Financial statements and ratios

📌 Key points

1. Profit = revenue − total costs; it rewards owners, is a source of finance and shows success.
2. In the income statement: revenue − cost of sales = gross profit; gross profit − expenses = profit; profit after tax and dividends is retained profit.
3. Cost of sales = opening inventory + purchases − closing inventory.
4. The statement of financial position shows assets (non-current and current), liabilities (non-current and current) and shareholders’ equity on one date.
5. Non-current assets last more than a year (buildings, machinery); current assets are used within a year (inventory, trade receivables, cash). Current liabilities are due within a year (overdrafts, trade payables).
6. Total assets − total liabilities = shareholders’ equity.
7. Gross profit margin = gross profitrevenue × 100; profit margin = profitrevenue × 100; ROCE = profitcapital employed × 100.
8. Current ratio = current assets ÷ current liabilities; acid test ratio = (current assets − inventory) ÷ current liabilities.
9. Liquidity is the ability to pay short-term debts; an acid test ratio below 1 can mean the business may struggle to pay its current liabilities.
10. Users of accounts include managers, shareholders, banks, suppliers, the government, workers and competitors.

📖 Key terms

Revenue

The income from sales: price × quantity sold.

Gross profit

Revenue minus cost of sales.

Non-current assets

Assets kept and used by the business for more than one year.

Current liabilities

Debts of the business that must be paid within one year.

Liquidity

The ability of a business to pay its short-term debts.

Return on capital employed

Profit as a percentage of capital employed.

Acid test ratio

Current assets minus inventory, divided by current liabilities.