Analysing financial performance

Question 1

What is a budget

Answer 1

An estimate of income and expenditure for a business covering a set period of time.

Question 2

Favourable variance?

Answer 2

where actual results are better than budgeted for. E.G costs are lower

Question 3

Unfavourable variance

Answer 3

where the actual results are worse than budgeted for E.G costs are higher

Question 4

Advantages of budget + variance analysis

Answer 4

Business can combine various sets of data and expertise to predict the the income and expenditure needed to meet business objectives.

Allow managers and stakeholders to monitor performance against budgeted.

Budgets can act as a method of motivating staff through management by objectives, with pay linked achievements, like reducing expenditure by 10% of budget.

managers can choose to ignore areas of the budget with little or no variance from that planned, focus efforts on areas that require attention rather on those that are running smoothly.

Question 5

Disadvantages of budgets + variance

Answer 5

Budgets are only as good as the data being used to create them. Inaccurate or unreasonable assumptions can quickly make a budget unrealistic.

Budgets need to be changed as circumstances change which can lead to more costs for the business.

budgeting is a time consuming process and the larger the business the more time consuming process, eg financial department spend long on this.

Employees may be demotivated if business blames them for variances in the budget.

Question 6

current assets

Answer 6

cash or other assets that can be converted into cash within 12 months

Question 7

current liabilities

Answer 7

the amounts due to be paid out within 12 months

Question 8

Non current asset

Answer 8

assets that cannot usually be converted to cash within 12 months of the balance sheet.

Question 9

non current liabilities

Answer 9

long term financial obligations that are due in the longer term usually more than 12 months after balance sheet.

Question 10

equity

Answer 10

any funds contributed by the owners or stockholders plus any retained earnings.

Question 11

Working capital

Answer 11

The cash needed to pay for the day-to-day operations of the business.
Working capital= current assets-current liabilities

Question 12

capital employed

Answer 12

the total amount of capital that is used for the acquisition of profits by a firm or particular project.”

Capital employed= share capital+ retained earnings + long term borrowings.

Question 13

Depreciation

Answer 13

an amount deducted from the original cost of an asset, to take into account wear and tear. Original cost of fixed asset/useful life of the asset

Question 14

Liquidity

Answer 14

A measure of the extent to which a business has cash to meet its immediate short-term obligations.Or assets that can be quickly converted into cash to do this.

Question 15

Return on capital employed

Answer 15

a financial ratio measuring what returns the business has made on the resources available to it.
Operating profit/capital employed x 100

Question 16

operating profit

Answer 16

how much profit in total the business has made from its trading activities before any account is taken of how the business is financed.

Question 17

Capital employed

Answer 17

Capital employed = shareholder funds + long term liabilities. it is the amount of share capital and debt that a company has and uses shareholder funds= share capital+ reserves.

Question 18

current ratio

Answer 18

shows the businesses ability to pay the bills due within the next 12 months. A ratio between 1.5 and 2.0 is desirable if ratio is lower than 1.5 business may struggle to meet its debts quickly.

current assets/current liabilities

Question 19

Gearing ratio

Answer 19

Measures the proportion of assets invested in a business that are financed by long term borrowing.

non current liabilities/capital employed x100

Question 20

What does gearing ratio mean
50%
25%
25% and 50%

Answer 20

a business with a gearing ratio of more than 50% is said to be highly geared.
A business with gearing of less than 25% is described as low gearing.
something between 25% and 50% would be considered normal for a well established business.

Question 21

How can gearing be reduced

Answer 21

by improving profits repaying long-term loans, retaining profits rather than paying dividends, issuing more shares or converting loans to some form of share capital.

Question 22

how can gearing be increased

Answer 22

by focusing on growth converting short term debt to long-term loans, buying back ordinary shares or paying increased dividends out of retained earnings.

Question 23

analysing profit and loss accounts

Answer 23

Allows stakeholders to see how business has performed and wether it has made an acceptable return

helps to identify wether the profit earned by the business is sustainable

enables comparisons to be made with competitors

allows providers of finance to see wether the business is able to generate sufficient profits to remain viable.

Question 24

Bankers-balance sheet

Answer 24

they can look at businesses long term borrowings when considering any further finance positions

Question 25

suppliers balance sheet

Answer 25

they can look at outstanding money owed by the business and question why this might be if the business has plenty of cash and stock.

Question 26

investors balance sheet

Answer 26

can see wether the business has plenty of cash and particularly the trend of cash over time.

Question 27

staff balance sheet

Answer 27

they may want to look at the accumulated profit of the business and how this has been distributed.

Question 28

factors that can affect the accounts of a business 1)Window dressing

Answer 28

presenting the accounts in a way that enhances its financial position, can be done to hide liquidity problems. from investors or enhance profits to have a better chance of obtaining finance

Question 29

2) changes in demand

Answer 29

can have positive or negative effect on the accounts, if a product suddenly becomes unsuccessful account may under report liabilities

Question 30

3) inflation

Answer 30

a sustained increase in the cost of living and can significantly diminish the financial position of the business, for eample, retained profit may diminish its buying power due to sharp rises in inflation and/or cost of raw materials.