Final accounts and ratio analysis - Business Management IB Study Notes

Think of it like a financial health check-up for a business. Just like you go to the doctor to check if you're healthy, businesses use final accounts to check their financial health.

• Final Accounts (Financial Statements): These are special reports that show how a business is doing with money. There are mainly two big ones:

  • Income Statement (also called Profit and Loss Account): This is like a report card showing how much money the business earned (sales) and how much it spent (expenses) over a period, usually a year. It tells you if the business made a profit (earned more than it spent) or a loss (spent more than it earned).
  • Statement of Financial Position (also called Balance Sheet): This is like a snapshot of what the business owns (assets), what it owes (liabilities), and what money the owners have put in (equity) at a specific moment in time. It's like checking your backpack: what's inside (assets), what you borrowed from a friend (liabilities), and what's truly yours (equity).

• Ratio Analysis: Once you have these reports, ratio analysis is like using a calculator to compare different numbers within them. For example, comparing how much profit you made to how much you sold. It helps you understand if the business is making good use of its money, if it can pay its bills, and if it's growing.

Let's imagine a popular local bakery called 'Sweet Treats'.

1. Income Statement: At the end of the year, the owner, Mrs. Chen, looks at her Income Statement. It shows she sold $100,000 worth of cakes and bread (her revenue). She spent $40,000 on flour, sugar, and eggs (her cost of goods sold), and another $30,000 on rent, electricity, and paying her staff (her operating expenses). So, she made $100,000 - $40,000 - $30,000 = $30,000 profit! That's great news!

2. Statement of Financial Position: On December 31st, Mrs. Chen looks at her Statement of Financial Position. It shows she owns the oven, mixers, and cash in the bank (her assets). She still owes the bank some money for a loan she took to buy a new delivery van (her liabilities). The money she originally put into the bakery, plus all the profits she's kept in the business, is her equity.

3. Ratio Analysis: Mrs. Chen then uses ratio analysis. She calculates her profit margin (profit divided by revenue) and sees it's 30%. She compares this to last year's 25% and realizes her bakery is becoming even more profitable! She also checks if she has enough cash to pay her suppliers next month (a liquidity ratio) and sees she's in good shape. This helps her decide whether to open a second bakery.