3.7 Internal analysis Flashcards
Balance sheets are
lists of assets and liabilities.
§ Balance sheets are a snapshot of a firms finances at a fixed point in time.
§ They show the value of all the business’ assets (the things that belong to the business, including cash in the bank)
and liabilities (the money business owes). They also show the value of all the capital (money invested in the business)
and the source of that capital (loans, shares or retained profits) – so they show where the money’s come from as well
as whats being done with it
§ The net assets value (total fixed assets- total current and non-current (long term) liabilities is always the same as
‘total equity’ value- the total of all the money that’s been put into the business- balance sheets- they balance
(non)current assets / liabilities and examples
Current assets:
Short term thing you own
§ Cash
§ Stock. Debtors/
receivables
Non- current asset (fixed
asset) – l/t thing you own
§ Property/ factory
§ Land/ vehicles
Current liability- s/t thing
you owe
§ Creditors (trade credit,
bills, rent, overdraft)
Non- current liability- l/t
thing you owe
§ Bank loan
§ Mortgage
Assets are
- why businesses by assets
-types of assets and examples
-what happens to non current assets over time
the things the business owns:
Businesses can use capital to buy assets that will generate more revenue in the future- investment
§ Assets (machinery and stock) provide a financial benefit to the business, given a monetary value on the balance
sheet. Can be classified as non- current assets (fixed assets) or current assets
§ Non- current assets are assets that the business is likely to keep for more than one year e.g. property, land,
production equipment, desks and computers. The ‘total non – current assets’ value on the BS is the combined value
of all the business’ non-current assets. often lose value over time, so they’re worth less every year= depreciation.
Businesses should factor in depreciation to give a realistic value of their non – current assets on the balance sheet.
§ Current assets are assets that the business is likely to exchange for cash within the accounting year, before the next
balance sheet is made. All the current assets are added together to give the ‘total current assets’ value on the
balance sheet
§ Current assets include receivables (money owed to the business) and inventories or materials that will be used to
make products , that will be sold to customers)
§ The business’ current and non- current assets are added together then current and non-current liabilities are
deducted to give the figure for ‘net assets’ on the balance sheet
Liabilities are
-what are bad debts and what happens to them
debts the business owes
§ Current liabilities are debts which need to be paid off within a year. They include overdrafts, taxes due to be paid,
payables, and dividends due to be paid to shareholders. Total current liabilities are deducted from total fixed and
current assets to give the value of assets employed
§ Non- current liabilities are debts that the business will pay off over several years e.g. mortgages and loans
Bad debts are debts that debtors won’t ever pay
§ Sometimes debtors default on their payments- debts which don’t get paid are ‘’bad debts’’-
§ Bad debts can’t be included on the balance sheet as an asset- as they don’t get money for them
§ Puts these as an expense on the profit and loss account- shows the business has lost money
Intangible assets:
§ Patents, trademarks, copyrights, intellectual property
§ Brand name = intangible assets
Tangible fixed assets=
total fixed assets- intangible assets
Working capital is
- day to day
- what is it also equal to
- what shouldn’t it be and why
- why do business need cash but not too much
-which businesses need more cahs
- when will firms need more cash
- what should a buisiness avoid when expanding (cash)
the finance available for day to day spending
§ It’s the amount of cash that the business has available to pay tis day to day debts. The more working capital – the
more liquid
§ Working capital= net current assets
§ Working capital shouldn’t be tied up in inventories or receivables- cant use these pay their current liabilities until
they’re turned into cash
§ Businesses need enough cash to pay s/t debts- shouldn’t have too much cash- opportunities
§ Businesses with a long cash flow cycle need more cash as they have to wait for money to come in
§ Firms need more cash when inflation is high
§ When a business expands, in needs more cash to avoid overtrading- expanding too quickly that the business
can’t afford to pay its suppliers until it gets paid by customers
Liquidity ratio shows
shows how much money is available to pay the bills
§ Business that doesn’t have enough current assets to pay its liabilities when they are due is insolvent. It either has
to quickly find money to pay them, cease trading or go into liquidation
§ Liquidity can be improved by decreasing stock level, speeding up collection of debts, or slowing down payments
to creditors
§ A liquidity ratio shows how solvent a business is
§ 1.5 – 2= good, healthy
§ >2, unused cash reserved that could productively be invested to increase profitability or given to
shareholders as dividends
Low liquidity ratios Suggest
- what will be needed
- what should happen
business may have difficulty in paying its s/t debts, bills especially If stock cannot be sold
quickly
§ More working capital may be needed
§ Risks should be assessed and action taken
High liquidity ratios:
§ Suggest
business Is liquid
§ Cash could be invested to produce a return
how must debtors and stock be controlled
RTN
Businesses need finance for capital expenditure
-what is capital expenditure aka (2 things)
-what must businesses set aside enuogh for
-what is capital employed
what are share holder funds
-
§ Fixed capital (capital expenditure) means money used to buy non- current assets. These are thing used over and
over again to product goods – factories, equipment
§ Businesses need capital expenditure to start up, grow and replace worn out equipment. Must set aside enough
money to stop non- current assets from wearing out and then decide how much money to invest in growth=
allocating capital expenditure
§ Capital expenditure= non -current assets
§ Capital employed: All l/t liabilities that don’t have to be paid back by a certain time e.g. shareholder/ investor
funds, retained profit
Shareholder funds:
§ Includes money involved in buying shares
§ Liability as the business is a separate legal entity, owes money to shareholders
Stock is valued at
cost or at net realisable value- whichevers lower
§ Accounting conventions say that stock values must be realisable. The net realisable value is the amount the company
could get by selling the stock right now in its current state (raw materials or finished products)
§ The realisable value might be lower than cost value or may be higher
§ Company must record stock value in its account as the lower value out of cost or net realisable value
Accounts reflect the
depreciation of assets:
§ Businesses calculate depreciation each year to make sure that an assets value on the balance sheet is a true reflection
of what the business would get from selling it
§ Building depreciation into each year’s account avoids the fall in value hitting all at once when the business sells the
asset-. Spreading out the cost of the depreciation over several years is a truer reflection of the situation and allows the
business to make comparisons between financial years more easily
§ The amount lost through depreciate is recorded on the income statement- expense.
Balance sheet shows the s/t
why are suppliers interested in working capital and liquidity
what does this ST info help asses
why should bus. compare banlance sheets
what does an increase in non current assets indicate
what does increase in reserves suggest
financial status of the company
§ Suppliers are interested in working capital and liquidity -= look at balance sheet to see how liquid assets- better at
paying bills more liquid they are. Helps to decide whether to offer the business supplies on credit and how much
credit to offer
§ s/t information helps assets internal strengths, weaknesses.
Comparing balance sheets= long term trends
§ A quick increase in non- current assets indicates that the company has invested in property or machinery- investing in
a growth strategy- increase profits – useful for shareholders and potential
§ Increases in reserves – suggest increase in profits
§ Identify strength and weaknesses.
Income statements:
what is inclueded and examp. of them
what is a sign that company is healthy
who has to publish
a way or reporting profit or loss over a certain period of time- a summary that shareholders and
potential investors can use to assess the company’s performance
§ Revenues is sales incomes, cash and credit
§ Expenses = raw materials, production costs, marketing costs, wages
§ These figures can be used in assessing a company’s financial performance- if revenue has increase by more than
rate of inflation – Sign Company is healthy
§ PLCs have to publish their account so that they’re available to anyone who wants to look at them- shareholders,
potential shareholders, competitors. Can be published by sole trader, Private limited company
Income statements cover a period of time:
§ Should cover one whole accounting year
§ Can also contain previous years data- easy comparison, trends
Companies must disclose in income statement:
§ Exceptional items- one off financial transactions arising from normal trading activities (e.g. opening of a new
store)
§ Extraordinary items- large transaction outside normal trading activities of a business e.g. (closure of a factory
might result in redundancy pay and any loans
Income statements show:
§ Finance income- any interest paid to the company of money spent or saved
§ Financial expenses- any payments of interest on loans
§ Public and private that have gone through legal incorporation process to gain limited liability will be charged
corporation tax
RTN!!!!!
These measures can be used to assess financial performance: (types of profit and what they show)
what does operating profit < gross profit suggest (plus steps to solve)
§ Gross profit shows the money being made from actually making and selling products. If gross profit is low
managers need to look at ways of reducing the cost, or increasing the selling price
§ Operating profit shows the money made from normal business operation. If operating profit is significantly lower
than gross profit- shows that the company’s operating expenses are a weak area. Managers should take steps to
reduce these expenses e.g. By reducing marketing costs. However the operating profit could reflect a big
investment in people, premises. Bank s and investor will look at this to assess risk
§ Comparing profit before tax to operating profit shows if income or expenses are coming from other activities rather
than normal activities - which may not continue in the future
§ Profit after tax tells you if the company is profitable- shareholders, investors
§ Retained profit- shows how much internal finance the company has available to invest, how strong its growth
potential is
Profit quality:
high qual profit vs low qual
refers to whether a
source of profit is sustainable in
the long term
High quality profift: source of
profit that’s likely to continue in
the future
Low quality profit- a result of
actions that are likely to occur
again
Income statements: profit margins +VE -VE
Benefits
§ Simple to calculate
§ Gives an overview of where most costs are incurred
§ Can be used to spot trends in profit/ costs
§ Can be used to compare similar businesses
§ Useful for assessing performance
Limitations:
§ Ratios aren’t enough to explain why costs are incurred
§ Shouldn’t base business decisions on ratio alone
§ Doesn’t include any info about external factors; market
demand which would be useful in forecasting future
revenue and profit
§ Doesn’t include any info about internal factors e.g. staff
morale- useful in determining productivity thus
profitability
§ In times of inflation, income statement isn’t so useful as
inflationary rises in price distort the true value of
revenue
§ Can be deliberately distorted by bringing forwards
sales from the next trading period and including them as
part of this trading period