Accounting and finance within the external environment

Welcome to Accounting and Finance in the Real World!

Hello! Today, we are exploring how the world outside a business impacts its bank balance and financial reports. If you have ever wondered why a sudden change in the news makes a company’s profits go up or down, you are in the right place. Don’t worry if this seems a bit broad at first—we are going to break it down into simple categories so you can master it in no time!

In this chapter, we look at how external influences—things the business cannot always control—affect its accounting and finance. These influences are often remembered using the list below.

1. Social Influences

Social influences refer to changes in the way people live, their tastes, and the "make-up" of the population (demographics).

Example: If more people decide to become vegan (a social trend), a meat-processing company might see its revenue drop, while a plant-based food company might see its profits soar.

How it affects finance:

• Revenue: Changes in consumer tastes can increase or decrease sales.
• Costs: An aging population might mean a business has to spend more on pension contributions for its workers.

Quick Review: Think of "Social" as "People Power." If people change their habits, the numbers in the Income Statement will change too.

2. Legal Influences

The law is non-negotiable! Legal influences are the rules set by the government that a business must follow.

How it affects finance:

• National Minimum Wage: If the government increases the minimum wage, a business’s labour costs will go up immediately.
• Taxation: Changes in Corporation Tax rates affect how much "Profit after Tax" a business keeps.
• Accounting Standards: Businesses must follow GAAP (Generally Accepted Accounting Practice). If the rules on how to record assets change, the Statement of Financial Position must be updated.

Common Mistake to Avoid: Don't confuse Legal with Ethical. Legal is what you must do by law; Ethical is what you should do because it is right.

3. Ethical Influences

Ethical influences involve the moral choices a business makes. This is about doing the right thing, even if it costs more.

How it affects finance:

• Fair Trade: Choosing to pay suppliers a fair price (rather than the lowest possible price) increases cost of sales but might improve the brand's reputation.
• Investment: Ethical businesses may refuse to take loans from banks that invest in harmful industries, which might limit their sources of finance.

Did you know? Many investors now look for "ESG" (Environmental, Social, and Governance) scores before they decide to buy shares in a company!

4. Environmental Influences

This is all about the planet. Environmental influences include climate change, pollution, and sustainability.

How it affects finance:

• Green Taxes: Governments may charge businesses for their carbon emissions, which increases expenses.
• Waste Management: Disposing of chemicals or plastic safely can be expensive, adding to the total costs of production.
• Renewable Energy: Investing in solar panels involves a large capital expenditure (outflow of cash) at the start, though it might save money on electricity bills later.

5. Economic Influences

This is the "big picture" of money in the country. Key factors include interest rates, inflation, and unemployment.

How it affects finance:

• Interest Rates: If interest rates rise, the cost of repaying loans goes up. This is recorded as a finance cost in the Income Statement.
• Inflation: If the price of raw materials rises (inflation), the gross profit margin might fall unless the business raises its own prices.
• Exchange Rates: If the value of the Pound (\$) falls, it becomes more expensive for a UK business to buy materials from abroad.

Memory Aid: Think of the economy as the "weather" for business. Some days it’s sunny (low interest, high growth), and some days it’s stormy (high inflation)!

6. Political Influences

Political influences come from government decisions and stability. Politics often goes hand-in-hand with economics and law.

How it affects finance:

• Subsidies: A government might give a business a "grant" (free money) to encourage them to build a factory in a high-unemployment area. This is a positive cash inflow.
• Trade Barriers: Political decisions to add tariffs (taxes) on imported goods will increase the costs for businesses that buy stock from other countries.

7. Technological Influences

Technology is constantly changing how we track and spend money. Technological influences include automation, software, and e-commerce.

How it affects finance:

• Cloud Accounting: Software like Xero or QuickBooks allows businesses to see their cash flow in real-time, helping them make better decisions.
• Automation: Spending money on robots (a non-current asset) might be expensive today, but it reduces variable costs (wages) in the long run.

8. International Influences

We live in a global world! International influences involve trade with other countries and global competition.

How it affects finance:

• Global Competition: If a cheaper international rival enters the market, a business may have to lower its prices, leading to a lower operating profit.
• Foreign Exchange: Managing different currencies adds complexity to accounting. A business must carefully track the value of its receivables (money owed by customers) if those customers are paying in a different currency.

Summary: The "Big Picture" Takeaway

All of these external factors eventually show up in the Financial Accounts. When you are writing an exam answer, try to follow this "chain of thought":

1. Identify the external change (e.g., Interest rates rise).
2. Explain the immediate effect (e.g., Loan repayments become more expensive).
3. Link it to a financial measure (e.g., This increases finance costs and reduces net profit).

Quick Review Box: Social - People/Tastes
Legal - Rules/Laws
Ethical - Morals/Right vs Wrong
Environmental - Planet/Sustainability
Economic - Money/Rates/Inflation
Political - Government/Grants
Technological - Machines/Software
International - Global Trade

Don’t worry if you find it hard to remember all eight at once! Just remember that "Accounting doesn't happen in a vacuum"—everything happening in the news eventually changes the numbers on the page.