Budgeting and Financial Indicators

Question 1

Use of Variance Reports

Answer 1

is an Accounting report that compares actual and budgeted figures, highlighting variances so that problems can be identified and corrective action can be taken.
used in planning the next budget, so that it is more accurate. (The unfavourable variances should be investigated, and their cause identified. This will allow the owner to take corrective action.)

Question 2

Trends for Cash Flow Variances

Answer 2

Favourable: Higher than expected cash inflows or lower than expected cash outflows.
Unfavourable: Lower than expected cash inflows or higher than expected cash outflows.

Question 3

Trends for Income Statement Variances

Answer 3

Favourable: Higher than expected revenues or lower than expected expenses.
Unfavourable: Lower than expected revenues or higher than expected expenses.

Question 4

Use of budgeted Cash Flow Statement

Answer 4

The budgeted cash flow can help the owner prepare for a budgeted increase/decrease in cash.

Use excess cash to:
make loan repayments
increase cash drawings
purchase more assets
pay additional expenses such as wages, advertising

Cash deficit:
defer loan repayments
reduce cash drawings
make a capital contribution
organise an overdraft or loan

in terms of decision making:
Debt collection
Level of drawings

Question 5

Budgeted Cash Flow Statement

Answer 5

A report that shows all expected future cash inflows and cash outflows, the actual bank balance at the start of the period, and the expected bank balance at the end of the period

Question 6

Limitations of analysis budgeted accounting reports

Answer 6

Budgeted reports report future events rather than historical events. As a consequence budgets use estimates or predictions rather than actual verifiable data.

Question 7

Profitability

Answer 7

The ability of a business to earn profit measured by comparing profit to a base, such as assets, sales or owners equity.

That is, its ability to earn revenue, and
Its ability to control expenses

indicators involve: ROI, ROA, NPM, GPM

Question 8

Liquidity

Answer 8

is the ability of a business to meet its short term debts as they fall due.

indicators involved: WCR, QAR, CFC

Question 9

Stability

Answer 9

the ability of the business to meets its debt and continue its operation in the long term.
indicators involved: Debt ratio

Question 10

ROI

Answer 10

net profit/average capital x 100
profitability indicator that assess how effectively the business has used it’s owner’s capital to earn a profit.

Question 11

ROA

Answer 11

net profit/average total assets x 100
profitability indicator which assess how effectively the firm has used its assets to earn a profit.

earned a return of x% on their investment in assets.
Higher ROA = earning more profit per dollar of asset controlled
Decreased ROA = increase in assets with smaller increase in net profit

Question 12

expense control

Answer 12

refers to the firm’s ability to manage its expenses so that they either decrease, or, increase no faster than sales revenue.

financial indicators: NPM and GPM

Question 13

NPM

Answer 13

net profit/net sales x 100
profitability indicator that measures the percentage of Sales revenue that is retained as Net Profit and assess the firm’s expense control.

Question 14

GPM

Answer 14

gross profit/net sales x 100
profitability indicator which assess the average mark-up by determining the percentage of sales retained as gross profit.
- Assess expense control specifically as it relates to inventory and Cost of Goods Sold.
- As such can indicate the adequacy of the firm’s average mark-up on goods sold in a particular period.

Question 15

Strategies to improve profitability

Answer 15

increasing revenue:
Adjust selling price
Advertising strategies
Change the Inventory mix
Non-current assets

expense control:
Relationship with supplier…
Staff management
Non-current assets

Question 16

Asset Turnover

Answer 16

net sales/average total assets.
efficiency indicator which assesses how productively the business has used its assets to ear revenue.
how many times the value of assets can be earned as revenue in a given reporting period

Question 17

difference between roa and ato

Answer 17

similarity between ATO and ROA reflects the fact that they both assess a firms ability to use their assets, the only difference is that ROA relates to profit while ATO relates to revenue.
Theoretically, an increase in ATO should increase ROA but it is not always the case.
The only difference is the difference between net profit and revenues, being expenses. If they move in different directions it is because of a change in expense control.

Question 18

Working Capital Ratio

Answer 18

current assets/current liabilities
liquidity indicator which asseses the ability of the business to meet its short term debts by measuring the ratio of current assets to current liabilities.

Question 19

WCR RATIO MEANING

Answer 19

less than 1:1 may struggle to pay back short term debts as they fall due
more than 1:1 is favourable but indicates the firm may not be using its assets effectively as they are idle.

bank - excess cash used to retire debt or expand operations
inventory - excess inventory is susceptible to damage and storage costs
AR - indicate mismanagement and higher likelihood of bad debts

Question 20

QAR

Answer 20

current assets - inventory/prepaid assets?current liabilities
liquidity indicator that assesses the firm’s ability to meet immediate short term debts strait away if they fall due.

Question 21

Inventory and prepaid expenses

Answer 21

recognises not all current assets are able to be converted into cash as readily as each other
inventory - no guarantee that inventory can be sold and converted into cash
prepaid expenses - cannot be liquidated or converted back into cash.

Question 22

Cash Flow Cover

Answer 22

net cash flows from operations/average current liabilities
liquidity indicator that measures the number of times net cash flows from operating activities is able to cover the current liabilities of the business.

Question 23

Debt Ratio/Gearing

Answer 23

total liabilities/total assets x 100
Debt Ratio stability indicator that measures the percentage of the firm’s assets which are financed by liabilities
Measures the extent the business relies on debts compared to capital to purchase assets.

Question 24

Low debt ratio

Answer 24

means the firm s not very reliant on borrowed funds and has a low risk of not being able to pay off their debts. Can result in a lower ROI. Low risk achieves low return.

Question 25

High debt ratio

Answer 25

high debt ratio means the firm is more heavily reliant on borrowed funds than on the owners capital. Increases ROI without increasing profit.

The business is using someone else’s funds to buy the assets to earn profit and still received all of that profit. A high debt ratio will also result in a higher risk the business cannot repay its debts and interest payments. Greater pressure on cash flows and liquidity.

Question 26

WCR vs QAR

Answer 26

If the Working Capital Ratio is satisfactory, but the Quick Asset Ratio is unsatisfactory is a direct result of the fact that the business has a large investment in its inventory and prepaid expenses.

Question 27

Disadvantges of WCR and QAR

Answer 27

Both the WCR and the QAR use static information, providing no real indication of cash flows. The Cash Flow Cover measures liquidity by looking at how the business generates its cash.

Question 28

relationship between roi and debt ratio

Answer 28

higher debt ratio is linked to roi as it indicates the firm relies on loans to purchase assets. If borrowed funds are put to profitable use, this means the owner will be earning a profit using someone else’s money rather than capital resulting in high ROI.

Question 29

Relationship between ROA, NPM and ATO

Answer 29

ROA = NPM x ATO

ATO increases but ROA decreases, NPM must have decreased at a larger rate (expense control worsened)
if ato decreases despite an increase in roa then the npm of the business must have increased (expense control improved).