Analyzing financial performance Flashcards
What are financial accounts used for
To analyse businesses financial performance
What does a business use to measure financial performance
Balance sheets
Trading profit and loss accounts (income statements)
Ratio analysis
Budget variances
What does a business use ratio analysis to calculate and interpret
Key performance indicators
What are budget variances
Difference between the figure the business budget for and the actual figure
What is a balance sheet or statement of financial position
A statement of business assets (what sines sons) and liabilities ( what business owes) at a certain point in time - usually last day of trading period
What are the 7 things a balance sheet made up
1 fixed assets - land, buildings, machines - things expected to be retained by company for more than a year and used to produce output
2 current assists - stocks, debtors (customers who haven’t yet paid for goods received - considered an asset and bank and cash balances
3 current liabilities - include trade creditors of the business and bank overdrafts. They are debts normally paid within a year and arise due to normal business practise eg trade credit from supplier.
4 long term liabilities - often bank loans or mortgages to be repaid over more than a year
5 net assists - calculated by adding fixed and current assets and deducting current and long term liabilities
6 net current assists - difference between current assets and current liabilities
7 shareholders funds - money invested into business by owners and include retained profit and reserves (money kept in business from profits. Owners may reinvest part of profit back into business to help future profits. Reserves usually used for buying business assets
Why is it called a balance sheet
The total of the company’s assets always equal the total of its liabilities shown as an equation
What is the equation for a balance sheet
Fixed assets +(current assets-current liabilities)= long term liabilities +shareholder funds
How many years financial data does a balance sheet generally show
2 years - current year and previous year so that a comparison can be made and to enable calculation of ratios
What is working capital and how is it calculated
The money needed in a business to pay for the day to day expenses
Calculated by taking the value of current liabilities from current assets
Working capital = current assets-current liabilities
What is working capital an indication of
The financial strength of a business over the short term
The higher the level of working capital the more able a business is to meet demands from creditors
Can a business have a negative working capital
Yes current liabilities are greater than current assets -m shown as a number in brackets to show it is negative
Give 3 examples of businesses who need different working capitals
1 a large business will need a larger amount of working capital than a smaller business
2 a retail business that needs to hold a high level of stock may need a higher level of working capital
3 the amount of debtors and creditors
What is liquidity
How quickly an asset can be converted into cash
What are the most and the least liquid of assets
Money in bank or cash is most liquid
Stock is the least liquid
What is liquidity an indication of
A measure of a businesses ability to pay its short term debts so a measure of available working capital
Why is it important a business has a good level of liquidity
If a business can not pay creditor then supplies of stock or raw material may stop and bank stops cheques so may be forced to stop trading
Which 2 ratios can be calculated to help a business understand liquidity position
Current ratio and acid test ratio
What is current ratio
Tells us about the relationship between current assets and current liabilities
What is the formula for current ratio
Current ratio= current assets/current liabilities
What is the disadvantage of using current ratio
It includes stock which may not be very liquid asset
What is the acid ratio test
It excludes stock from current assets as a way to measure the ability of a business to meet short term demands for cash - more reliable than current ratio
What is the formula for acid ratio test
Acid test ratio = surrender assets - stock/current liabilities
What is the gearing ratio
Compares the amount of capital employed that is financed by borrowing with the total capital employed
What is the formula for calculating gearing
Gearing ratio = long term liabilities / capital employed x100
What is capital employed
The sum of the company’s share capital , reserves and long term liabilities
When is a business said to be highly geared
If gearing ratio exceeds 50%
Where is a company that is low gearing getting its funding
From share capital and reserves
Where is a business with high gearing getting funding
Mainly loan capital
When can high gearing be a bad thing
The interest paid on debts reduces profit and if interest rates increase costs to business will increase
Is high gearing always a bad thing
No - it can indicate a company is adventurous in expansion plans and has taken the opportunity to invest by borrowing at low rates
When can low gearing be a bad thing
It may indicate the company is not aggressive enough to survive and may not be seeking opportunities to survive
What is return of capital employed (ROCE)
Another profitability ratio used to analyse performance
What does ROCE measure
How effective the capital invested in the business is being used not create a profile
What is the formula for calculating ROCE
ROCE= net profit before tax/shareholders funds+long term liabilities. X100
What do some analysts state the desirable figure for ROCE is
15%- but like other ratios it depends on the type of business as to what rate of return is acceptable to investors
In order to evaluate the financial position o a business what must you take into account
All of the 6 ratios and any non financial information available eg customer satisfaction, quality, employee motivation
Provide as much context as possible
Comparisons with previous years and competitors
Wider economic environment
What is window dressing
The manipulation of financial accounts by a business to improve the appearance of its performance
Which body lays down the rules for the presentation of accounts for ltd companies and plus
Rules laid down by statue and the professional accountancy bodies
List examples of methods of window dressing
1 overstate brand valuations
2 sale and leaseback to improve liquidity
3 presentation of financial data
4 hiding the cost of poor investments and hiding costs
5 use of exceptional and extraordinary items
How can presentation of financial data be a method of window dressing
Manipulating the presentation of the information in the accounts eg using graphs with distorted scales to give the impression of bigger or smaller changes in sales, only highlighting certain data eg product lines that have done well and not presenting any compariative data
Explain how overstating brand value assists with window dressing
An increase in the value of the brand increases the paper worth of the company and make it harder or more expensive to take over
How is hiding cost of poor investment and hiding costs a method of window dressing
Business may understate any huge losses made from failed investments and give the appearance of minimising losses ad therefore inflating profit levels
How is sale and leaseback to improve liquidity window dressing
Sale and leaseback can improve cash flow , it involves sale of fixed assets and then leasing them back so they can still be used - it can improve short term cash flow and improve current asset ratios and liquidity. Large amounts of money are injected into the business and shows a higher cash balance improving cash flow short term
How is the use of exceptional and extraordinary items an example of window dressing
Exceptional items are costs or revenue to the business that arise from normal business activity but are in some way unusual. Eg redundancy exceptional revenue can be passe off as normal business revenue
Why do businesses window dress
1 to improve share price and attract investment
2 take overs - more valuable businesses can attract a takeover and increase the amount they get.or can deter a takeover because brand to expensive
3 reduce a tax bill - by making profits look smaller a business can reduce how much it pays in tax
4 improve credit rating - business with high profits and assets can gain finance more easily from banks
5 praise and rewards - having a good set of financial figures could result in rewards from managers
What is depreciation
Decrease in value of assets value over time due to age or developments in technology making the asset obsolete
Some show the asset on the balance sheet at its historic value and not its true or book value
How is net book value calculated
Historic cost - depreciation = net book value
What is a budget
A financial plan for the future - tells us where money is coming aim and where it is going out
What is the consequence of no budget plan
Can lead to insolvency as you can’t pay creditors
What is the most important aspect of budgeting
To check the actual outcomes against predicted .
What are the 2 types of outcomes
Favourable or adverse effects
What might cause a favourable or adverse variance
Favourable sales variance can be caused by an effective bonus scheme for salesmen or successful advertising campaign
Adverse sales variance may be caused by successful competitor activities , ineffective advertising, bad weather or logistical problems
What might cause favourable or adverse cost variances
Favourable cost variance caused by improved labour productivity, reduced costs
Adverse cost variance may be caused by strike, bad weather, unexpected supply price rise
Which non financial performance measures are there
1 market share- the proportion of total sales a business has in the market
2 sales targets - based on sales forcasting techniques
3productivity - measure of output against a fixed input
4 environmental impact -
5 customer satisfaction - degree to which customers expectations are met in terms of price and product, amount of complaints or feedback to a survey
6 employee attitude survey - finding out their views allows a business to identify issues , indicate how motivation can be improved , assess effectiveness of policies
