IGCSE Business Studies - 5.5.3 Users of Accounts

This section explores who uses a company's financial accounts and how they utilize the information provided. We will focus on external users, including suppliers, government bodies, and lenders/banks, and discuss the importance of ratio analysis for these users.

External Users of Accounts

External users are individuals or organizations outside of the company who rely on its financial statements to make decisions. These users need reliable and relevant information to assess the company's performance, financial position, and future prospects.

1. Suppliers

Suppliers use financial accounts to assess the creditworthiness of a company before extending credit. They want to know if the company is likely to be able to pay its debts.

• Liquidity: Suppliers will examine the company's ability to meet its short-term obligations (e.g., current ratio).
• Solvency: They will also look at the company's ability to meet its long-term obligations (e.g., debt-to-equity ratio).
• Profitability: A profitable company is more likely to be able to pay its bills.

2. Government

Government bodies, such as tax authorities, regulatory agencies, and Companies House, use financial accounts for various purposes.

• Taxation: Tax authorities use accounts to determine a company's taxable income.
• Regulatory Compliance: Regulatory agencies may require companies to submit accounts to ensure they comply with laws and regulations.
• Companies House: Companies House uses accounts to maintain a public record of companies and their financial status.

3. Lenders/Banks

Lenders and banks are crucial users of financial accounts. They use this information to decide whether to grant loans and what interest rate to charge. They assess the risk associated with lending money to the company.

• Profitability: Banks want to see a consistent history of profitability.
• Solvency: A strong solvency position indicates the company can repay its debts.
• Liquidity: Banks need to be confident the company can meet its short-term obligations.
• Asset Quality: The value and nature of the company's assets are important.

Ratio Analysis for External Users

Ratio analysis is a key tool for external users to interpret financial statements. Ratios provide a standardized way to compare a company's performance over time and against its competitors.

Ratio	Formula	What it measures	What external users look for
Current Ratio	$\frac{Current Assets}{Current Liabilities}$	Ability to pay short-term liabilities	A ratio above 1 is generally considered healthy.
Quick Ratio (Acid Test)	$\frac{(Current Assets - Inventory)}{Current Liabilities}$	Ability to pay short-term liabilities without relying on inventory sales	A ratio above 1 is generally considered healthy.
Debt-to-Equity Ratio	$\frac{Total Debt}{Total Equity}$	Proportion of debt financing relative to equity financing	A lower ratio is generally preferred, indicating less reliance on debt.
Profit Margin	$\frac{Net Profit}{Sales}$	Profitability of sales	A higher profit margin is generally preferred.
Gross Profit Margin	$\frac{Gross Profit}{Sales}$	Profitability after deducting the cost of goods sold	Indicates efficiency in production and pricing.
Return on Capital Employed (ROCE)	$\frac{EBIT}{Capital Employed}$	How effectively a company uses its capital to generate profit	A higher ROCE is generally preferred.

Example: A bank might analyze a company's current ratio to determine if it has enough liquid assets to cover its immediate debts. A supplier might look at the profit margin to assess the company's ability to pay for goods and services in the future.

Understanding the needs of external users and the information they require is crucial for businesses. Preparing clear, concise, and well-presented financial accounts, along with relevant ratio analysis, helps build trust and facilitates access to finance and credit.