Book - Chapter 8 ST Questions Flashcards
- What is the accounting equation that underpins the construction of the statement of financial position?
The accounting equation that underpins the construction of the statement of financial position is: assets = liabilities + equity.
- Company A has a 10% stake in Company B. How would this be reflected in Company A’s financial statements?
It would be recognised as an investment and shown as an asset in the statement of financial position and any dividends received would be shown in the income statement in arriving at profit on ordinary activities before taxation.
- How do asset turnover and profit margin relate to ROCE?
Asset turnover measures the level of sales achieved for every £1 of assets.
Profit margin measures the profit portion ‘for each £1 of sales.
The two measures multiplied together give the overall return on capital employed (ROCE) of a company.
- What is gearing and how might it affect company profitability?
Gearing measures the proportion of company funding provided by debt as opposed to equity. A highly geared company has a higher proportion of debt funding, and profits are likely to be more volatile than for a lowly geared company, particularly in rapidly changing economic circumstances.
- What are the profit implications of a company with a high break-even point?
A high break-even point means that profits are only generated above a high level of capacity utilisation. Above this point, profits can grow very rapidly, but below it losses accumulate equally rapidly. When sales are fluctuating around the break-even point, a company will move rapidly between profits and losses, giving a highly volatile ride for the investor.
- Why is it worth measuring company liquidity?
Liquidity ratios measure the degree to which a company can raise or generate cash to pay its bills and interest charges as they become due. A company that is unable to pay these liabilities on time could become subject to legal action and insolvency proceedings.
- What is meant by a ‘positive operating cash flow’ when referring to a company? Is this a good or bad thing?
A positive operating cash flow means that a company is generating more cash from its operations than it is spending. This implies that its products or services are achieving sales at price levels that more than cover the costs involved, and that it is managing to turn these sales into cash.
- What is working capital and how is it funded?
Working capital is made up of current assets less current liabilities, and represents the ‘circulating’ capital of the business. Although the items that comprise working capital are all short-term items (that is, they are expected to be turned into cash at least once during the operating year and usually many times), the net balance of working capital requires long-term capital to finance it.
A company is paying a dividend for the last financial year of 3p per share and has dividend cover of 0.9. What does this indicate?
A dividend cover of less than 1 indicates that the company has insufficient earnings to cover the payment being made and can only do so if it has reserves from earlier years from which the dividend can be paid.
