Analysing financial performance Flashcards
what is a budget variance?
a budget variance is the difference between the budgeted figure and the actual figure in the financial plan
what are the two types of budget variances?
- favourable variance: actual revenue is higher or actual costs are lower than budgeted
- adverse variance: actual revenue is lower or actual costs are higher than budgeted
how do you calculate a budget variance
budget variance = actual value - budgeted value
what might cause a favourable sales variance?
- favourable weather
- successful advertising
- demise of a competitor
what might cause an adverse sales variance
- success of a competitor
- ineffective advertising
- change in consumer tastes
- poor economic conditions
what may cause a favourable cost variance
- employees may have been better trained/motivated leading to increased efficiency
- raw material costs falling
- strengthening of the pound
what may cause an adverse cost variance
- employee strikes
- unexpected rising costs of raw materials
- weakened pound
what are the main components of a balance sheet?
- fixed assets: land, buildings and machinery
- current assets: stock, cash, trade receivables (debtors)
- current liabilities: trade payables, overdrafts
- long term liabilities: bank loans, mortgages
- shareholders capital: investment from owners and retained profits
advantages of budgets
- Budgets provide clear targets to be met
- A means of controlling income and expenditure.
- motivates staff by setting clear targets
- Regulate the spending of money and highlight losses,
waste and inefficiency.
disadvantages of budgets
- can be rigid
- can be unrealistic
- may lead to short term focus, ignores long-term strategy
how is working capital calculated
working capital = current assets - current liabilities
what is working capital?
the funds available for day-to-day operations
what is capital employed
The total money that has been invested in the business such as shareholders’ funds (share capital), owners’ capital, retained profit and reserves.
how do you calculate capital employed?
capital employed = shareholders capital + long-term liabilities
what is depreciation
the reduction in an assets value over time
how is depreciation calculated?
original cost - residual value/ expected life of the asset
why is a balance sheet useful to a company?
- Shareholders are owners of the business, so they want to know how well it is doing
- gives a picture of the assets and liabilities of a company
- how liquid a business is, how easily they can pay back there debts
what is return on capital employed
- how efficiently a company uses capital to generate profit
- higher ROCE = better profitability
what does current ratio show and what are the ranges that is has?
- A liquidity ratio that measures a business’ ability to pay short-term obligations
- A figure less than 1.5 indicates that the business may
experience difficulties in meeting its short-term debts - A figure of more than 2 indicates that the business may
be holding cash in an unproductive and unprofitable
form, and it may be better used elsewhere.
how is current ratio calculated?
current assets/current liabilities
how it ROCE calculated?
(Net profit before tax/ capital employed) x 100
what is the acid test ratio and why is it useful
- determines whether a business has enough short-term assets to cover its immediate liabilities without selling stock. Most businesses seek a value of at least 1.
- excludes inventory
- determines immediate liquidity
how do you calculate acid test ratio?
(current assets - stock)/ current liabilities
what does a gearing ratio indicate?
- high gearing (above 50%) = more debt, higher financial risk
- low gearing (below 50%) = less reliance on debt, possibly slower growth
- optimal gearing is 25% - 50%
how can financial performance be assessed over time?
- comparing data from previous years
- analysis ratios like ROCE, liquidity and gearing
- benchmarking against competitors
what is the purpose of a profit and loss account?
measures profitability of a business
what factors can affect financial evaluation?
- internal factors e.g. sales performance, capacity utilization
- external factors e.g. market condition, economic factors
- financial statement manipulation (window dressing)
what is window dressing in financial accounts?
manipulating accounts to make financial performance look better than reality
what are the methods of window dressing?
- delaying expenses
- sale and leaseback to improve liquidity
- overstating assets to improve brand value
