204 analysing financial performance Flashcards
explain what is meant by budget variance
- a budget is a financial plan for the future, variance analysis s checking actual outcomes over predicted outcomes
- the difference between the business budgeted and the actual figure
variance calculation
actual- budgeted figures
favourable variance is shown when
- actual revenue is greater than budgeted revenue
- actual costs and below budgeted costs
- the variance results in more profit being made
adverse (unfavourable) variance is shown when
- actual revenue is less than budged revenue
- actual costs are above budgeted costs
- the variance results in less profit being made
importance of budgets to stakeholders
- understand when money is coming in and out- avoid cash flow difficulties
- understand why variances have occurred- solutions to maximise favourable variances
- can be used to se and monitor achievements to targets - motivating for employees
- helps set departmental targets for individual managers for focus on
disadvantages of budgets to stakeholders
- competition and economy - unable to predict budget
- only a prediction of future- if incorrect/unreliable research is used- inaccurate budgets- can be demotivating (if targets are set too high)
usefulness of budgeting depends on
- expertise of budget setter
- stability of market
- amount of historical data available
- size of business - small may not have time/knowledge
what is a balance sheet
- a balance sheet is a statement of a firms assets, liabilities and shareholder’s or owners funds.it shows the net worth of a business at a specific point in time.
what are fixed (non-current) assets
fixed assets expected to be retained in the business for over a year, used to produce output of the business eg.machinery , land
what are current assets
- short term assets, maintain value for the business for less than a year eg.stock
what are current liabilities
- debts that are normally paid within a year eg. overdraft, loan
what are long term (non-current) liabilities
- money repaid over more than a year eg bank loans and mortgages
what are net assets
- total assets- total liabilities
- calculated by adding both fixed an current assets together and then deducting current liabilities and long term liabilities
- this shows business value
what is shareholders capital/ funds
-also called equity
- is money that has been invested into the business by owners (through the sale of shares) and also includes retained profit and reserves
shareholders funds equation
Fixed assets + (Current assets- Current liabilities) - Long term liabilities = Shareholder’s funds
what is working capital
- the money needed in the business to pay for the day-to-day expenses of a business
current assets-current liabilities
what is meant by capital employed
- the amount of money that is used to. finance a business sin the long term, this finance has either been invested by shareholders or borrowed long term
capital employed equation
capital employed= shareholder’s funds + long. term liabilities
what is depreciation
- the decrease in value of fixed assets overtime eg.due to wear and tear
- the straight-line method of depreciation assumes that a fixed asset depreciates an equal
amount to each year of its expected useful
decrepitation equation
Calculation:
Original Cost - Residual Value
———————————————-
Useful life of the asset (years)
-> take the answer from the equation away year by year from the original cost
what is ROCE
- measures how effectively a business is creating profit based on the money they invested into the business
- the answer is a percentage
ROCE equation
ROCE = net profit before tax
———————————- x 100
capital employed
what is current ratio
shows the business ability to meet short term payments eg. to suppliers
current ratio equation
current ratio= current assets
———————— : 1
current liabilities
(idea, ratio between 1.5:1 and 2:1)
interpreting current ratios
- below 1.5:1-> business may not be able to pay its short term debts
- ^above 2:1*-> business has space cash that is not being used productively
- but some business hapily survive on low ratios -> eg. supermarkets have high volume sof stock and are able to sell stock quickly and consistently
what does the acid test ratio show
- shows how well a company can cover its short term liabilities, without relying on the sale of stock
what does the acid test ratio show
- shows how well a company can cover its short term liabilities, without relying on the sale of stock
acid test ratio formula
current assets - stock
———————————-
current liabilities
interpreteing acid test ratio
- ideal range 1:1
- less than 1:1- business does not have enough cureent asets (minis stock) to cover its liablities
- some busisnes surive on low acid test ratios-> business swith high level of stock turnover
- acid tes of 2:1- buisness holding too much cash-could be better used investing in growth
what does gearing ratio look at
- shows how much a company relies on borrowed money compared to its own money
gearing ratio equation
long term (non-current liabilties)
—————————————————————— x 100
capital employed
(as a %)
inrepret gearing ratios
high gearing :
(-)- interest rates increase-costly payments-reduces pfofits available to shareholders-less money to re-invest/- investors reluctant to invest in companies with high gearing ratio-feel lower chance of profit
(+) - interest rate low-cost effectve to borrow-helps business grow
- quciker way of raising finance for larg companies
-low gearing :
(+) less risk to changes in interst rates as most of the capital in the business comes from shareholder investment, more capital available to pay shareholders their dividends
(-) business might only be focusing on cash flow- not expanding-miss out on oppotunities/markets
usefullness of a balence sheet
-shareholders are owners of the business-want to know how well it is doing.
-If the current liabilities are a lot more than the currentassets in each year, then the business could have a problem in paying its debts.
-can be compared over time.
gearing ratio percenatges
- high= 51%+
-medium= 26-50%+
-low = 0-25%
what is window dressing
manipulation of financial accounts by a business to improve the appreance of its preformace
methods of window dressing
- overstating brand value
- cash flow problmes can be hidden using sale and leaseback eh.sale of fixed assets eg.buildings, and leasing then back so they can still be used
- expetional items
- if fixed asset isjt depreacuated enough it will make the balence sheet look better as the asset will be listed as having higher value than they actually do
what can affect window dressing
- change in demand eg.covid-busineses had to close-not reperesntive of the state of the business
- inflation- may look like a business has increased sales/profits- all businses increased profts-not refeltive of improved performace
evalaute window dressing
(-) legal implications, demanged stakehlder relationshop,devalue comany, loose acsess to soirces of finance
income statement equation
- gross profit = revenue- cost of sales
- net profit = grss profit - expences
- GPM= pross profit
—————— x 100
revenue
-NPM= net profit
—————— x100
revenue
