Cambridge Syllabus Notes

5.5.3 Users of Accounts 📊

Who uses the accounts? 👥

Think of the company’s accounts as a giant scoreboard. Different people look at the scoreboard for different reasons:

Managers – want to see how well the business is doing to make decisions.
Investors – check if the company is a good place to put their money.
Creditors – need to know if the company can pay back loans.
Employees – look for job security and future growth.
Government & Tax Authorities – ensure taxes are paid correctly.

Limitations of using accounts ⚠️

While the scoreboard is useful, it has some blind spots:

Historical data only – accounts show what happened in the past, not what will happen.
Non‑financial information missing – things like employee morale or brand strength aren’t in the books.
Estimates & judgments – some figures (e.g., depreciation) are based on assumptions.
Manipulation risk – clever accounting tricks can hide problems.
Time lag – financial statements are released after the period ends, so they may be outdated.

Exam Tip: When answering “What are the limitations of using accounts?”, list at least three and explain why each matters for decision‑making. Use examples from real or fictional companies.

Ratio Analysis – Turning Numbers into Insights 📈

Ratios are like cheat codes that help you compare different parts of the business quickly.

Profitability Ratios 💰

Gross Profit Margin – $ \frac{\text{Gross Profit}}{\text{Revenue}} \times 100\% $
Net Profit Margin – $ \frac{\text{Net Profit}}{\text{Revenue}} \times 100\% $
Return on Assets (ROA) – $ \frac{\text{Net Profit}}{\text{Total Assets}} \times 100\% $

Liquidity Ratios 🚀

Current Ratio – $ \frac{\text{Current Assets}}{\text{Current Liabilities}} $
Quick Ratio – $ \frac{\text{Current Assets} - \text{Inventory}}{\text{Current Liabilities}} $

Efficiency Ratios 🔄

Asset Turnover – $ \frac{\text{Revenue}}{\text{Total Assets}} $
Inventory Turnover – $ \frac{\text{Cost of Goods Sold}}{\text{Average Inventory}} $

Solvency Ratios 🏦

Debt to Equity – $ \frac{\text{Total Debt}}{\text{Shareholders' Equity}} $
Interest Coverage – $ \frac{\text{EBIT}}{\text{Interest Expense}} $

Ratio	Formula	Interpretation
Gross Profit Margin	$ \frac{\text{Gross Profit}}{\text{Revenue}} \times 100\% $	Higher = better cost control.
Current Ratio	$ \frac{\text{Current Assets}}{\text{Current Liabilities}} $	>1 means you can cover short‑term debts.
Debt to Equity	$ \frac{\text{Total Debt}}{\text{Equity}} $	Lower = less risky for creditors.

Exam Tip: When asked to calculate a ratio, show the formula, plug in the numbers, and explain what the result tells you about the company’s performance or position.

Putting It All Together – A Mini Case Study 🧩

Imagine TechToys Ltd. has the following figures for 2023:

Revenue: £1,200,000
Gross Profit: £480,000
Net Profit: £120,000
Current Assets: £300,000
Current Liabilities: £200,000
Total Assets: £800,000
Total Debt: £400,000
Shareholders' Equity: £400,000

Calculate the Net Profit Margin and Current Ratio and interpret the results.

Exam Tip: Show each step clearly: first compute the ratio, then state the value, and finally explain what it means for the business.

limitations of using accounts and ratio analysis