3.7.2 Analysing The Existing Internal Position Of A Business: Financial Ratio Analysis Flashcards
- How to assess the financial performance of a business using balance sheets, income statements and financial ratios -The value of financial ratios when assessing performance
What is a “balance sheet” ?
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”
What are “assets” ?
An item owned by a business, such as cash in the bank, vehicles, property and machinery
What are “liabilities” ?
Money owed by a business to individuals, suppliers, financial institutions and shareholders
What is a “consolidated balance sheet” ?
The total balance sheet for a business, including its divisions
Key balance sheet relationships: (3)
- 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
Why do shareholders use balance sheets ?
To asses a business’ potential to generate profit (higher portion of assets)
Why do suppliers use balance sheets ?
To investigate the short-term position of the company in relation to offering credit and judging whether a business can pay its bills
Why do managers use balance sheets ?
To give an indication of the performance of a business and asses how to raise capital for further investments
What are “non-current assets” ?
Assets owned by a that it expects to retain for over a year, which are not purchased for the purpose of resale
What are examples of “non-current assets” ? (4)
- land
- property
- production equipment
- vehicles
What are “current assets” ?
Assets which are likely to be converted to cash before the next balance sheet is drawn up
What are examples of “current assets” ? (3)
- cash
- inventory
- receivables
What are “tangible assets” ?
Assets which have a physical existence and have previously been included on a balance sheet
What are examples of “tangible assets” ? (2)
- land and property
- machinery and equipment
What are “intangible assets” ?
Assets which do not take a physical form
Only recorded on the balance sheet if they can be separately identified
What are examples of “intangible assets” ? (3)
- patents and other rights
- goodwill (value of establish custom)
- brands (if purchased separately)
What are “current liabilities” ?
Payments due within a relatively short period of time (usually a year)
What are examples of “current liabilities” ? (1)
- trade and other payables
What are “non-current liabilities” ?
Debts a business isn’t expected to repay within the period of one year
What are examples of “non-current liabilities” ? (2)
- mortgages
- bank loans
What is “total equity” ?
All the money initially invested into a business by its owner which would be repaid if a business were to cease trading
What are “net assets” ?
The funds which would be left to the owners if all assets were sold and all liabilities were paid
What happens after a successful trading period ? (Internal (3) & external (1))
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)
How is a balance sheet structured ? (6)
- assets are listed in order of liquidity - illiquid first
- 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)
- net assets = working capital
- non-current liabilities
- net assets
- total equity
What does a business’s short term situation show ?
It’s ability to pay its bills over the next 12 months
What is “working capital” ?
The balance between current assets and current liabilities
Working capital = current assets - current liabilities
What does positive and negative working capital mean ?
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
How does a balance sheet show long-term predictions ? (4)
- 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)
Capital employed (shareholders capital, debentures & mortgages) =
Working capital (cash, receivable & inventories)
+
Non-current assets (property, machinery & vehicles)
Factors which influence working capital (5)
- 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
What is “depreciation” ?
The reduction of the value of an asset over a period of time
Show as an expense on a company’s income statement
Why do firms depreciate assets ?
- 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
