3.7.2 Analysing The Existing Internal Position Of A Business: Financial Ratio Analysis

Question 1

What is a “balance sheet” ?

Answer 1

A financial statement recording the assets and liabilities of a business at the end of an accounting period

Also known as a “statement of financial position”

Question 2

What are “assets” ?

Answer 2

An item owned by a business, such as cash in the bank, vehicles, property and machinery

Question 3

What are “liabilities” ?

Answer 3

Money owed by a business to individuals, suppliers, financial institutions and shareholders

Question 4

What is a “consolidated balance sheet” ?

Answer 4

The total balance sheet for a business, including its divisions

Question 5

Key balance sheet relationships: (3)

Answer 5

• ASSETS = LIABILITIES
  explains why balance sheets should always balance
• TOTAL ASSETS = CURRENT ASSETS + NON-CURRENT ASSETS
  businesses need to invest in a range of assets to operate efficiently
• LIABILITIES = SHARE CAPITAL + BORROWING + RESERVES

Question 6

Why do shareholders use balance sheets ?

Answer 6

To asses a business’ potential to generate profit (higher portion of assets)

Question 7

Why do suppliers use balance sheets ?

Answer 7

To investigate the short-term position of the company in relation to offering credit and judging whether a business can pay its bills

Question 8

Why do managers use balance sheets ?

Answer 8

To give an indication of the performance of a business and asses how to raise capital for further investments

Question 9

What are “non-current assets” ?

Answer 9

Assets owned by a that it expects to retain for over a year, which are not purchased for the purpose of resale

Question 10

What are examples of “non-current assets” ? (4)

Answer 10

• land
• property
• production equipment
• vehicles

Question 11

What are “current assets” ?

Answer 11

Assets which are likely to be converted to cash before the next balance sheet is drawn up

Question 12

What are examples of “current assets” ? (3)

Answer 12

• cash
• inventory
• receivables

Question 13

What are “tangible assets” ?

Answer 13

Assets which have a physical existence and have previously been included on a balance sheet

Question 14

What are examples of “tangible assets” ? (2)

Answer 14

• land and property

- machinery and equipment

Question 15

What are “intangible assets” ?

Answer 15

Assets which do not take a physical form

Only recorded on the balance sheet if they can be separately identified

Question 16

What are examples of “intangible assets” ? (3)

Answer 16

• patents and other rights
• goodwill (value of establish custom)
• brands (if purchased separately)

Question 17

What are “current liabilities” ?

Answer 17

Payments due within a relatively short period of time (usually a year)

Question 18

What are examples of “current liabilities” ? (1)

Answer 18

• trade and other payables

Question 19

What are “non-current liabilities” ?

Answer 19

Debts a business isn’t expected to repay within the period of one year

Question 20

What are examples of “non-current liabilities” ? (2)

Answer 20

• mortgages

- bank loans

Question 21

What is “total equity” ?

Answer 21

All the money initially invested into a business by its owner which would be repaid if a business were to cease trading

Question 22

What are “net assets” ?

Answer 22

The funds which would be left to the owners if all assets were sold and all liabilities were paid

Question 23

What happens after a successful trading period ? (Internal (3) & external (1))

Answer 23

Some profits are left for the business:
- dividends are paid to shareholders

Some profits are retained in the business:

• reserves are accumulated
• figures for reserves arise (representing a liability)
• profits are re invested in assets (rise in value of assets)

Question 24

How is a balance sheet structured ? (6)

Answer 24

1. assets are listed in order of liquidity - illiquid first
2. comparison of short term assets and liabilities to give information on the business’s cash position (if pos the business howls be able to pay)
3. net assets = working capital
4. non-current liabilities
5. net assets
6. total equity

Question 25

What does a business’s short term situation show ?

Answer 25

It’s ability to pay its bills over the next 12 months

Question 26

What is “working capital” ?

Answer 26

The balance between current assets and current liabilities

Working capital = current assets - current liabilities

Question 27

What does positive and negative working capital mean ?

Answer 27

Positive working capital - a business should be able to pay its debts int he short term

Negative working capital - a business may have liquidity or cash problems

Question 28

How does a balance sheet show long-term predictions ? (4)

Answer 28

• shows the movement of non-current assets ( ^ in n-ca = rapid company growth)
• shows the importance of using different methods to raise capital ( borrowing > capital & reserves = vulnerable to rise in interest)
• reserves provides an indication to the profits earned by a business
• the overall value of a business (if na have increase and borrowing decrease = pos development)

Question 29

Capital employed (shareholders capital, debentures & mortgages) =

Answer 29

Working capital (cash, receivable & inventories)
+
Non-current assets (property, machinery & vehicles)

Question 30

Factors which influence working capital (5)

Answer 30

• the volume of sales
• the amount of trade credit offered by the business
• whether or not the firm is growing
• the length of the operating cycle
• the rate of inflation

Question 31

What is “depreciation” ?

Answer 31

The reduction of the value of an asset over a period of time

Show as an expense on a company’s income statement

Question 32

Why do firms depreciate assets ?

Answer 32

• to spread the cost of an asset over here it’s useful life
• calculate the true cost of production during a financial year
• gain an accurate view of profitability