Analysing financial performance specification Q & A Flashcards
Explain what is meant by budget variance
Budget variance is the difference between the budgeted amount and the actual amount for each item in a budget. A favorable variance is when the actual amount is better than budgeted figures (e.g. revenues are higher / costs are lower), while an adverse variance is when the actual amount is worse than the budget (e.g. revenues are lower / costs are higher). Budget variance analysis is important because it helps a business to monitor their financial performance, identify potential problems and make adjustments to improve future performance.
Calculate budget variances
Budgeted - Actual
Analyse budgets and budget variances - reasons for favourable sales
- Effective bonus scheme
- Successful advertising campaign
- Favourable weather
- The demise of a competitor
Analyse budgets and budget variances - reasons for adverse sales
- Successful activities from competitors
- ineffective advertising
- logistical problems (stock did not arrive with customer)
- Bad weather
- Economic conditions (recession)
- Changes in consumer taste
Analyse budgets and budget variances - reasons for favourable costs
- Better trained / motivated employees
- Reduced costs of imported goods due to strengthening of the pound
- Raw material costs fallen
Analyse budgets and budget variances - reasons for adverse costs
- A strike by employees
- Bad weather in growing region (sugar / coffee)
- Devaluation of the sterling
- Unexpected price rise from suppliers
Evaluate the use and impact of budgets and budget variances for a business and its stakeholders - Advantages
- Provide clear targets
- Motivator for staff
- Improved communication between different sectors of the business
Evaluate the use and impact of budgets and budget variances for a business and its stakeholders - Disadvantages
- Time consuming for managers in small businesses
- Actual figures are very different from the budgeted ones = loose significance
- Budget must not be too inflexible - business opportunities can be missed
Explain the components of a balance sheet and the way that it is constructed - components
- Fixed assets - Items owned by the business which can not be converted into cash quickly (e.g. buildings, machines)
- 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
- Long-term liabilities - Depts payable by a business after 12 months (e.g. mortgage, bank loan)
Explain the components of a balance sheet and the way that it is constructed - terminology
- Deptors - People who owe the business money
- Trade creditors -Businesses that the business owes money to (must be payed within 12 months)
- Drawings - Money taken out of the business by the owner (could be salary)
- Capital expenditure - Spending on new fixed assets (e.g. machinery, buildings)
Explain what is meant by working capital, capital employed and depreciation
- Working capital - The cash needed to pay for the day-to-day operations of the business
- Capital employed - Money that is invested into the business (e.g. share capital, retained earnings and long term borrowings of a business)
- Depreciation - An amount deducted from the original cost of an asset to take into account the wear and tear in its use over time
Calculate working capital, capital employed and depreciation
Working capital = current assets - current liabilities
Capital employed = LTL + shareholder funds
Depreciation = (Original cost - residual value) / Expected life
Interpret and analyse a balance sheet - Importance of working capital
- Fund day to day finance
- Pay for raw materials
- Fund credit offered to customers (deptors)
- (possibly) finance increased production
Interpret and analyse a balance sheet - Usefulness of Balance Sheets
- Shareholders want to know how well the business is doing
- Gives a clear picture of what the business owes and owns
- Bad current ratio = problem paying depts
- Can be compared over time
Calculate and interpret return on capital employed (ROCE)
ROCE = (Net profit / Capital employed) x 100
- Satisfactory figure = 20% or higher
- Risk free interest-bearing accounts at banks / building societies 3%
- The higher the risk the better the return
Reasons for high returns:
- Increase in GP / NP margins
- Decrease in retained profit / Shareholder funds
- Decrease in LTL’s
Calculate and interpret current ratio and acid test ratio - Current ratio
Current ratio = current assets / current liabilities
- Ideal figure 1.5 to 2
<- 1.5 = difficulties meeting short term depts (i.e. liquidity crisis)
> 2 = holding too much cash (unproductive / unprofitable)
Reasons for high current ratio:
- Increase in stock
- Increase in cash in the bank
- Decrease in time it takes to receive money from debtors
- Increase in time it takes to pay creditors
Calculate and interpret current ratio and acid test ratio - Acid test ratio
Acid test ratio = (Current assets - stock) / Current liabilities
(Stock is excluded because a business may not be able to convert it into cash quickly)
- Ideal figure = 1:1
- <1 = difficulties meeting short term depts (i.e. liquidity crisis)
>1.2 = holding too much cash (unproductive / unprofitable)
Reasons for high acid test ratio:
- Increase in cash in the bank
- Decrease in time it takes to receive money from debtors
- Increase in time it takes to pay creditors
Calculate and interpret the gearing ratio
Gearing ratio - (LTL / capital employed) x100
- > 50% = highly geared (High risk, less finance options, High potential)
- 20% - 50% = normal gearing
- < 20% - low gearing (low risk, more finance options, safe but dull investment)
Reasons for high gearing:
- Decrease in retained profit
- Decrease in shareholder funds
- Increase in LTL
Analyse the trading, profit and loss account (the income statement) and the balance sheet in order to assess the financial performance of a business - Trading, profit and loss account
Gross profit % = (Gross profit / Sales revenue) x100
(If the GPM is 30%, cost of sales are 70%)
Reasons for high GPM:
- Increase in sales turnover
- Decrease in cost of goods sold
Net profit% - (Net profit / Sales revenue) x100
(If the NPM is 20%, total costs are 80%)
Reasons for high NPMJ:
- Increase in sales turnover
- Decrease in cost of goods sold
- Decrease in expenses
Other factors that can effect accounts
- Window dressing
- Inflation
- Changes in demand
