Analyzing financial performance

Question 1

What are financial accounts used for

Answer 1

To analyse businesses financial performance

Question 2

What does a business use to measure financial performance

Answer 2

Balance sheets
Trading profit and loss accounts (income statements)
Ratio analysis
Budget variances

Question 3

What does a business use ratio analysis to calculate and interpret

Answer 3

Key performance indicators

Question 4

What are budget variances

Answer 4

Difference between the figure the business budget for and the actual figure

Question 5

What is a balance sheet or statement of financial position

Answer 5

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

Question 6

What are the 7 things a balance sheet made up

Answer 6

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

Question 7

Why is it called a balance sheet

Answer 7

The total of the company’s assets always equal the total of its liabilities shown as an equation

Question 8

What is the equation for a balance sheet

Answer 8

Fixed assets +(current assets-current liabilities)= long term liabilities +shareholder funds

Question 9

How many years financial data does a balance sheet generally show

Answer 9

2 years - current year and previous year so that a comparison can be made and to enable calculation of ratios

Question 10

What is working capital and how is it calculated

Answer 10

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

Question 11

What is working capital an indication of

Answer 11

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

Question 12

Can a business have a negative working capital

Answer 12

Yes current liabilities are greater than current assets -m shown as a number in brackets to show it is negative

Question 13

Give 3 examples of businesses who need different working capitals

Answer 13

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

Question 14

What is liquidity

Answer 14

How quickly an asset can be converted into cash

Question 15

What are the most and the least liquid of assets

Answer 15

Money in bank or cash is most liquid
Stock is the least liquid

Question 16

What is liquidity an indication of

Answer 16

A measure of a businesses ability to pay its short term debts so a measure of available working capital

Question 17

Why is it important a business has a good level of liquidity

Answer 17

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

Question 18

Which 2 ratios can be calculated to help a business understand liquidity position

Answer 18

Current ratio and acid test ratio

Question 19

What is current ratio

Answer 19

Tells us about the relationship between current assets and current liabilities

Question 20

What is the formula for current ratio

Answer 20

Current ratio= current assets/current liabilities

Question 21

What is the disadvantage of using current ratio

Answer 21

It includes stock which may not be very liquid asset

Question 22

What is the acid ratio test

Answer 22

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

Question 23

What is the formula for acid ratio test

Answer 23

Acid test ratio = surrender assets - stock/current liabilities

Question 24

What is the gearing ratio

Answer 24

Compares the amount of capital employed that is financed by borrowing with the total capital employed

Question 25

What is the formula for calculating gearing

Answer 25

Gearing ratio = long term liabilities / capital employed x100

Question 26

What is capital employed

Answer 26

The sum of the company’s share capital , reserves and long term liabilities

Question 27

When is a business said to be highly geared

Answer 27

If gearing ratio exceeds 50%

Question 28

Where is a company that is low gearing getting its funding

Answer 28

From share capital and reserves

Question 29

Where is a business with high gearing getting funding

Answer 29

Mainly loan capital

Question 30

When can high gearing be a bad thing

Answer 30

The interest paid on debts reduces profit and if interest rates increase costs to business will increase

Question 31

Is high gearing always a bad thing

Answer 31

No - it can indicate a company is adventurous in expansion plans and has taken the opportunity to invest by borrowing at low rates

Question 32

When can low gearing be a bad thing

Answer 32

It may indicate the company is not aggressive enough to survive and may not be seeking opportunities to survive

Question 33

What is return of capital employed (ROCE)

Answer 33

Another profitability ratio used to analyse performance

Question 34

What does ROCE measure

Answer 34

How effective the capital invested in the business is being used not create a profile

Question 35

What is the formula for calculating ROCE

Answer 35

ROCE= net profit before tax/shareholders funds+long term liabilities. X100

Question 36

What do some analysts state the desirable figure for ROCE is

Answer 36

15%- but like other ratios it depends on the type of business as to what rate of return is acceptable to investors

Question 37

In order to evaluate the financial position o a business what must you take into account

Answer 37

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

Question 38

What is window dressing

Answer 38

The manipulation of financial accounts by a business to improve the appearance of its performance

Question 39

Which body lays down the rules for the presentation of accounts for ltd companies and plus

Answer 39

Rules laid down by statue and the professional accountancy bodies

Question 40

List examples of methods of window dressing

Answer 40

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

Question 41

How can presentation of financial data be a method of window dressing

Answer 41

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

Question 42

Explain how overstating brand value assists with window dressing

Answer 42

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

Question 43

How is hiding cost of poor investment and hiding costs a method of window dressing

Answer 43

Business may understate any huge losses made from failed investments and give the appearance of minimising losses ad therefore inflating profit levels

Question 44

How is sale and leaseback to improve liquidity window dressing

Answer 44

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

Question 45

How is the use of exceptional and extraordinary items an example of window dressing

Answer 45

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

Question 46

Why do businesses window dress

Answer 46

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

Question 47

What is depreciation

Answer 47

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

Question 48

How is net book value calculated

Answer 48

Historic cost - depreciation = net book value

Question 49

What is a budget

Answer 49

A financial plan for the future - tells us where money is coming aim and where it is going out

Question 50

What is the consequence of no budget plan

Answer 50

Can lead to insolvency as you can’t pay creditors

Question 51

What is the most important aspect of budgeting

Answer 51

To check the actual outcomes against predicted .

Question 52

What are the 2 types of outcomes

Answer 52

Favourable or adverse effects

Question 53

What might cause a favourable or adverse variance

Answer 53

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

Question 54

What might cause favourable or adverse cost variances

Answer 54

Favourable cost variance caused by improved labour productivity, reduced costs Adverse cost variance may be caused by strike, bad weather, unexpected supply price rise

Question 55

Which non financial performance measures are there

Answer 55

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