Analysing internal position: financial ratio analysis

Question 1

Financial information assists stakeholders in assessing the businesses performance and to inform decision making : 2 financial statements:

Answer 1

• Balance sheet
• Income statement

Question 2

Why is financial information important for internal users : managers, employees and shareholders.

Answer 2

Managers: Is the business using resources efficiently ?

Employees: Are they receiving fair pay in the light of the business’s performance ?

Shareholders: What is the return on their investment ?

Question 3

Key terms when analysing balance sheets:

Answer 3

Assets = items owned by a business e.g vehicles or property

Liabilities = represent money owed by a business e.g to suppliers, shareholders or banks

Statement of financial position = alternative name for a balance sheet introduced in 2009

Consolidated balance sheet = the total balance sheet for a business, including all its divisions.

Question 4

Key balance sheet relationships:

Answer 4

1) Assets = Liabilities

2) Total assets = current assets + non-current assets

3) Liabilities = share capital + borrowings + reserves.

Question 5

What is a Balance sheet ?

Answer 5

• Financial statement recording the assets and liabilities of a business on a particular day at the end of an accounting period.
• ‘Snapshot’ of a business’s financial position.

Question 6

Balance sheets are an essential piece of information for a variety of business decisions and stakeholders:

Answer 6

• Shareholders: assess business’s potential for good returns in the future.

Suppliers: investigate the short term position of a business. Assess cash and whether they will be able to pay them over the coming months.

Managers: indication of performance.

Question 7

2 categories of assets for a business:

Answer 7

1) Non-current assets (long-term) = expects to retain for more than one year. Such assets are used regularly by a business e.g. equipment/machinery

2) Current assets (short-term) = likely to be turned into cash before the next balance sheet is drawn up. e.g cash or inventories. Receivables aswell.

Question 8

What are tangible assets ?

Answer 8

• Have a physical existence.
• They include land, property, machinery and equipment.

Question 9

What are intangible assets ?

Answer 9

• Do not take a physical form
• Examples include: Patents and Brands

Question 10

What are liabilities ?

Answer 10

Debts owed by the business to organisations or individuals.

Question 11

3 Different categories of liabilities:

Answer 11

1) Current liabilities (short-term debts) = Payments due within 1 year or less e.g. overdrafts or tax due payments.

2) Non-current liabilities (long-term debts) = don’t expect to pay within a year e.g. mortgages or bank loans

3) Total equity = If the company ceases trading shareholders would hope for the repayment of their investment.

Question 12

Net assets:

Answer 12

Net assets = (non-current assets + current assets) - (non-current liabilities + current liabilities)

One way of calculating the value of a business.

Question 13

Why does a balance sheet always stay balanced ?

Answer 13

‘Dual aspect’ - any transaction recorded on the balance sheet has 2 effects that cancel each other out.

Balance it’s reserves e.g. retained profits are reinvested.

Question 14

Reading and interpretating balance sheets example :

Answer 14

Assets are listend in order of liquidity - illiquid first

Comparing current assets are liabilities gives information on the businesses cash position

Net current assets also known as working capital

Net assets show the worth of the business

Non-current liabilities records money long term borrowed by the business.

Total equity is the money invested by the business’s shareholders

Question 15

The short term:

Answer 15

If a business has a positive figure for working capital they should be able to pay their debts in the short term.

If a business has a negative figure for working capital may cause liquidity and cash problems

Question 16

The long term:

Answer 16

• Considering how a business managed their assets can be valuable as borrowing too much can be risky, vulnerable to rising interest rates

Sudden increase in non-current assets may indicate a business is growing rapidly.

Question 17

What is working capital ?

Answer 17

Measures the amount of money available to a business to pay it’s day to day expenses e.g. bills and raw materials

Question 18

The right amount of working capital:

Answer 18

• Holding excessive amounts of working capital is not wise, means little or no return for the business.

Well managed business will hold sufficient liquid assets to meet it’s need for working capital but will avoid having too many assets in such an unprofitable form.

Question 19

Factors affecting how much working capital a firm has to hold:

Answer 19

Rate of inflation: firms require greater amounts of working capital to fund increased wages and raw material costs

Amount of trade credit offered by the business: if a business offers customers a lengthy time period before they have to pay increases the requirement for working capital.

Question 20

What is depreciation ?

Answer 20

• Reduction of the value of an asset over a period of time

Question 21

Why do firms depreciate assets?

Answer 21

• Spread costs of an asset over its useful life. Ensures the value of a business recorded on a balance sheet is accurate