Analysing financial performance Flashcards
What is a budget ?
Estimate of income and expenditure for a business covering a set period of time
What is the 4 purposes of a budget ?
- Establish priorities
- Meet financial objectives
- Motivate staff
- Monitor performance
What is a variance ?
The difference between the budgeted amount and actual amount for each item in a budget
What is a favourable/positive variance ?
Actual results are better than budgeted
What is a unfavourable/adverse variance ?
Actual results are lower than budgeted
What is a variance analysis ?
The process of comparing the budget and actual figures and investigating why there are differences
What are 5 advantages of budgets and variances ?
- Can combine sets of data & staff expertise
- Can monitor performance
- Motivating staff through MBO
- Can ignore areas of little to no variance
- Resources can be targeted to large variances
What are 6 disadvantages of budgets and variances ?
- May be inaccurate assumptions
- Lead to inflexibility in decision making
- Need to change if circumstances change
- Time consuming
- Can make short term decisions instead
- If employees accountable for variance, may be demotivated
What is a balance sheet ?
Summary of assets and liabilities of a business at a certain period in time
What are current assets ?
Cash or other assets that can be converted into cash within 12 months of balance sheet
What are non current assets ?
Assets that cannot be converted to cash within 12 months
What are current liabilities ?
The amounts due to be paid out within 12 months
What are non current liabilities ?
Long term financial obligations due more than 12 months
What is equity ?
Any funds contributed by owners or stockholders plus any retained earnings
What is working capital and equation ?
Cash needed to pay for day to day operations. = current assets - current liabilities
What is the working capital cycle ?
The period of time between cash first spent on production and collection of cash from a customer
What is capital employed and equation ?
Total resources the business has available. = share capital + retained profits + long term borrowings
What is depreciation and equation ?
Amount deducted from original asset cost due to wear over time. = original cost / useful life of asset
What are 2 advantages of depreciation ?
- Simplistic and quick
- Provides acknowledgement
What are 2 disadvantages of depreciation ?
- Open to interpretation
- Difficult to quantify useful life
What is ROCE and equation ?
Shows what profits the business has made with resources available. = operating profit / capital employed x100
What is operating profit ?
How much profit has been made from trading before how business is financed
How can you improve ROCE ?
Increase operating profit or reduce value of capital employed
What is current ratio and equation ?
Ability to pay bills due within next 12 months. = current assets / current liabilities
What is acid test ratio and equation ?
Severe test of business’ capabilities in meeting debts. = current assets - stock / current liabilities
What is gearing ratio and equation ?
Proportion of assets financed by long term borrowing. = non current liabilities / capital employed x 100
What are levels of gearing ?
High = 50%
Low = 25%
How can gearing be reduced ?
- Improving profits
- Retaining profits
- Repaying long term loans
How can gearing be increased ?
- Focus on growth
- Convert short term debt to long term
- Buy back ordinary shares
How can ratios help make decisions ?
Help decide whether it can afford to make decisions
Who is the balance sheet important to ?
- Suppliers
- Bankers
- Investors
- Staff
What 3 factors affect business accounts ?
- Window dressing
- Changes in demand
- Inflation
How can balance sheets assess financial performance ?
- Sees competitiveness
- Helps to understand if profits are sustainable
How can businesses consider accounts in relation to previous years ?
- Can ensure it business stays financially healthy
- Looks for trends
- Can identify problems in accounts
- Strategic decisions can be made
What are 3 disadvantages of accounts ?
- Can give more favourable way of outlook on different sheets
- Only provides figures
- Previous accounts offer little help in predicting future performance
