29 February 2024. round up your answer
to the next whole day.
Answer
Calculate the trade receivables turnover

Trade receivables
× 365
Credit sales
11 000
× 365 = 100 . 375
40 000
Round up to the next whole day
Trade receivables turnover = 101 days

Trade Payables Turnover

What is the trade payables turnover?
What is the formula? Trade payables
× 365
Credit purchases

How should the value Write as the number of days (X days)

be written?

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How should the value Round up to the next whole day

be rounded?
Your notes
What does the value The value represents the average number of days it takes a business to fully
mean? pay for goods purchased from credit suppliers

How can the ratio be Take advantage of any interest-free periods

increased?
This helps the business keep their cash for as long as possible in case
of emergencies

How can the ratio be Pay for goods using cash when possible
decreased?
Pay invoices quicker

There are benefits to paying for goods using credit:

The business can keep its cash for as long as possible in case of emergencies
The business can wait until it receives payment from customers before paying its suppliers
There is no optimal value for the trade payables turnover
The value should not be too high otherwise the business might be charged interest or late fees
The value should not be too low otherwise the business will have a low working capital

WORKED EXAMPLE
Omatola runs a small business by herself. She provides the following information for the year ended
29 February 2024.

Purchases 25 000

Trade payables 4 000

All purchases were made on a credit basis.

Calculate the trade payables turnover for the year ended 29 February 2024. round up your answer to
the next whole day.
Answer
Calculate the trade payables turnover
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Trade payables
× 365
Credit purchases Your notes
4 000
× 365 = 58. 4
25 000
Round up to the next whole day
Trade payables turnover = 59 days

Evaluating Efficiency
How do I evaluate the efficiency of a business?
Look at all the efficiency ratios together
The rate of inventory turnover tells you how quickly the business can sell its inventory
The higher the rate, the better the liquidity of the business
Look at the difference between the trade receivables turnover and trade payables turnover figures
It is better if the trade receivables turnover is lower
This means the business receives money from its credit customers before paying its credit
suppliers
This helps with the liquidity of the business
The difference between them is then the number of days that the business has the money
from the customers before paying the suppliers
If the trade receivables turnover is higher:
The business pays its suppliers before receiving money from its customers
This could result in the business taking out short-term loans to pay its suppliers

How do I compare the efficiency of a business over the years?

Compare the ratios to the same ratios from previous years
For each ratio
Make a general comment
State whether it has improved or gotten worse
State the ratios
Give possible reasons for the change
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Look at the difference between the trade receivables turnover and the trade payables turnover
Comment on the difference Your notes
WORKED EXAMPLE
Odin is a sole trader and his financial year ends 31 October. He provides the following information.

Year ended

31 October 2022 31 October 2023

Rate of inventory turnover 8.25 times 10.40 times

Trade receivables turnover 35 days 27 days

Trade payables turnover 20 days 28 days

(a) Explain why Odin is satisfied with the change in the rate of inventory turnover.
(b) Suggest two reasons for the decrease in Odin's trade receivables turnover.
(c) Suggest two reasons for the increase in Odin's trade payables turnover.
Answer
(a) State the benefits of having a higher rate of inventory turnover.
The rate of inventory turnover has improved by increasing from 8.25 times to 10.40 times. This means
Odin sold his inventory at a faster rate than the previous year. This has improved the liquidity of the
business as Odin is able to convert assets into cash more quickly.
(b) Give two reasons why the trade receivables turnover might decrease.
On average, Odin is receiving payment from his credit customers 8 days faster.
One possible reason is that Odin has started to offer cash discounts for early repayment.
Another possible reason is that Odin has increased the amount of interest that is charged on
overdue balances.
(c) Give two reasons why the trade payables turnover might increase.
On average, Odin is paying his credit suppliers 8 days slower.
One possible reason is that Odin has less available cash to pay his suppliers as promptly.
Another possible reason is that the suppliers are no longer offering cash discounts for early
repayments. In this case, Odin is taking longer to pay but still aiming to avoid overdue fees.

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Inter-firm Comparison
Your notes
Comparison of Accounting Ratios
How can I make inter-firm comparisons using the accounting
ratios?
You can compare the performance of similar businesses using the accounting ratios

Ratio Possible comparisons

Gross margin The business with the higher gross margin might be better at passing the
cost of goods on to the customers by applying a higher mark-up

Profit margin The business with the higher profit margin might be more profitable
The business with the smaller difference between the gross margin
and profit margin is likely to have better control of its expenses

Return on capital The business with the higher ROCE might be deploying its capital more
employed (ROCE) effectively

Current ratio The business with a higher current ratio might be able to pay off its short-
term debts more easily

Liquid (acid test) ratio The business with a higher liquid ratio might be able to convert its most
liquid current assets into cash more easily to pay off its short-term debts

Rate of inventory The business with the higher rate can sell its inventory more quickly
turnover
It is less likely to lose money by writing off inventory

Trade receivables The business with the lower number of days receives payments from its
turnover credit customers faster
It is less likely to need to write off debts
It might have a better credit control policy
Check if the trade receivables turnover is less than the trade payables
turnover

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This means the business receives money from credit customers

before paying credit suppliers
Your notes
It is efficient with its cash flow

Trade payables The business with the lower number of days pays its credit suppliers faster
turnover
It is less likely to be charged interest on overdue amounts
It is more likely to benefit from cash discounts
It might have a better relationship with its suppliers
The business with the higher number of days might prefer to take full
advantage of the interest-free periods
It might keep the cash in the business for as long as possible in case of
emergencies

Problems of Inter-firm Comparison

What are the potential problems of inter-firm comparisons?
The businesses might be in different trades
Comparisons should only be made between businesses within the same trade
Inventory, expenses and profit margins are usually different for businesses in different trades
A business selling food is likely to sell inventory quicker than a business selling new cars
The businesses might have been operating for different amounts of time
Comparisons should be made between businesses which are roughly the same age
Newer businesses are likely to have higher expenses and liabilities
More experienced businesses are likely to have developed a loyal customer base and a good
reputation
The businesses might have different financial periods
The end date of a financial year can impact the financial position of the business
Inventory levels can be affected by the seasons and holidays
The businesses only report on financial information
Comparisons cannot be made about the employees' satisfaction or experience

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The businesses might have different policies

One business might buy on a cash basis whereas the other might buy on a credit basis Your notes
This can affect current assets and current liabilities
The businesses might be different types of organisations
The type of organisation can affect its ability to raise capital and purchase assets
A limited company might have more available resources whereas a sole trade might just have
one employee

CASE STUDY
Cool Clothes Ltd and Sheer Style Ltd are companies, of a similar size, that sell a range of clothes. The
financial year for both companies ends on 31 March. The accounting ratios for the year ended 31
March 2024 are shown below.

Cool Clothes Ltd Sheer Style Ltd

Gross margin 32.25% 28.50%

Profit margin 15.45% 18.06%

Return on capital employed 11.11% 9.83%

Current ratio 1.94 : 1 1.45 : 1

Liquid (acid test) ratio 1.01 : 1 0.89 : 1

Rate of inventory turnover 13.21 times 14.88 times

Trade receivables turnover 28 days 45 days

Trade payables turnover 32 days 40 days

Comparisons
Cool Clothes Ltd has a higher gross margin than Sheer Style Ltd which suggests that it is better at
passing on more of the costs to the customers by using higher selling prices. However, the
difference between the gross margin and profit margin is larger for Cool Clothes Ltd (16.8%
compared to 10.44%), which suggests that its control of expenses is not as effective as Sheer Style
Ltd. Cool Clothes Ltd is making more profit on their capital employed which suggests it is using its
money more efficiently.
The current ratio for both companies shows that they have enough current assets to cover the short-
term debts. Cool Clothes Ltd is likely to be able to repay short-term debts more easily as its current
ratio is higher. The liquid ratio for Cool Clothes Ltd is ideal and shows that it will be able to convert its

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most liquid current assets into cash to cover short-term debts. Sheer Style Ltd, on the other hand,
might struggle to repay short-term debts using its most liquid current assets as the liquid ratio is less
than 1 : 1. This means it might need to take out extra short-term loans if its existing payables ask for Your notes
the owed money to be paid immediately. Sheer Style Ltd should look at ways to increase its liquid
(i.e. non-inventory) current assets. For example, it could sell some non-current assets and lease
them instead. However, this would increase its expenses and reduce its profit margin.
Sheer Style Ltd sells its inventory at a faster rate as its rate of inventory turnover is higher, however,
the rate for Cool Clothes Ltd is not much lower. Cool Clothes Ltd receives money from credit
customers faster than Sheer Style Ltd as its trade receivables turnover is smaller. Also, Cool Clothes
Ltd receives payment from customers before paying suppliers, which means it does not have to rely
on other sources of finance to fund the goods. Sheer Styles Ltd, on the other hand, pays its suppliers
on average 5 days before receiving payment from its customers. This means that Sheer Styles Ltd
might have to rely on short-term finance to cover the costs of goods; this could be a reason why its
liquid ratio is low.

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Interested Parties
Your notes
Who are the interested parties for accounting information?
The interested parties are the people or organisations that use the accounting information for
decision-making
There are internal and external interested parties
The accounting information might not always be available to all interested parties
Sole traders and partnerships can keep their financial statements private
Whereas public limited companies publish their financial statements to the public
Private limited companies have to publish some financial information

Internal Parties
Why might internal parties of a business be interested in the
accounting information?
Interested Reason for their interest in accounting information
party

Owners To compare the performance with previous years

To plan for the future
To make decisions about which areas need action

Managers To check on the efficiency of the business

To check on the progress of the business compared to previous years

Employees To check that the business is profitable and likely to continue to trade so that they
have job security

External Parties
Why might external parties of a business be interested in the
accounting information?
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Interested party Reason for their interest in accounting information

Your notes
Trade receivables (and To check on the probability that their goods will continue to be supplied
customers) by the business

Trade payables (and To check whether the business can pay for its supplied goods as
suppliers) agreed
To examine the trade payables turnover to identify how long, on
average, it takes the business to pay for its goods
To look at the trade receivables to assess whether there is still a
demand for the supplied goods

Banks To assess whether the business is suitable for an overdraft or a bank

loan
To assess the value of the assets owned by the business so that they
can be used as security against loans

Investors To assess the profitability of the business

To assess the likelihood of the investors making money if they invested
in the business

Competitors To compare the profitability of the business against their own business
To identify gaps in the market

Club members To assess whether the club is likely to continue to operate so that they
can continue to use the facilities available

Government and tax To calculate how much tax is owed

authorities
To gather data for the government statistics

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Limitations of Accounting Statements

Your notes
Limitations of Accounting Statements
What are the limitations of using accounting statements?
Limitation Explanation

Historic cost The historic cost accounting principle means that the actual cost is recorded on
the statements for each transaction
It can be difficult to compare transactions if they did not happen at the same
time

Time factor There is a gap between the end of a financial year and the preparation of the
financial statements
The current information might be different from the information stated on the
financial statements

Difficulties of Businesses might have different layouts of their financial statements

definition
Some businesses might subtract the goods taken for the owner's use from
purchases before stating it on the income statement
Some businesses might subtract sales returns from the sales before
stating it on the income statement
Some businesses might not explicitly state the profit from operations
whereas others might
It can be difficult to make comparisons if the items do not represent exactly the
same thing

Non-financial The money measurement accounting principle means that only information
aspects involving money is recorded
There are a lot of other important aspects which are not included in the
statements
Quality of the goods
Employee satisfaction

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Reputation

Your notes

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