0452 · 6.4Interested parties

Accounting information and key statements

0:00An owner may want to expand a repair shop, while its supplier worries about receiving payment. Both can use the same accounting information for different decisions. This video covers owners, managers, employees, banks, investors and lenders, suppliers and customers. It then turns to governments and tax authorities, club members, and other interested parties such as public and environmental bodies. For each party, you will see the figures it uses, the decision they inform and, where possible, the ratio or statement involved.

0:28Interested parties are people or groups that use information about a business or club to make decisions. What each one needs depends on its relationship with the organisation. An employee relies on wages, whereas a lender expects borrowed money to be repaid. Start with that need, then connect it to useful accounting information. Most interested parties rely on financial statements. Financial statements are summaries that show a business's profit or loss for a period and what it owns and owes at a date.

0:56Nadia’s Repair Shop, which fixes household equipment, supplies every example in this video. Its statements are the evidence each party examines before deciding. Revenue is the income a business earns from its main activity, such as selling goods or providing services. For Nadia’s shop, that means the fees charged for repairs. Expenses are the costs used up in running the business and earning revenue during a period. Spare parts, wages and rent are among the shop’s expenses.

1:24Profit is the amount by which revenue exceeds expenses for a period. Accounts usually measure this result over a full year. Profit for the year is the amount by which revenue exceeds expenses over one financial year. Owners, managers and lenders all study that figure for different reasons. The statement of profit or loss is the financial statement that shows the revenue, expenses and profit or loss for a period.

1:48An owner uses it to judge performance over the year. Managers examine its individual expense figures when deciding where spending needs attention. A lender considers whether the business earns enough to support future repayments. Other parties need to know what the shop owns and owes. Assets are resources owned or controlled by a business that bring future benefit, while liabilities are amounts the business owes to others. Repair tools are assets of Nadia’s shop, and unpaid bills for spare parts are liabilities.

2:17Owner's equity, also called capital, is the owner's investment in the business, or the amount the business owes the owner. A statement of financial position shows assets, liabilities and owner's equity at a particular date. Two further ideas link these statements to decisions. Profitability is the ability to earn profit in relation to revenue or resources invested. A profitable year shows on the statement of profit or loss. Liquidity is the ability to meet short-term debts when they fall due.

2:44A business can report a profitable year but have too little money available for a payment due tomorrow.

Owners, managers and employees

2:50Owners use accounting information to judge whether their investment is worthwhile. Capital employed is the total of issued shares, reserves and non-current liabilities. A sole trader has no shares, so owner's capital takes the place of shares and reserves. Return on capital employed measures profit for the year before interest as a percentage of capital employed. An owner compares this percentage with the income the same money would earn if deposited in a bank.

3:15The result helps the owner decide whether to continue, expand or invest more. Suppose Nadia plans to expand, and the larger shop would earn more profit but need much more capital. She should compare the return on capital employed before and after the expansion. A larger profit does not automatically make the investment more attractive, because the return could fall. Expansion should also leave enough money available to pay the shop’s existing commitments.

3:40Managers need more detailed information because they make day-to-day operating decisions. They examine revenue, repair costs and wages when planning work or controlling spending. A budget is a financial plan for a future period. Comparing actual results with that plan helps managers investigate unexpected costs and decide whether prices or working methods need adjustment. For example, Nadia’s manager could examine the cost of completing different repairs before changing prices. A repair service that brings in substantial revenue may also require expensive parts and many working hours.

4:13A falling profit margin on the statement of profit or loss would signal costs rising faster than revenue. The manager can use this evidence to revise prices, cut costs or change the services offered. Employees look at financial performance because their jobs depend on the business continuing to operate. Profit for the year on the statement of profit or loss gives evidence about job security and the ability to afford wage rises.

4:37Available money also matters because wages must be paid when due. Employees may use this information when deciding whether to remain with the business or request higher pay.

Banks, investors and suppliers

4:46Before a bank lends money, it assesses whether the borrower can repay the loan and interest. Interest is the cost paid for borrowing money. The bank checks liquidity through the current ratio and the acid test ratio. Liquidity ratios compare short-term resources with the debts that must be paid soon. Beyond liquidity, the bank weighs profitability, existing borrowing and security. Security is an asset pledged to support repayment if the borrower fails to pay.

5:12The statement of financial position helps a bank identify resources that might provide security. However, owning valuable equipment does not guarantee that tomorrow’s repayment can be made. The bank must also assess when money will become available. Its decision may concern whether to grant a loan, the amount offered and the repayment terms. Investors and lenders both provide finance, but their expected rewards differ. An investor puts in funds hoping for a share of future profits, while a lender advances money that must be repaid with interest.

5:43Investors assess profitability, possible returns and the risk of losing their investment. Banks belong to the lender group, since their concern is repayment with interest. Investors who buy shares in a company may receive dividends. A dividend is a distribution of company profits to shareholders. Investors compare return on capital employed and past dividends with returns available elsewhere. Existing shareholders choose whether to keep their shares, while potential investors decide whether to buy.

6:11Strong past results provide useful evidence, but they do not guarantee future returns. Suppliers face a payment risk whenever they let a business receive goods before paying. Buying on credit means receiving something now and agreeing to pay for it later. A supplier examines liquidity, especially the current ratio and acid test ratio, to judge whether payment will arrive on time. That evidence helps determine whether to give credit, how much to allow and how soon payment should be required.

6:39Trade payables are amounts owed to credit suppliers that the business has not yet paid. A parts supplier to Nadia’s Repair Shop would check its trade payables turnover in days. This ratio measures the average time the shop takes to pay its credit suppliers. A period longer than the supplier’s own credit terms is a warning sign. The supplier might then reduce the credit offered or require payment before supplying further parts.

Customers, authorities and club members

7:01Customers may need financial information when they depend on a continuing service. Someone arranging regular equipment repairs wants Nadia’s Repair Shop to remain available. Profit for the year and the statement of financial position give evidence about its ability to keep operating. Customers use that evidence when choosing where to take repairs and judging whether after-sales service and guarantees will be honoured. Governments and tax authorities use accounting information for several purposes.

7:27Profit for the year can provide a starting point for calculating tax, subject to the applicable tax rules. Financial records also help authorities check whether the business has met its reporting obligations. Governments may combine information from businesses to prepare statistics about economic activity and employment. Club members have a different concern from business owners. Non-trading organisations exist to provide facilities for members, not to make profit. Subscriptions are the regular fees payable by members of a club or society.

7:56Members want evidence that these fees are used appropriately and that the club can continue providing its facilities. An income and expenditure account shows a non-trading organisation's income and expenses for a period, and its surplus or deficit. Members use it to see how subscriptions were spent on coaching, equipment and clubhouse repairs. A surplus is the excess of income over expenditure for a period. When expenditure exceeds income, the difference is a deficit.

8:22Repeated deficits may lead members to vote for higher fees or fewer activities. Other interested parties include the public and environmental bodies. Local residents may examine wages and financial performance when considering the business’s contribution to local employment. Environmental bodies may look for expenditure on waste treatment or pollution prevention. Such figures show financial commitments, but direct evidence is also needed to assess actual environmental impact.

Worked example: supplier credit decision

8:49Consider a supplier deciding whether to provide more parts to Nadia’s Repair Shop on credit. The shop reports profit for the year of nine thousand dollars. It has two thousand dollars available in the bank now. A payment of three thousand five hundred dollars to this supplier is due tomorrow. Begin with the supplier’s decision, which concerns receiving payment on time. The annual profit figure provides evidence of profitability over the year.

9:12Next, compare tomorrow’s required payment with the money available now. Three thousand five hundred dollars minus two thousand dollars is fifteen hundred dollars, so the available money falls short by that amount. The supplier should establish whether additional money will arrive before the payment falls due. Annual profit alone does not answer that question because some amounts earned may still be unpaid by customers. The shop could have adequate annual profitability and an immediate liquidity problem.

9:38These figures therefore raise a specific concern about tomorrow’s payment. There are reasons both for continuing supply and for caution. The reported profit supports an ongoing business relationship, but the immediate shortfall creates payment risk. The supplier should therefore supply more parts on credit only if the shop shows how it will cover the fifteen hundred dollar shortfall. Otherwise, it should require payment before delivering further parts.

Exam answers and recap

10:02Examiners reward a reason that is specific to each interested party. Match the information to the particular decision that party makes. Owners assess returns on their investment, suppliers judge the likelihood of timely payment, and customers look for continuity of service. A complete explanation names useful information and states what the user decides from it. Keep profitability and liquidity separate. Profitability is the measure for returns, whereas immediate obligations call for liquidity, shown by available money and payment dates.

10:32Interested-party categories can also overlap. An owner may manage the business, while a bank acts as a lender. Paper One contains forty multiple-choice questions, while Paper Two contains five compulsory structured questions. A multiple-choice item may ask which party needs information for a particular decision. Structured questions can require you to identify users or explain their needs. Identify means name or select, while explain means give reasons, why and how, supported by evidence.

11:01Consider the question, explain why employees and a bank would be interested in Nadia’s Repair Shop’s financial statements. First identify the decision relevant to each party. Then select information that supports that decision. Each party then receives its own specific reason. Employees assess profitability to judge job security and the business’s ability to afford wage rises. They also consider available money because wages must be paid when due. A bank assesses liquidity and profitability to judge whether the shop can repay a loan and interest.

11:34It examines assets that could provide security for the borrowing. Each reason names the information and the decision, which is what earns the marks. The central connection is between the interested party, the accounting information and the decision. Owners and investors assess returns, while managers use detailed figures for planning and control. Employees, banks and suppliers consider the business’s ability to meet commitments. Customers assess continuing service, while authorities, club members and public bodies examine how resources are used and obligations are met.