Accounting for Business

Question 1

Purpose of ratio analysis

Answer 1

• Review performance over time
• To be compared with prior years, industry average, competitors
• Enables problems to be highlighted and corrective action then taken

Question 2

Limitations of ratio analysis

Answer 2

• The analysis only looks back, and may not represent the future
• Some ratios only use financial position information which is only applicable at that date
• Figures in financial statements contain assumptions and estimates
• Only identify symptoms not causes of problems

Question 3

Gross Profit margin

Answer 3

measures the profitability of sales before expenses

Question 4

Operating profit margin

Answer 4

measures the profitability of sales after expenses
- retail may have a lower operating profit than heavy equipment manufacture, but will still sell more products
- small profit margin per loaf but will still sell a lot

Question 5

Return on Total Capital employed

Answer 5

They key profitability ratio - measures the profit relative to the total capital of the business

Question 6

EBIT

Answer 6

Earnings before interest/finance costs + tax

Question 7

Long term debt

Answer 7

Is to represent the funding for the business provided by external parties

Question 8

Liquidity ratios…

Answer 8

-Provide info on the ability of the company to pay its short term commitments if they fall due
- ‘Cash is king’ as a business could be profitable but have no cash to pay salaries, expenses and revenue
- Liquidity is crucial for business survival

Question 9

Liquidity ratios significance

Answer 9

• Current ratio - measures the ability to meet short term debts - prudent ratio being 2:1
• Acid test - to see what would happen if a company were forced to settle their debts immediately - prudent ratio considered 1:1

Question 10

Efficiency ratios…

Answer 10

• Measure how effective the business is in collecting its debts
• Expressed using days
• Calculate how many days credit the company is taking from suppliers
• Comparison between time taken to collect debts and to pay them

Question 11

Efficiency ratios - inventory days

Answer 11

• Calculates how quickly the company is turning over its stocks during the year
• Efficiency of stock control policy

Question 12

Gearing ratios

Answer 12

• Show the proportion of assets the company has been financed by lenders rather than shareholders
• the higher the proportion of debt the more vulnerable the company is perceived to be
• Debt/Equity ratio of 1:1 would be considered high for a quoted company
• The interest/finance cover ratio shows the ability of the company to cover the interest out of its profits

Question 13

Considerations when deciding which business to invest in

Answer 13

1. Type of Business and the economic outlook in that field
2. Future sales contracts and orders in place for next year
3. Past financial statements in order to look at the trajectory for each company and the plans for future growth
4. Board structure and management in each company - review the corporate governance for each company
5. The level of employment in the area of the company
6. The company’s public image and attempts in ESG etc.

Question 14

Rules applying to public listed companies when preparing accounts

Answer 14

• Accounting standards of accounting bodies
• Legal rules of the country and wider e.g. EU
• Stock exchange regulations when country listed on the stock exchange.

Question 15

Variable cost

Answer 15

• Those costs that vary with number of units sold

Question 16

Fixed costs

Answer 16

• Costs that don’t vary with number of units sold - such as machinery or wages

Question 17

Contribution

Answer 17

• Represents the amount each unit sold contributes to the fixed costs
• Represented by the sales price less the variable cost

Question 18

Breakeven cost

Answer 18

• Fixed costs / contribution per unit
• The number of units needed to be sold in order to cover costs

Question 19

Margin of safety

Answer 19

• Represents the excess the business is expected to sell over the breakeven point

Question 20

Sources of finance

Answer 20

• Venture capital
• Angle investors
  -Govt. grants
• Leasing

Question 21

Venture capital + Angel investors

Answer 21

Adv
- Investment without interest costs
Disadvs
- Loss of control, voting rights + share of profits

Question 22

Leasing

Answer 22

Adv
- No capital layout
- Tax deductible
Dis
- Don’t own asset

Question 24

Breakeven

Answer 24

Fixed costs/contribution

Question 25

Contribution

Answer 25

Selling price (sales rev per unit) - Variable costs per unit

Question 26

Why may a job be underpriced?

Answer 26

• Differences in material costs
• Differences in material usage
• Differences in labour costs
• Differences in labour hours required
• Differences in overall overhead costs
• Differences in allocation base used in allocating overheads

Question 27

How to calculate a target profit

Answer 27

Fixed costs + target profit/ contribution