7.2 Financial Ratio Analysis (Analysing internal position) Flashcards
2 key financial reports to assess financial performance:
Income statements
Balance sheets
Income statements
Formal financial documents that summarise business’ trading activities and expenses to show whether profit or loss made over specified period of time.
Profitability
measures financial performance by comparing profits to a 2nd variable (revenue)
-gross profit margin
-operating/net profit margin
-profit for year margin
Within an income statement:
-Sales revenue
-Cost of sales
-Gross profit
-Expenses
-Operating profit
-Interest
-Profit for year
Sales revenue
Money coming in from sales.
(qty sold x selling price)
Cost of sales
Costs directly linked to production of goods/services sold.
e.g raw materials.
Gross profit
Sales revenue - cost of sales
Expenses
All other costs associated with trading of business.
e.g salaries, marketing expenditure.
Operating profit
Gross profit - expenses
Interest
Interest paid on debt or received on positive balances.
Cost of borrowing, Reward for saving.
Profit for year
Operating profit - interest (tax is still to be deducted)
Income statements; Profit quality
Firms with high profit quality will have income statements that can show consistent increases in profit year on year due to business performance.
Inconsistent profit
Often a result of a one-off activity such as selling an expensive asset.
Group income statements
Companies have been taken over by other companies to form GROUPS.
-Each company within group retains separate legal identity, so are obliged to produce own income statement by law.
Income statements and the law
Every business must complete income statements by law- the tax paid to government by business will be based on their operating profit.
Within the income statement, companies must disclose…
1) Exceptional items
2) Extraordinary items
Exceptional items
Large one-off financial transactions arising from “ordinary trading activities”.
e.g opening new stores.
Extraordinary items
Large financial transactions outside normal trading activities.
Unlikely to happen again.
Balance sheets
A financial statement produced on the final day of financial year, records a business’;
-Assets
-Liabilities
-Equity.
Non-current assets
Fixed assets, tangible items.
-Items owned by business, expect to own for year or more.
-Usually most valuable assets e.g land, equipment.
Current assets
These change all the time.
-Items owned by business that change on daily basis.
-Converted to cash at some point.
e.g inventories (stock) trade receivables (debtors)
Current liabilities
Business is responsible for.
-Debts owed by business, expected to be paid within one year.
e.g overdraft, tax, trade payables (creditors)
Net current assets / working capital
Used to help business operate on daily basis and pay short term debts, overall keep business going.
-Deduct current liabilities from current assets.
( CURRENT ASSETS - CURRENT LIABILITIES)
Non-current liabilities
Long term debts taken out for more than one year, often longer.
May be long term bank loan or mortgage.
