Briefly explain the general purpose of each of the three financial statements (the income statement, the balance sheet and the cash flow statement) and the usefulness of each of them for the owners of cutting edge Ltd.

case study:

Becky and Dan established a hairdressing company together in 2010, cutting edge Ltd. At first, they had one salon but over time they have opened six more, two of which opened at the very end of 2019. In other words, the 2019 figures are for five branches, whereas those for 2020 are for seven branches. The salons, which are all roughly the same size, cater to both men and women. Their business model now is to rent out 'chairs', a system whereby self-employed hairdressers pay a monthly rent to use a chair in one of the salons. The rents are set annually in advance and should be paid monthly in arrears. Becky and Dan no longer style hair themselves but oversee the business. This involves the accounting and administration from their home-office, marketing and branch visits.

Additionally, they sell hair products in store. These are typically sold at a 150% mark up (that is, the sales price is two and half times the cost of purchase. For example, if a product cost Snip 10 then it would be sold at 10 + (10 x 1.5 = 15) = 25, or 10 x 2.5 = 25.). Hairdressers do not get a commission for making product sales, but those who sell more get reduced chair rents at the annual re-negotiation. Any receivables in the balance sheet relate to hairdressers' chair rents.

Although most of the hairdressers are self-employed, Becky and Dan take a salary. They also currently have twelve apprentices on their books, whom they help to train. The apprentices help the self-employed stylists and only receive a salary. The customers' payments go to the stylists. Hence the apprentices do not generate income for cutting edge.

The cutting edge chain has a reputation for high quality and a loyal customer base locally. This has been done through a combination of recommendations by satisfied customers and by marketing and advertising. However, they have noticed a drop in customers recently with a trend in some customers deciding to cut their own hair at home.

80% of the shares of the company are owned by Dan and Becky and the rest by Becky's mother, Susan. The shareholders have not been taking dividends out of the business in order to increase funds for investment by the company.

Over the past few years, the return on equity has been around 34%. Part-way during 2019 cutting edge increased their debt to 125,000 to help fund expansion.

Susan is concerned that the business is not realising its full potential as well as how to address the possibility of falling customer numbers. For example, she has read that more men are starting to cut their own hair at home. Susan wishes to understand more about the latest financial statements, any trends indicated by an analysis of the financial statements and any future plans as to how any concerns may be addressed. She is quite concerned that the cash flow statement was negative last year and not very positive this year.

At 31 Dec 2020 At 31 Dec 2019 Ek Ek Ek Ek Non-current assets Property and fixtures 715 617 Total non-current assets 715 617 Current assets Inventory 187 130 Receivables 147 119 Cash at bank 203 237 Total current assets 607 486 Current liabilities Payables 260 305 Corporation tax 37 38 Total current liabilities 297 343 Net current assets 310 143 Total assets less current liabilities 1,025 760 Long-term liabilities Bank loan 125 125 Net Assets 900 635 Equity Share capital 50 50 Reserves: retained earnings 850 585 Total Equity 900 635Year to 31 Dec 2020 Year to 31 Dec 2019 Ek Ek Operating activity: Operating profit 314 205 Corporation tax paid C 38) ( 25) Non-cash expenses: Depreciation 123 115 Changes in cash invested in working capital: (Increase)/Decrease in inventory 37) (Increase)/Decrease in receivables 28) 3 Increase (Decrease) in payables 45) Net cash inflow from operating 289 382 activities Investing activity: Purchase of non-current assets ( 221) ( 492) Net cash outflow from investing ( 221) ( 492) activities Financing activity Interest paid on bank loans 12) Net cash outflow from ( 12) 3) financing activities Change in cash balances 56 ( 113) Opening cash balance at 1 237 350 January Closing cash balance at 31 293 237 DecemberYear to 31 Dec 2020 Year to 31 Dec 2010 Ek Ek Ek EK Sales revenue Products 752 713 Rent of chairs 1.698 1,380 2,450 2,102 Less cost of goods sold: Opening inventory 130 98 Purchases 381 343 511 441 Less closing inventory 167 130 Cost of goods sold 344 311 Gross profit 2,106 1,791 Less expenses: Salaries 417 254 Insurance, legal and professional 81 75 Rents and local taxes 759 680 Energy and other utilities 356 282 Marketing and advertising 90 Depreciation 123 115 Total expenses 1,792 1.496 Operating profit 314 295 Less interest cost 12 3 Profit before taxation 302 292 Less Corporation Tax 37 3.8 Profit after taxation 265 254