Analysing financial performance

Question 1

advantages of budgets and budget variance analysis

Answer 1

• controlling income and expenditure.
• They act as a review and allow time for corrective
  action to take place.
• Budgets provide clear targets to be met and should
  help employees to focus on costs.
• Can act as a motivator for staff if budget is met
• They help in the co-ordination of a business and
  improve communication between different sections of
  the business.

Question 2

disadvantages of budgets and budget variance analysis

Answer 2

• They can be time consuming for managers in small
  businesses; especially for those who are not particularly
  numerate.
• If the actual figures are very different from the
  budgeted ones the budget can lose its significance.
• The budget must not be too inflexible as business
  opportunities might be missed.
• Poorly constructed budgets can lead to poor decision
  making.

Question 3

What are the components of a balance sheet?

Answer 3

• current assets
• non current assets
• current liabilities
• non-current liabilities

Question 4

What are trade payables?

Answer 4

Amounts owed to suppliers

Question 5

What is equity?

Answer 5

Any funds contributed by the owners or stockholders

Question 6

What is the formula for working capital?

Answer 6

Current assets - current liabilities

Question 7

What is a good indicator for a business having sufficient cash?

Answer 7

It has enough working capital to pay off its short-term liabilities indicating liquidity

Question 8

What is working capital cycle?

Answer 8

The amount of time it will take for the business to convert its working capital into revenue

Question 9

Formula for straight line depreciation

Answer 9

Original cost of the fixed asset / useful like of the asset

Question 10

What is total equity?

Answer 10

The total amount of money that shareholders have invested into the business, plus any retained earnings

Question 11

ROCE formula

Answer 11

(Operating profit / capital employed) x100

Question 12

Why is ROCE valuable to investors?

Answer 12

A business’s ROCE is compared to other similar businesses to assess which business will give them a better return on their investment.

Question 13

What is operating profit?

Answer 13

The money a business makes from its regular activities after paying for things it needs to run (e.g. salaries / supplies)

Question 14

What is current ratio?

Answer 14

Shows the businesses ability to pay the bills due within the next 12 months. A current ratio of between 1.5 and 2.0 is regarded as desirable

Question 15

What is the desires acid test ratio?

Answer 15

Any figure above 1

Question 16

What are accounts receivable?

Answer 16

The amount of money customers owe a business from paying off credit.

Question 17

What is long term capital?

Answer 17

The funds available for long term investments (e.g. shares/loans/retained profit)

Question 18

What is gearing ratio?

Answer 18

Measures the proportion of assets invested in a business that are financed by long term borrowing. It is a way of measuring the long term financial stability of a business.

Question 19

Formula for gearing ratio

Answer 19

(Non-current liabilities / capital employed) x100

Question 20

An example of how having a higher level of borrowing imposes more risk on a business

Answer 20

E.g. if interest rates on a loan go up significantly, a business with weak cash flow could fail to pay those interest charges.

Question 21

When will gearing ratio be beneficial?

Answer 21

When the business had good cash flow / interest rates are low on loans - getting a loan will reduce the amount of finance needed from shareholders, retaining which may be cheaper than paying dividends

Question 22

When is a business considered to be highly geared?

Answer 22

When it has a gearing ratio of >50%

Question 23

When is a business considered to have low gearing?

Answer 23

When it has a gearing of <25%

Question 24

When is a business considered to have normal gearing?

Answer 24

When it has a gearing between 25% and 50%

Question 25

How can gearing be reduced?

Answer 25

• improving profits
• repaying long term loans
• retaining profits rather than paying divedends
• issuing more shares (dept free cash boost)
• converting loans to some form of share capital

Question 26

How can the trading, profit and loss account help assess the competitiveness of of a business?

Answer 26

• shows stakeholders how well the business is doing and if it’s making enough profit
• helps determine if profits are sustainable over time
• allows comparisons with competition and the overall industry
• it helps lenders to see if the business has enough profit to stay afloat
• helps company directors meet legs, reporting requirements
• gives staff an idea of what they might earn if the company does well

Question 27

Who is a balance sheet important to?

Answer 27

Bankers, suppliers, investors, staff

Question 28

Why might a balance sheet be important to a banker?

Answer 28

They can look at a businesses long-term borrowing when considering any further finance options

Question 29

Why might a balance sheet be important to a suppliers?

Answer 29

They can look at the money the business owes and question why this might be if the business has plenty of cash and stock

Question 30

Why might a balance sheet be important to investors?

Answer 30

They can look at whether the business has plenty of cash (a current asset) and particularly the trend for cash over time. This will help to insulate the business from tough times in the future and ensure its liabilities remain within reasonable boundaries.

Question 31

Why might a balance sheet be important to staff?

Answer 31

They may want to look at the accumulated profit of the business and how this has been distributed in terms of or any profit-sharing scheme

Question 32

Why is it important to monitor business performance over multiple years?

Answer 32

To track financial health, see if cash and debt levels stay balanced, and ensure goals are met.

Question 33

What trends should businesses look for over time?

Answer 33

Look for changes in cash flow and debt to spot financial strengths and weaknesses.

Question 34

analyzing accounts help identify problems?

Answer 34

Comparing ratios across years can reveal issues, like rising debt or low cash, that need fixing.

Question 35

Why is tracking performance essential for strategic decisions?

Answer 35

It guides decisions to solve problems now and plan for growth in the future.

Question 36

Problems in using accounts to measure the performance of a business

Answer 36

• Assets and liabilities can be recorded in numerous ways on a balance sheet, resulting in window dressing.
• Accounts provide figures only, lacking context or explanations.
• Past accounts are often unhelpful for new businesses expanding into new markets.

Question 37

Factors that can effect the accounts of a business

Answer 37

• window dressing
• changes in demand
• inflation

Question 38

What is window dressing and why might businesses use it?

Answer 38

Presenting the accounts of a business in a way that enhances its financial position, can be done in order to hide a liquidity problem from investors or enhance profits so as to have a better chance of gaining finance

Question 39

How can changes in demand negatively affect accounts?

Answer 39

E.g if a product suddenly becomes successful, accounts may under
-report its liabilities (like extra material costs or borrowing money to meet high demand)

Question 40

What is inflation and how can it diminish the financial performance of a business?

Answer 40

Inflation is a sustained increase in the cost of living. It reduces the buying power of retained profits, making it harder to invest. Rising prices can increase costs for raw materials, leading to lower profit margins and potential financial strain on the business.