Analysing financial performance Flashcards
What is a budget
An estimate of income and expenditure for a business covering a set period of time.
Favourable variance?
where actual results are better than budgeted for. E.G costs are lower
Unfavourable variance
where the actual results are worse than budgeted for E.G costs are higher
Advantages of budget + variance analysis
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.
Disadvantages of budgets + variance
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.
current assets
cash or other assets that can be converted into cash within 12 months
current liabilities
the amounts due to be paid out within 12 months
Non current asset
assets that cannot usually be converted to cash within 12 months of the balance sheet.
non current liabilities
long term financial obligations that are due in the longer term usually more than 12 months after balance sheet.
equity
any funds contributed by the owners or stockholders plus any retained earnings.
Working capital
The cash needed to pay for the day-to-day operations of the business.
Working capital= current assets-current liabilities
capital employed
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.
Depreciation
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
Liquidity
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.
Return on capital employed
a financial ratio measuring what returns the business has made on the resources available to it.
Operating profit/capital employed x 100
operating profit
how much profit in total the business has made from its trading activities before any account is taken of how the business is financed.
Capital employed
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.
current ratio
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
Gearing ratio
Measures the proportion of assets invested in a business that are financed by long term borrowing.
non current liabilities/capital employed x100
What does gearing ratio mean
50%
25%
25% and 50%
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.
How can gearing be reduced
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.
how can gearing be increased
by focusing on growth converting short term debt to long-term loans, buying back ordinary shares or paying increased dividends out of retained earnings.
analysing profit and loss accounts
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.
Bankers-balance sheet
they can look at businesses long term borrowings when considering any further finance positions
suppliers balance sheet
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.
investors balance sheet
can see wether the business has plenty of cash and particularly the trend of cash over time.
staff balance sheet
they may want to look at the accumulated profit of the business and how this has been distributed.
factors that can affect the accounts of a business 1)Window dressing
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
2) changes in demand
can have positive or negative effect on the accounts, if a product suddenly becomes unsuccessful account may under report liabilities
3) inflation
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.
