Accounting Study Notes: Chapter 6.4 - Interested Parties
Introduction: Who Cares About Your Accounts?
Welcome to the final section of Analysis and Interpretation! You’ve learned how to calculate ratios and prepare Financial Statements. But why do we bother? It’s because these statements are powerful tools used by many different groups of people—or "interested parties"—to make important decisions.
Think of a business’s Financial Statements (the Income Statement and the Statement of Financial Position) as a health report. Different doctors (interested parties) check different sections of the report depending on what they need to know.
In this chapter, we will look at exactly what information these parties use and why they need it.
Don't worry if this seems like a lot of different people. We will break them down based on whether they care about Profitability (making money) or Liquidity (paying bills).
1. Internal Interested Parties
These parties are directly involved in running the business.
1.1 Owners (Proprietors, Partners, Shareholders)
The owners are the people who put the money into the business. They have the biggest financial stake, so they need to know if their investment is safe and growing.
What do Owners look at?
- Profitability Ratios: Especially Return on Capital Employed (ROCE). This shows how effectively the total long-term money invested in the business is generating profit.
- Profit for the Year: The final amount of earnings.
- Owner's Equity/Capital: To see if their total wealth invested in the business has increased over time.
Why do Owners need this information?
Owners use the accounts for monitoring progress and making major decisions:
- Investment Decisions: Should I put more money into the business or take some out?
- Performance Review: Is the business meeting its goals?
- Continuation: Should I continue operating, or sell the business?
Analogy: An owner is like a farmer checking the harvest. They want to know: Did the seed money (capital) yield enough crop (profit) to make the hard work worthwhile?
1.2 Managers (The day-to-day decision makers)
Managers are responsible for the operations of the business. They use accounting information much more frequently and in greater detail than owners.
What do Managers look at?
- Gross Margin and Profit Margin: To assess pricing policies and cost control.
- Rate of Inventory Turnover: To ensure stock is not held too long (which costs money).
- Detailed Expense Reports: To identify areas where costs can be cut (e.g., advertising, utilities).
- Trade Receivables Turnover: To ensure customers are paying quickly.
Why do Managers need this information?
Managers use this data for operational control and budgeting:
- Cost Control: Identifying inefficient departments or excessive spending.
- Pricing Strategy: Determining if the selling price is high enough to cover costs and achieve the required margin.
- Efficiency: Making decisions about inventory management and resource allocation.
✅ Quick Review: Internal Parties
Owners: Care about Profitability (ROCE) and overall wealth growth.
Managers: Care about Efficiency and detailed Cost Control.
2. External Interested Parties (The Creditors and Authorities)
These parties exist outside the business structure but have a financial relationship with it.
2.1 Trade Payables (Suppliers)
Trade payables are people or businesses who have sold goods or services to the company on credit. They need reassurance that they will be paid back.
What do Trade Payables look at?
- Liquidity Ratios: Especially the Current Ratio and Liquid (Acid Test) Ratio. These show if the business has enough short-term assets to cover its short-term debts.
- Trade Payables Turnover: To see the average time it takes the business to pay its suppliers.
Why do Trade Payables need this information?
They are deciding on credit terms:
- Risk Assessment: Is it safe to grant credit to this business?
- Setting Limits: How much credit should we offer?
If the liquidity ratios are very low, the supplier might refuse to sell on credit or demand cash upfront!
2.2 Banks and Lenders
Banks provide large loans or overdrafts. They are interested in both the short-term ability to pay interest and the long-term viability of the business.
What do Banks look at?
- Liquidity Ratios: To check the ability to manage overdrafts and short-term debt.
- Return on Capital Employed (ROCE): A high ROCE suggests the business is profitable enough to generate the cash needed to pay back a loan.
- Non-current Liabilities: To see how much debt the business already owes.
Why do Banks need this information?
They are deciding on loan approval and loan security:
- Repayment Capacity: Can the business pay the interest and repay the principal loan amount on time?
- Security: Do the assets of the business (found on the Statement of Financial Position) provide enough security for the loan?
2.3 Investors (Potential future owners)
These are people considering buying shares or investing capital in the business. They care about future profitability and growth potential.
What do Investors look at?
- Profitability Ratios: ROCE and Profit Margin, often compared over several years (trends).
- Statement of Financial Position: To assess the overall health and size of the business’s assets.
Why do Investors need this information?
They are making a buy or wait decision:
They want to know if the business is a worthwhile, profitable investment that will provide a good return in the future.
❌ Common Mistake to Avoid!
Students often mix up owners and investors. Owners are already in the business; investors are potential owners or lenders looking from the outside. Both care about profit, but owners often have more detailed internal knowledge than external investors reading a public report.
3. Other Key Parties
3.1 Governments and Tax Authorities (e.g., HMRC, IRS)
These official bodies ensure businesses comply with laws and contribute fairly to the economy.
What do Tax Authorities look at?
- Profit for the Year: This figure is essential for calculating the correct amount of income tax or corporate tax due.
- Revenue (Sales) figures: Needed for calculating taxes like VAT or GST (sales tax).
Why do Tax Authorities need this information?
They enforce compliance and tax collection. They use the statements to verify that the declared taxable profit is accurate.
3.2 Club Members (Non-Trading Organisations)
For organisations that exist not to make a profit but to provide a service (like a sports club or society), the "owners" are the members.
What do Club Members look at?
- Income and Expenditure Account: To check if there was a Surplus (like profit) or a Deficit (like loss).
- Accumulated Fund: The club's total reserve of wealth.
- Detailed Expenses: To ensure subscriptions and fees are being spent wisely and on activities that benefit the members.
Why do Club Members need this information?
They need to ensure fees are managed responsibly and to approve future spending plans (e.g., buying new equipment or lowering/raising fees).
Did you know? Even though clubs don't aim for profit, they still need accounting statements to prove they are solvent (can pay their bills) and that their funds are being used ethically.
Key Takeaway Summary Table
Summary of Interested Parties and Their Focus
| Party | Primary Focus | Key Ratios/Figures |
|---|---|---|
| Owners | Return on Investment & Growth | ROCE, Profit for the Year, Capital/Equity |
| Managers | Operational Efficiency & Costs | Margins, Inventory Turnover, Detailed Expenses |
| Trade Payables | Short-term Credit Risk (Will they pay me?) | Current Ratio, Liquid Ratio, Payables Turnover |
| Banks/Lenders | Long-term Solvency & Security | ROCE, Liquidity Ratios, Existing Non-current Liabilities |
| Tax Authorities | Legal Compliance & Tax Calculation | Profit for the Year, Revenue |
You have now learned that accounting is truly the language of business, allowing diverse groups to understand and evaluate the performance of an entity!