Analyzing of Financial statements (7)

Question 1

Financial reporting focuses on an entity’s financial position, financial performance and?

Answer 1

the cash flow position of the entity.

Question 2

Define Activity ratios?

Answer 2

Ratios that enable the business to determine how soon they can convert their assets into cash.

Question 3

Define Capital development projects or capital expenditures?

Answer 3

A long-term project that requires large sums of money to acquire; for example, building a new factory or purchasing new machinery.

Question 4

Define Capital structure?

Answer 4

This refers to how a company is funded. In other words, the mix of long-term debt and owner’s equity (i.e. own capital).

Question 5

Define Credit providers?

Answer 5

According to the National Credit Act 34 of 2005 (NCA), a broad definition consists of anyone that exchanges money, goods or services – under an agreement from the consumer – that he or she will return the value of the goods, services or money over an agreed-upon period of time, with possible added interest.

Question 6

Define Fair value?

Answer 6

Value at which two knowledgeable and willing parties (buyer and a seller) are willing to transact.

Question 7

Financial statement analysis

Answer 7

This refers to the use of analytical or financial tools to examine and compare financial statements in order to make business decisions (MyAccountingCourse.com, n.d.). Analysis and interpretation of financial statements are an attempt to determine the significance and meaning of the financial statement data. In this way, a forecast can be made to depict the prospects for future earnings, the ability to pay interest, debt maturities – both current as well as long term – and the profitability of a sound dividend policy (Shivam, n.d.).

Question 8

Define Historical cost?

Answer 8

An accounting principle that states that all non-current assets should be recognised in the business’s books at their cost price (i.e. the price originally paid for). This means that if the business purchased a building 25 years ago for R 350 000, but it is worth R 2 400 000 today, it should still be recognised in the business’s books as R 350 000.

Question 9

Define Liquidity?

Answer 9

A business’s ability to pay short-term obligations. In other words, does the business have enough cash to pay any money that is due within 12 months? For example, creditors, the South African Revenue Services (SARS), dividends to shareholders, a bank overdraft or short-term loans.

Question 10

Define Solvency?

Answer 10

A business’s ability to meet long-term obligations; for example, to pay off a long-term loan. When looking at a business’s solvency, you will take into consideration all its assets and all its liabilities. In other words, if you were to sell all the business’s assets, would you be able to use that money to cover all its debt? If the answer is yes, the business is solvent; if the answer is no, the business is insolvent.

Question 11

What is solvency?

Answer 11

The ability to meet any long-term debts

Question 12

The ability to pay debts? The cost of any expenses?
What is ‘historical cost’?

Answer 12

The original price paid

Question 13

Which of the following can be classified as a credit provider?

Answer 13

Bank

Question 14

Which term refers to how a company is funded?

Answer 14

Capital structure

Question 15

Which term refers to being able to pay off any short-term debts?

Answer 15

Liquidity

Question 16

The primary objective of analysing financial statements is to assess a business’s financial health, so as to make informed decisions and forecasts about?

Answer 16

the future financial position and performance of the business.

Question 17

The other objectives of analysing financial statements include, but are not limited to:

Answer 17

• determining the profitability and future prospects of the business;
• comparing the operational efficiency of the business to its competitors;
• examining the earning capacity and efficiency of various business activities; and
• determining the short-term and long-term solvency of the business.

Question 18

Internal users
Let’s take a brief look at each of the internal users in some more detail?

Answer 18

• Directors
• Management
• Employees

Question 19

External users

Now let’s take a brief look at each of the external users in some more detail?

Answer 19

• Suppliers
• Credit providers
• Government departments
• Labour unions
• Investors
• Competitors
• Rating agencies
• Research agencies

Question 20

What would directors mainly use financial statements for?

Answer 20

Measure business performance

Question 21

Why would labour unions use financial statements?

Answer 21

To obtain information for wage negotiations

Question 22

Which financial statement would be used to analyse net profit?

Answer 22

Statement of profit or loss and other comprehensive income

Question 23

Why would rating agencies use a business’ financial statements?

Answer 23

To give a credit rating

Question 24

Which of the following would be an external user of financial statements?

Answer 24

Suppliers

Question 25

Name three examples of financial statements?

Answer 25

Three examples of financial statements can include any of the following: statement of profit or loss and other comprehensive income; statement of financial position; statement of changes in equity; statement of cash flows.

Question 26

Financial statements are important because they:

Answer 26

• determine the ability of a business to generate cash, as well as the sources and uses of that cash;
• determine whether or not a business will be able to pay back its debts;
• help the business to track financial results on a trend line to easily identify any issues with profitability;
• indicate the condition (health) of a business by deriving financial ratios from the statements;
• investigate the details of certain transactions, as outlined in the disclosures that accompany the statements; and
• enable the different users of financial statements to make informed economic decisions.

Question 27

Explain the concept of financial statements analysis?

Answer 27

Financial statements analysis is the use of analytical or financial tools to examine and compare financial statements in order to make business decisions.

Question 28

The analysis and interpretation of financial statements relies solely?

Answer 28

on accounting information

Question 29

The limitations of accounting information also need to be taken into account. Some of these limitations include the following?

Answer 29

• Different accounting policies and frameworks
• Accounting estimates
• Measurability
• Financial statements are historic documents
• Fraud and error
• Other information not taken into account
• Different accounting policies and frameworks: Although businesses draw up financial statements according to prescribed frameworks, businesses use a diverse set of accounting policies. This may make it difficult to compare one entity to another. One of these differing policies is when accounting is done for non-current assets (i.e. property, plant and equipment). A business can choose to either use the cost model or the revaluation model. When using the cost model, the business will report its non-current assets at cost less accumulated depreciation. When using the revaluation model, the business will report its non-current assets at revalued amounts, being their fair values less accumulated depreciation. When comparing two businesses’ financial statements, it is important to keep in mind that they may be using these two different models, ultimately making it difficult to draw comparisons accurately.
• Accounting estimates: Drawing up financial statements requires the use of estimates where precise amounts cannot be established. Estimates are subjective, and can therefore reduce the reliability of the information. Estimates are used when providing for credit losses, for example. It is impossible to know how many debtors will not be paying their accounts in the upcoming year. Accountants usually make an estimate based on the previous year, but unforeseen circumstances, like a recession, can make it hard to make an accurate estimate. Since it is subjective, some accountants may make a more conservative estimate than others, making it hard to compare one business’s statements to another.
  Use of historical cost: Historical cost is the most broadly used basis for measuring assets. The use of historical cost fails to account for the change in price levels of assets over a period of time.
• Measurability: Financial statements only represent transactions that can be measured in monetary terms. Resources – such as workforce competence or goodwill – cannot be represented in the statements.
• Financial statements are historic documents: Financial statements present the past performance of a business and offer limited insight into the future prospects of the business.
• Fraud and error: Financial statements are drawn up by people, making them susceptible to fraud and errors. This can damage the overall credibility and reliability of the accounting information.
• Other information not taken into account: Technological advances, changing user preferences, the changing economic environment (especially in a country like South Africa), trends in the business sector, and changes within the business, cannot be predicted in financial statements.

Question 30

Give examples of a non-current assets? (i.e. property, plant and equipment

Answer 30

• Noncurrent assets are a company’s long-term investments that are not easily converted to cash or are not expected to become cash within an accounting year. Also known as long-term assets, their costs are allocated over the number of years the asset is used and appear on a company’s balance sheet.
• property, plant and equipment

Question 31

Which of the following accounts is estimated in financial statements?

Answer 31

Allowance for credit losses

Question 32

What does historical cost not account for when recording the value of assets?

Answer 32

Change in asset value over time

Question 33

Which of the following is a method for recording non-current assets?

Answer 33

Revaluation model

Question 34

Since financial statements are drawn up by people, what can they be susceptible to?

Answer 34

Fraud and human error

Question 35

What can financial statements NOT offer information about?

Answer 35

Competency of staff

Question 36

List three limitations of accounting information?

Answer 36

Three limitations of accounting information include the following:
- Different accounting policies and frameworks
- Accounting estimates
- Use of historical cost
- Measurability
- Financial statements are historic documents
- Fraud and error

Question 37

Discuss other types of information that are not taken into account when using accounting information?

Answer 37

Technological advances, changing user preferences, the changing economic environment (especially in a country like South Africa), trends in the business sector, and changes within the business, cannot be predicted in financial statements.

Question 38

Analysing financial statements using ratios is one of the most?

Answer 38

common analysis techniques.

Question 39

financial ratio analysis is the process of?

Answer 39

calculating financial ratios and ‘[…] analysing those ratios to find out reasons behind the business’s current financial position, its recent financial performance, and develop expectations about its future outlook’ (Obaidullah, n.d.).

Question 40

Ratios illustrate relationships between different aspects of a?

Answer 40

business’s operations, and provide relative measures of the financial condition and performance of the business.

Question 41

Financial ratios can be categorised in the following ways?

Answer 41

• Liquidity ratios: These ratios focus on a business’s ability to cover short-term obligations; for example, payment of creditors, short-term loans, shareholders, SARS etc.
• Asset management ratios: These ratios indicate how effective the business is in using its assets and other resources to create sales.
• Debt management ratios: These ratios indicate how the business is financed, if it will be able to meet its long-term obligations, as well as the risk factor.
• Profitability ratios: These ratios indicate if a business is making a sufficient profit and if there is a satisfactory return on assets and equity invested into the business.
• Cash flow ratios: These ratios are important for a business to determine if it will have enough cash on hand to make payments and purchase trading inventory. T
• Market value ratios: These ratios are used by investors and management to determine how the business is faring, in comparison to other businesses in the same industry.

Question 42

Comparative financial statements refer to?

Answer 42

when a business uses a complete set of financial statements, for more than one accounting period, or compares its financial statements with those of other businesses in the same industry, over the same period.

Question 43

An analysis of the statement of cash flows can answer the following questions?

Answer 43

• Did the business generate sufficient cash from its operations to pay the rent expense, dividends and tax?
• How were capital development projects financed?
• Is the business a net generator or user of cash?
• Does the business generate enough cash from its operations to maintain its current operating capacity?

Question 44

A common-size financial statement is a financial statement where?

Answer 44

each item is presented as a percentage of the total amount of which it is a part. By removing the numbers, it becomes comparatively easier to understand.

Question 45

Explain Statement of financial position analysis?

Answer 45

The common figure for a common size statement of financial position analysis, is its total assets. This means that current assets and non-current assets will be stated as a percentage of the total assets.

Question 46

Discuss the purpose of comparative financial statements?

Answer 46

It helps management to identify financial trends or measure performance over time.

Question 47

Describe the interest that external parties may have in a cash flow analysis of a business?

Answer 47

Other parties may want to know why less cash is available, despite a larger profit, or what influenced the change in the cash balance from one year to the next.

Question 48

Explain what a common size financial statement is?

Answer 48

A common size financial statement is a financial statement where each item is presented as a percentage of the total amount of which it is a part.

Question 49

Which category does the price earnings ratio fall under?

Answer 49

Market value ratios

Question 50

When doing a cash flow analysis, what other financial statements should be considered?

Answer 50

Statement of financial position

Question 51

What does a common size analysis use instead of figures?

Answer 51

Percentages

Question 52

Which category does the capital gearing ratio fall under?

Answer 52

Debt management ratios

Question 53

Which of the following is a liquidity ratio?

Answer 53

Quick ratio