9. Financial reporting and Analysis Flashcards
What is the Nominal/General Ledger
Contains all sales and purchases
Ledger containing all transaction records relating to a companies assets, liabilities, owner’s equity, revenue and expenses.
Will include one or more sales accounts (i.e. different products) and one or more purchase accounts (i.e. divisions) to record details of goods bought intended for resale
What is the Sales Ledger
The sales a business has made, amount of money received for goods or services, money owed (debtors) at the end of each month.
Contains customer accounts
What is Purchase ledger
Ledger containing supplier accounts where business has made purchases
What is double entry book keeping?
Where transactions are recorded twice using at least 2 accounts
e.g. When item is sold for cash, there will be entries in the sales and bank accounts
When might a balance be transferred to a P&L?
Periodically balances for items that have been used up or consumed are transferred to P&L, shows profit made for period
Balances for items not consumed with an on-going balance are not transferred and will instead be shown on BALANCE SHEET
What is the purpose of a Balance sheet?
To show a snapshot of financial position at a particular point in time
What does a Balance sheet show?
Source and use of funds at any one time
- What the company owns (ASSETS)
- What the company owes (LIABILITIES)
What is the structure of a Balance sheet?
Fixed assets (Things company owns, not normally for sale)
Current assets (AR - Things company owns short-term (e.g. stock) expected to be turned to cash within year)
Current liabilities (AP - Within a year)
Long-term liabilities (Loans - Over a year)
Financed by - Capital - Equity (funds injected)
What is a P&L?
Profit and Loss Account/Income statement
- Statement of profit within a given period
- Income less expenditure
- Expenditure relevant to the income not period
e.g. purchase 20 computers, sell 12
- Profit = Income from 12 sold
- Expenditure = Cost of 12 sold
Cost of remaining 8 carried forward to next period
What is the importance of ‘Operating profit’?
- Profit made from operating business
- Revenue less operating cost of business
- Does not include financial or funding related expenses (e.g. Loan repayments)
What is turnover/revenue?
Revenue from sales of goods
Regardless if paid or not
Not to be confused with turnover of assets
What is cost of sales
Cost directly related to turnover/revenue
cost of purchase or manufacture
Give me an example of Administrative expenses
Overhead e.g. postage costs
Expenses incurring in running/operating business not directly related to sales. Expenses occurred regardless of sales made
True/False? Profit after tax is net profit
True
Profit after tax is net profit
belongs to owners after all expenses met
Fund for shareholder dividends or may be retained within business (Reflected on balance sheet)
What is a cash flow statement?
A summary of transactions affecting the cash position since the previous balance sheet or financial position statement
Shows cash movements during a period
- Same period as P&L but deals with cash rather than profit
Name some typical elements of a Cash Flow statement
Operating activities - Cash received - Cash paid AP - Cash paid in salaries Interest paid and received Tax paid or refunded Capital expenditure Dividends paid Raising or repayments of long term finance
What is the purpose of a Cash Flow statement
To show the flow of cash in and out of business with a period (rather than focus on profits, focus is on activity)
Statement captures both the current operating results and the changes in balance sheet
Useful in determining the short-term viability of a company, particularly ability to pay bills
What are Ratios used for
Used to interpret accounts - Help report on performance and position - Control assets and liabilities Simple comparisons Examine trends
What types of ratios are there?
Profitability - Operating Margin - Return on Capital employed Liquidity - Current ratio - Acid test ratio Gearing - Debt to equity ratio (what we have vs what we owe)
What are profitability ratios used for?
To determine profitability of a business
Shows % of profit made by investment
Help to compare with other Investment opportunities
Name the 2 profitability ratios
Operating Margin
Return on Capital employed
What does the Operating Margin show?
Indicates how effective a company is at controlling their costs and expenses associated with their normal business expenditure
Shows % of revenue left after deducting all costs including expenses of selling and delivering to customer, administering business BUT excluding tax, interest and dividends
THE HIGHER OPERATING MARGIN THE BETTER
How do we work our Operating Margin
Operating profit/revenue
£4000/£10000 = 40%
Operating profit could be gross profit minus admin expenses
What does ‘Return on Capital Employed’ (ROCE) show?
Percentage ‘return’ made from using long-term money employed in business
Measure of the returns a company is making from it’s Capital
Shows how efficiently Capital is being used to generate revenue
THE BIGGER RETURN ON CAPITAL EMPLOYED THE BETTER
How do we work out ROCE?
Operating profit/Equity plus loans
£4000/£20000 = 20%
Capital employed is equity (Capital invested) plus long term debt
What is the difference between Operating Margin and Return on Capital employed?
Operating margin compares Operating profit to revenue (What revenue is left after costs of running business)
Operational profitability
Return on Capital employed looks at how efficiently Capital is used to generate revenue.
measures profitability after factoring in the amount of capital used to create that level of profitability.
What are Liquidity ratios?
Ratios that consider the availability of cash in the immediate future
What is Liquidity?
The extent to which a business has cash and assets that could be turned into cash
Primarily about whether a business can fulfill its Financial obligations as they fall due
What Liquidity ratios do we use?
Current Ratio
Acid test ratio
What is the Current ratio used for?
To show what extent current assets are adequate to meet current liabilities
The extent to which current assets are financed by current liabilities
It’s a good indicator of a companies ability to meet short-term debt obligations
True/False - The higher the Current ratio the more liquid a company is
True
A current ratio of less than one is generally considered cause for concern
How do we work out current ratio
Current assets divided by current liabilities
£15000 in assets
£5000 in Liabilities
= 3
3 times capable of paying off liabilities
Current assets can include cash, receivables (owed by debtors) and stock
Current liabilities include payables owed to creditors
What is the ACID TEST RATIO used for?
Shows companies ability to meet current liabilities, excluding the value of company stock.
By excluding inventory stock it removes the one current asset that is not usually convertible to cash other than through the usual process of business.
Why may the Acid test ratio be a truer reflect of liquidity than Current ratio?
Acid test does not include the liquidity of stock which is not easily liquidated and could be used to make more profit
What does the Acid test ratio show?
How well a company can cover it’s short-term debt
A ratio of less than 1 means a company would struggle to meet its immediate obligations.
A value of over 2 generally indicates no short-term trading problems
How do we work out the Acid test ratio?
Current assets (minus stock) over Current liabilities
£12000-£2000
£5000
= 2
What is the Gearing ratio?
The debt to Equity ratio
What is the debt to Equity ratio used for?
Reviewing relationship between shareholders money and borrowed money
The higher proportion of borrowed money the more ‘Geared’ a company is said to be
True/False - The higher the gearing of a business the less it can do
False - The higher the gearing of a business the more they can do (Because it has more money)
However if it becomes too high then the interest burden is too great and the business may come to a stop!
What is Capital employed
Loans plus equity
How do we work out the Gearing ratio of a business?
Gearing % = Long term liabilities/Capital employed X100
£1200
£5655
= 0.2122
21.2%
Which of these should a balance sheet not show? Current assets Current liabilities Long-term liabilities Value of inventory sold
Value of inventory sold would not be included in a balance sheet
Is a fixed (non-current) asset normally for sale?
No a fixed asset is normally not for sale
Name 3 examples of fixed assets
Buildings Land Machinery Equipment Vehicles
Name 2 examples of current assets
Stock
Money owed to company
Debtors
Cash
Name 2 examples of current liabilities
Overdraft
Money owed to suppliers
Tax (VAT)
Name a long-term liability
Loans
Share Capital
Name 3 examples of operating costs
Advertising Insurance Rent Rates Depreciation Electricity Wages Postage
