Final accounts

Gross profit is the profit a business makes from trading before deducting its overheads/expenses. It is calculated as sales revenue minus the cost of goods sold (the direct cost of the goods actually sold in the period).

A non-current (fixed) asset is something a business owns and keeps for more than one year to help run the business, such as machinery or vehicles. A current asset is cash or an item expected to be turned into cash within one year, such as inventory, trade receivables or cash. The key distinction is the time the asset is held/used: over a year versus within a year.

First, they let shareholders and potential investors judge whether the business is profitable and whether their investment is safe and worth increasing. Second, they let lenders (e.g. banks) assess whether the firm can repay debt by comparing its assets, liabilities and profitability before granting a loan.

Gross profit = sales revenue − cost of goods sold = 520,000 − 300,000 = $220,000. Net profit (profit before interest and tax) = gross profit − total expenses = 220,000 − 140,000 =$80,000. So the business makes a gross profit of $220,000 and a net profit of$80,000 for the period.

Annual depreciation = (cost − residual value) ÷ useful life = (80,000 − 8,000) ÷ 8 = 72,000 ÷ 8 = $9,000 per year. Book value after 3 years = 80,000 − (9,000 × 3) = 80,000 − 27,000 =$53,000. Depreciation affects both final accounts: on the INCOME STATEMENT the $9,000 is recorded as an expense each year, which reduces net profit; on the BALANCE SHEET the accumulated depreciation is subtracted from the asset's original cost, so the equipment appears at its lower book value ($53,000 after three years). This matters because ignoring depreciation would overstate both profit and the value of the business's assets.

Net assets = total assets − total liabilities = (420,000 + 110,000) − (70,000 + 180,000) = 530,000 − 250,000 = $280,000. By the accounting identity, equity = net assets =$280,000, and equity = share capital + retained earnings, so retained earnings = 280,000 − 200,000 = $80,000. The net assets figure of$280,000 represents the book value of the owners' stake in the business — what would, in principle, remain for shareholders if all assets were realised and all liabilities repaid. A rising net assets figure over time suggests the business is building value (partly through retained profit), which reassures the owners, though it is a book value and may not equal market value.

Final accounts give the investor real evidence, but they must be read carefully. In favour of investing: the income statement shows rising sales revenue, suggesting growing demand and a successful expansion, and the balance sheet may show a growing base of net assets, indicating the business is building value that could support a higher share price and future dividends. If the chain is still investing heavily to open new outlets, some pressure on profit is expected and may reverse once the new sites mature.

However, the falling net profit margin is a warning. Rising revenue with shrinking margins means costs (expenses, COGS, perhaps rent and wages from expansion) are growing faster than sales, so the business is converting less of each dollar of revenue into profit. If the trend continues, absolute net profit and dividends could fall despite higher turnover, and an over-geared balance sheet (large non-current liabilities relative to equity) would make the firm risky if interest rates rise. The investor cannot judge these risks from one year alone.

Critically, final accounts have limitations for this decision. They are historic and backward-looking, they can be legally 'window dressed' (e.g. through depreciation estimates or asset valuations), and they ignore qualitative factors such as brand strength, staff quality, competition and market saturation in the café sector. On balance, the investor should NOT invest on these figures alone: the rising revenue is encouraging but the falling margin is a genuine red flag. I would recommend the investor examine several years of accounts and liquidity/gearing ratios, and weigh qualitative factors, before committing — the decision depends on whether the margin fall is a temporary cost of expansion or a structural problem.

The choice of depreciation method changes the profit and asset figures the company reports, so it is a genuine strategic and accounting decision. In favour of reducing balance: vehicles lose most of their value in the first years, so reducing balance (a fixed percentage on the falling book value) MATCHES the real pattern of value loss more realistically than an equal annual charge. This gives a more accurate book value on the balance sheet and a more prudent, higher expense early in the asset's life, which can look responsible to lenders and reduces the risk of overstating profit and net assets while the fleet is new.

Against the switch: reducing balance is more complex to calculate and produces uneven annual charges, which makes profit harder to forecast and compare year to year. The larger early-year depreciation depresses early net profit, reducing distributable profit and possibly disappointing shareholders in the short run. There are also comparability and consistency concerns — frequently changing method can be seen as manipulating results, and some stakeholders prefer the simplicity and predictability of straight-line.

A judgement must weigh realism against simplicity and consequences. For a delivery firm whose main non-current assets ARE fast-depreciating vehicles, reducing balance is the more faithful method and is likely to give truer asset values and a more prudent profit figure, which strengthens the credibility of the accounts with banks that finance the fleet. However, the firm should switch only for genuine accounting reasons, apply it consistently thereafter, and explain the change, because switching purely to flatter or depress profit would undermine trust. On balance, given the nature of the assets, adopting reducing balance is justified — but the benefit is in accuracy and prudence, not in the raw profit number, and consistency matters more than the method chosen.

Final accounts give the bank a lot of the information it needs, but relying on them alone is risky. Their strengths for a lending decision: the balance sheet shows the business's assets and liabilities, letting the bank assess whether there are enough net assets and non-current assets to act as security, and whether existing gearing (non-current liabilities relative to equity) is already high. The income statement shows whether the firm is profitable enough to generate the earnings needed to service interest and repay capital, and comparing several years reveals the trend. For a manufacturer with substantial machinery and property, the asset base on the balance sheet is especially relevant as collateral.

However, final accounts alone are insufficient. They are historic and backward-looking, so they show where the firm HAS been, not its future ability to repay in changing market conditions. Profit is not the same as cash — a profitable firm can still fail to meet loan repayments if it has poor cash flow (a separate cash-flow forecast is needed). The accounts can be window dressed through depreciation estimates and asset valuations, and they omit crucial qualitative factors: the quality of management, the order book, competition, and the state of the economy. A single year's snapshot can also mislead.

Overall, final accounts are a necessary but not sufficient basis for the decision. The bank should use them for what they do well — assessing profitability, net assets and gearing — but must combine them with a cash-flow forecast, liquidity and gearing ratios, a business plan, and qualitative judgement about management and the market. The extent to which the accounts alone suffice is therefore limited: they are the starting point of the analysis, not the whole of it, and their usefulness depends on how recent, audited and representative they are.