e-Consult | Revision Qns

1.

A business owner has prepared a set of financial statements. Discuss how the following external users of accounts might use this information and what specific information they would be most interested in:

a) Suppliers

b) Banks/Lenders

c) Government (e.g., HMRC)

Financial statements provide crucial information for various external stakeholders. Here's how each user group might utilize them:

a) Suppliers: Suppliers are primarily interested in the business's ability to pay its debts. They want to assess the creditworthiness of the company before extending credit. They would be particularly interested in:

Profitability (Profit & Loss Account): To see if the business is generating enough profit to comfortably meet its obligations.

Liquidity (Balance Sheet): Specifically, current assets and current liabilities. Suppliers want to ensure the business has sufficient liquid assets to pay short-term debts.

Solvency (Balance Sheet): To assess the long-term financial stability and ability to meet long-term obligations.

Cash Flow (Statement of Changes in Equity/Cash Flow Statement): To understand the business's ability to generate cash to pay suppliers.

b) Banks/Lenders: Banks and lenders assess the risk of providing loans to a business. They need to determine if the business is likely to repay the loan with interest. They will focus on:

Profitability (Profit & Loss Account): A strong profit history indicates a higher likelihood of repayment.

Solvency (Balance Sheet): The ratio of assets to liabilities is key. Lenders want to see a healthy level of assets compared to liabilities.

Liquidity (Balance Sheet): Sufficient current assets to cover current liabilities are essential for short-term repayment.

Cash Flow (Statement of Changes in Equity/Cash Flow Statement): A positive and consistent cash flow demonstrates the business's ability to service debt.

Ratio Analysis: Banks will use various ratios (e.g., current ratio, debt-to-equity ratio) to assess the overall financial health and risk.

c) Government (e.g., HMRC): HMRC (Her Majesty's Revenue and Customs) and other government bodies are interested in a business's financial performance for tax purposes and regulatory compliance. They will examine:

Profitability (Profit & Loss Account): To determine the business's taxable profit.

Tax Liability (Statement of Changes in Equity/Profit & Loss Account): To assess the amount of tax owed.

Solvency (Balance Sheet): To ensure the business is financially stable and can continue operating and contributing to the economy.

Compliance with accounting standards: To ensure the financial statements are prepared in accordance with relevant regulations.

2.

A business owner is considering taking out a loan to expand their operations. Explain three different ways the business owner might use the information provided in the business accounts to make an informed decision about whether to accept the loan. Provide specific examples of financial information from the accounts that would be relevant to each decision.

The business owner can use the accounts in several ways to assess the loan's viability. Here are three examples:

Assessing Profitability and Ability to Repay: The owner can analyze the Profit & Loss Account to understand the business's profitability. A consistently profitable business is more likely to be able to repay the loan.
Relevant Information: Gross Profit, Net Profit, Profit Margins (calculated as Net Profit / Revenue). A high and stable net profit suggests the business has the financial capacity to service the debt.

Evaluating Liquidity and Short-Term Solvency: The owner needs to ensure the business has sufficient liquid assets to meet its short-term obligations, including loan repayments. This involves examining the Balance Sheet.
Relevant Information: Current Assets (e.g., Cash, Inventory, Receivables) and Current Liabilities (e.g., Accounts Payable, Short-term Loan). The Current Ratio (Current Assets / Current Liabilities) is a key indicator of liquidity. A ratio above 1 suggests the business can cover its short-term debts.

Assessing Financial Stability and Long-Term Solvency: The owner can use the Balance Sheet to assess the business's overall financial health and ability to meet long-term obligations.
Relevant Information: Total Assets, Total Equity, and Total Liabilities. The Debt-to-Equity Ratio (Total Liabilities / Total Equity) indicates the proportion of debt financing relative to equity financing. A lower ratio is generally preferred, suggesting the business is less reliant on borrowing and has a stronger financial foundation.

3.

Explain the difference between internal and external users of a business's accounts. For each type of user, describe the key information they would be interested in finding within the accounts and why they need this information.

Internal users are individuals who work within the business. They have direct access to the business's operations and are directly affected by its performance. External users are individuals or organizations outside the business who have no direct involvement in its operations. They rely on the accounts to assess the business's performance and financial health.

Here's a breakdown:

User Type	Key Information Needed	Reason for Need
Managers	Profit & Loss Account, Balance Sheet, Budget vs. Actual figures, Performance Reports.	To monitor performance, make operational decisions, control costs, and plan for the future. They need to understand profitability, efficiency, and financial position.
Employees	Job security, wage levels, company performance (indirectly through news and announcements).	To assess the stability and success of the company, which impacts their job security and potential for future earnings.
Owners (Sole Traders, Partnerships, Shareholders)	Profit & Loss Account, Balance Sheet, Financial Ratios.	To assess the profitability, financial stability, and overall value of their investment in the business. They need to understand the business's performance and potential for future returns.
Banks	Balance Sheet, Profit & Loss Account, Cash Flow Statement.	To assess the business's ability to repay loans. They need to understand the business's financial stability, profitability, and ability to generate cash.
Tax Authorities	Profit & Loss Account, Balance Sheet, Tax Returns.	To determine the amount of tax owed by the business. They need accurate financial information to ensure compliance with tax regulations.

5.5.3 Users of accounts (3)