6.4 Financial statements Flashcards
What is a financial statement?
financial statement showing a business’s revenues and costs and so its profits or loss over time
statement of financial position?
sets out the assets and liabilities that a business has on a particular day
Why do businesses prepare financial statements?
The law, To help a business, To guide investors
What are the components of financial statements?
(6 sections)
Revenue, Costs of sales, Gross profit, overheads, operating costs, net profit
What 3 key pieces of information does an income statement show?
- Revenue earned by a business
- Costs of production that have been paid by a business
- Amount of profit earned by a business or loss it has made
what is an asset?
An asset is something of value that is owned by a business (usually generates profit)
what 2 types of asset are there?
current and non-current
what is a current asset?
assets the business only expects to keep for a short time. Current assets are used to settle debts such as raw material costs
what is a non-current asset?
A business will normally keep this type of asset for many years, this type generates revenue for the business and allows for profits
what is a liability?
Amounts owed by a business to other businesses / individuals
what are 2 types of liabilities?
current and non-current
what is current liability?
debts that a business will pay within a year. For example, money owed to suppliers and tax
what is non-current liability?
debts that will be paid back over many years. for example, loans from the bank
what is total equity?
part of a company’s money that belongs to the shareholders
what is ‘net assets employed’
The value of the assets owned by a business once it has paid its liabilities
why is the statement of financial position balanced?
total equity = net assets
why are net assets and total equity directly correlated?
The more money put into the business to invest into assets, the more the value of both rises.
What comparisons can be made to interpret financial statements?
- comparisson with previous years
- comparisson of preformance with competitors
- profit ratios
- gross profit margin
- net profit margin
what can be used from previous years to measure a business’s performance
- revenue from sales of goods and services
- gross and net profits
why is a comparison with competitors useful?
if the business is making profit quicker than competitors can, this shows their progress in comparrison to competition (if they are likely to grow or shink etc)
what are profit ratios?
Financial ratios compare two figures from a business’s financial statement. A common figure to compare with profit is revenue.
what equations are used in profit ratios?
gross profit and net profit on the income statement. Using these allows us to calculate two profit ratios: gross profit margin and net profit margin
what is gross profit margin?
This compares a business’s gross profit for a trading period with the revenue figure for the same year.
what is net profit margin?
Compares a business’s net profit for a trading period with the revenue for the same period
what do shareholders and owners look at on financial statements to judge a business?
- level of sales achieved
- costs the business has had to pay
- the amount of profit or loss that has been made
why do managers look at financial statements ?
Assess whether or not their decisions are effective
what do suppliers look at on financial statements to judge a business?
shows reliability on if they will be paid if the busines makes much profit
what do employers look at on financial statements to judge a business?
Pay may depend on profit levels and shows job security (is the business stable?)
why are financial statements important to stakeholders?
2 main reasons
assessing business performance and helping managers effective decsions
how do stakeholders assess business performance through financial statements?
- Shows revenue and profits which increases value of the business
- Show data for several years so trends can be observed
- conduct ratio analysis to make better judgement by comparing
How do financial statements help managers assess decision making
- Find reasons for falling profits and find ways to improve
- Show whether costs have risen or not and how costs can be cut
- Can identify decline in sales which equates to decline in profits
What is ratio analysis?
A method of assessing a firm’s financial situation by comparing two sets of linked data
How is ratio analysis formed?
Mainly formed by extracting information from financial accounts (Income statement, Balance Sheet)
what is ratio analysis used for?
Used to draw conclusions about a company’s performance
what are the 2 catagories of ratio?
profibility ratios and liquidity ratios
what does a profitibility ratio measure?
measure a firm’s efficiency at achieving profit - relate profit to size of firm, past performance, competitors
what is liquidity ratio?
examining the ability to meet short-term debts called solvency
what are types of profitibility ratios?
- Gross Profit Margin
- Net Profit Margin
- Return on Capital Employed (ROCE)
what are types of liquidity ratios?
current ratios and acid tests
what is the equation for the acid test?
Current assets - stock / Current liabilities
what is the equation for current ratios?
Current assets / Current liabilities
why are ratios used?
- To assess how well a business is preforming
- To compare performance with a competitor
- For owners and lenders to know how successful a business is
what is the equation for gross profit margin?
gross profit earnings (earnings) / sales revenue (turnover) x100
what is the equation for net profit margin?
Net profit (earnings) before tax / sales revenue (turnover) x 100
what is the issue with GPM?
one issue with this is that it ignores overheads: useful to assess control of direct costs and ability to max sales
what is NPM a good measure of ?
Best measure of quality of profit, sales turnover measures scale of business
what is the equation for ROCE?
Net profit (earnings) before tax / capital employed (equity) x 100
what is ROCE a good measure of?
Equity (or Capital Employed) is the best measure of size or scale of operations
What are the 4 types of comparisons of statements?
Inter firm, intra firm, Comparisons to a standard, Comparisons over time
what is an inter firm comparison?
between companies (usually with rivals)
what is an intra firm comaprison?
Within the economy to measure relative efficiencies (improvements/decline)
what is a comparison to a standard?
Certain levels of performance are recognised - compare to these
what is a comparison over time?
to register trends in efficiency and allow for exceptional circumstances
