3.7.2- Analysing the existing internal position of a business to assess strengths and weaknesses: financial ratio analysis Flashcards
3.7 Analysing the strategic position of a business
What are balance sheets?
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
What are assets?
Things the business owns. E.g. machinery, stock
What are the 2 types of assets?
- Non-current assets
- Current assets
What are current assets?
Assets the business is likely to exchange for cash within accounting year. All current assets makes up ‘total current assets’
What are non-current assets?
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
What are liabilities?
Debts the business owes.
What are the 2 liabilites?
- Current liabilities
- Non-current liabilities
What are current liabilities?
Debts which need to be paid off within a year
What are non-current liabilites?
Debts that the business will pay off over several years
What is working capital?
The finance available for day-to-day spending. Working capital is the same as net current assets
Why should businesses have enough cash but not too much?
- 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
Why doe businesses need finance for capital expenditure (fixed capital)?
- Money to buy non-current assets
- Need to start up, grow, and replace equipment
Why is it important for debtors (recievables) to be controlled?
Important that debtors pay business on time
Why is it important for stock (inventories) to be controlled?
- 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
What are assets depreciate?
They lose value over time, but in some cases can do opposite, E.g. property can increase value over time
Why do assets lose value over time?
- They suffer wear and tear
- May break down
- Become old fashioned
How can balance sheets show short-term financial status of company?
- 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
What is liquidity?
How easy it is to turn an asset into cash and spend it
How can comparing balance sheets show long-term trends?
- 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
What are income statements?
Shows revenue and expenses of a business. PLCs have to publish their statements
How much does an income statement cover over a period of time?
A year, too short is misleading.
What are the different measures of profit show in income statements?
- Gross profit
- Operating profit
- Profit before tax
- Profit after tax
- Retained profit
What does gross profit show?
- Shows money made from making and selling products
- If low, reduce costs or increase selling price
What does operating profit show?
- Shows money made from ‘normal’ operations
- If lower than gross profit it shows operating expenses are weak. Should reduce expenses
What does profit before tax show?
Shows income coming from other activities (selling/buying a building) that may not continue in the future
What does profit after tax show?
- Tells if the company is profitable
- Shareholders/investors will look into this
What does retained profit show?
Shows how much internal finance the comany has to invest in themselves, showing growth potential
What can business choose to do with their profits?
- 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
How can business analyse their finance statements to make decisions?
- 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
What are some limitations of balance sheets?
- 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
What are some limitations of income statements?
- 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
