3.5 Flashcards
Statement of comprehensive income: income statement?
This measures the business’ performance (income and costs) over a given period of time, usually one year
Statement of comprehensive income: statement of financial position?
A snapshot of the business’ assets (what it owns or is owed) and it’s liabilities (what it owes) on a particular day
Statement of comprehensive income: cash flow statement?
Shows how the business has generated and disposed of cash and liquid funds during a specific period
Stakeholder interest in the income statement: shareholders
How much profit is our business making?
How much profit can be distributed to us in dividends?
Stakeholder interest in the income statement: competitors
What is the profit and profitability?
Is the business more efficient or does it add more value?
Stakeholder interest in the income statement: government
How much tax should this business pay on its profits?
Stakeholder interest in the income statement: employees
How secure is the business in terms of product or loss?
If bonuses are based on profit, has it been active?
Statement of financial position: income statement
This measures the business’ performance over a given period of time, usually one year
Statement of financial position
A snapshot of the business’ assets (what it owns or or owed) and its liabilities (what it owes) on a particular day
Statement of financial position: cash flow statement
Shows how the business has generated and disposed of cash and liquor during a specific period
What is gearing?
Measures the proportion of a business’ capital provided by debt
What is the capital structure of a business?
Capital of a business represents the finance provided to it to enable it to operate over the long term. Two parts: equity and debt finance
What is equity and debt finance?
E: amounts invested by the owners of the business
D: finance provided to the business by external parties
Reasons for higher equity
Where there is greater business risk
Where more flexibility required
Reasons for higher debt
Where interest rates are very low = debt is cheap to finance
Where profits and cash flows are strong; so debt cab be repaid easily
Benefits to calculating the gearing ratio
- a useful measure the financial health of a business
- focuses on the level of debt in the financial structure of a business
- a high gearing ratio can mean higher risk of business failure
Gearing formula
Non current liabilities/ total equity + non current liabilities x 100
High and Low gearing
gearing ratio of 50%+ is normally said to be high
gearing ratio of less than 20% is low
the level of acceptable gearing depends on the business and industry
Benefits of high gearing
Less capital required to be invested by the shareholders
Debt can be a relatively cheap source of finance compared with dividends
Easy to pay interest if profits and cash flows are strong
Benefits of low gearing
Less risk of defaulting on debts
Shareholders rather than debt providers “call the shots”
Business has the capacity to add debt if required
What is ROCE?
ROCE tells us what returns (profits) the business has made on the resources available to it
Why is ROCE useful?
- evaluate the overall performance of the business
- provide a target return for individual projects
- benchmark performance with competitors
Formula for ROCE
Operating profit (or net profit) / Total equity + non current liabilities x 100
Evaluating ROCE
- ROCE will vary between industries; particularly important in capital intensive industries
- ROCE is based on a snapshot of a business’ balance sheet
- Comparisons over time and with key competitors are most useful
