3.7.2- Analysing the existing internal position of a business to assess strengths and weaknesses: financial ratio analysis

Question 1

What are balance sheets?

Answer 1

Snapshots of firms finances at a fixed point in time. They show value of businesses assets and liabilities. As well as showing the value of all capital

Question 2

What are assets?

Answer 2

Things the business owns. E.g. machinery, stock

Question 3

What are the 2 types of assets?

Answer 3

• Non-current assets
• Current assets

Question 4

What are current assets?

Answer 4

Assets the business is likely to exchange for cash within accounting year. All current assets makes up ‘total current assets’

Question 5

What are non-current assets?

Answer 5

Assets that the business is likely to keep for more than a year. E.g. land, property, equipment. They often lose value over time which is called depreciation

Question 6

What are liabilities?

Answer 6

Debts the business owes.

Question 7

What are the 2 liabilites?

Answer 7

• Current liabilities
• Non-current liabilities

Question 8

What are current liabilities?

Answer 8

Debts which need to be paid off within a year

Question 9

What are non-current liabilites?

Answer 9

Debts that the business will pay off over several years

Question 10

What is working capital?

Answer 10

The finance available for day-to-day spending. Working capital is the same as net current assets

Question 11

Why should businesses have enough cash but not too much?

Answer 11

• Just enough to pay short-term debts because spare cash is great at paying debts but lousing at earning money
• Inflation can increase costs of wages and buying/holding stock
• If the business wants to expand
• Businesses with long cash-flow cycles need extra cash

Question 12

Why doe businesses need finance for capital expenditure (fixed capital)?

Answer 12

• Money to buy non-current assets
• Need to start up, grow, and replace equipment

Question 13

Why is it important for debtors (recievables) to be controlled?

Answer 13

Important that debtors pay business on time

Question 14

Why is it important for stock (inventories) to be controlled?

Answer 14

• Hold stock to satisfy market demands
• Too little stock will lose sales as cannot meet demand
• Too much stock has money tied to stock rather than working for business
• Business can predict demand to know stock needed

Question 15

What are assets depreciate?

Answer 15

They lose value over time, but in some cases can do opposite, E.g. property can increase value over time

Question 16

Why do assets lose value over time?

Answer 16

• They suffer wear and tear
• May break down
• Become old fashioned

Question 17

How can balance sheets show short-term financial status of company?

Answer 17

• Find working capital in the short term
• Suppliers can look at balance sheets to see how liquid the firms asstes are, the more liquid, the better at paying bills, can offer supplies on credit

Question 18

What is liquidity?

Answer 18

How easy it is to turn an asset into cash and spend it

Question 19

How can comparing balance sheets show long-term trends?

Answer 19

• See how the business is changing
• Quick increase in non-current assets shows business is investing in property, machinery
• Increase in revenue suggest increase in profit
• Shows trend in how businesses rasied its capital

Question 20

What are income statements?

Answer 20

Shows revenue and expenses of a business. PLCs have to publish their statements

Question 21

How much does an income statement cover over a period of time?

Answer 21

A year, too short is misleading.

Question 22

What are the different measures of profit show in income statements?

Answer 22

• Gross profit
• Operating profit
• Profit before tax
• Profit after tax
• Retained profit

Question 23

What does gross profit show?

Answer 23

• Shows money made from making and selling products
• If low, reduce costs or increase selling price

Question 24

What does operating profit show?

Answer 24

• Shows money made from ‘normal’ operations
• If lower than gross profit it shows operating expenses are weak. Should reduce expenses

Question 25

What does profit before tax show?

Answer 25

Shows income coming from other activities (selling/buying a building) that may not continue in the future

Question 26

What does profit after tax show?

Answer 26

• Tells if the company is profitable
• Shareholders/investors will look into this

Question 26

What does retained profit show?

Answer 26

Shows how much internal finance the comany has to invest in themselves, showing growth potential

Question 27

What can business choose to do with their profits?

Answer 27

• Shareholders: usually want high dividends which comes from profit. If not recieved they may sell shares
• Retain: Allows business to spend on things that will increase profit, or to grow the business

Question 28

How can business analyse their finance statements to make decisions?

Answer 28

• Analysing can help to compare to competitors performance and own perfomance in the past
• Identify trends
• Make decisions on financial strengths and weaknesses
• Potential investors can use data to see if they want to invest or lend to business

Question 29

What are some limitations of balance sheets?

Answer 29

• Only one point in the past, may not help predict future
• Doesnt give clues about market or economy
• Doesnt value intangible assets like stafe skill
• If debts are bad, can be mislead

Question 30

What are some limitations of income statements?

Answer 30

• Doesnt include information about external factors which can help forecast future revenue or profit
• Doesnt include internal factors like staff morale, can determine productivity
• During inflation, income statement isnt useful as inflation disorts true value of revenue