Chapter 2.3 - Calculation and assessment of performance indicators

Question 1

Name 3 financial accounts you can use to conduct financial reviews on suppliers

Answer 1

1. Profit and loss account/income statement
2. Balance sheet
3. Cash flow statement

Question 2

What does a profit and loss/income statement show

Answer 2

Income (or revenue), costs and expenses that an organisation has incurred within a financial period

Question 3

What is the formula for gross profit

Answer 3

Gross profit = total revenue - cost of sales

Question 4

What does a balance sheet show?

Answer 4

Highlights things than an organisation owns (assets) and things that an organisation owes (liabilities).

Question 5

What shows shareholder equity / shareholder funds

Answer 5

Balance sheet

Question 6

Shareholder equity

Answer 6

The owners of organisations residual claim once all debts have been paid

Question 7

Formula for shareholder equity

Answer 7

Shareholder equity = total assets - total liabilities

Question 8

What can a cash flow statement be used for?

Answer 8

To determine whether a potential supplier or existing supplier has enough cash coming in to be able to pay its expenses, as well as to assess the long term strength of the organisation

Question 9

What is the aim of a cash flow statement

Answer 9

To assess how well an organisation is managing its cash in relation to paying its creditors and funding new investments such as fixed assets

Question 10

Accrual

Answer 10

An adjustment made to a set of financial accounts to reflect activity that has occurred but for which cash has not yet been received or paid

Question 11

Profitability

Answer 11

The organisations revenues minus its total costs

Question 12

Liquidity

Answer 12

A solvency measure to determine whether an organisation is able to meet its liabilities (short term debts) when they come due from net current assets

Question 13

Gearing

Answer 13

A measure of how the business is being funded, based on its ratio of debts to equity, quality of debt or cost of debt

Question 14

Debtor days

Answer 14

A measure of how quickly an organisation gets paid

Question 15

Creditor days

Answer 15

A measure of how quickly an organisation pays its suppliers

Question 16

Stockturn

Answer 16

How quickly an organisation uses its inventory

Question 17

Bad debt

Answer 17

An invoice which is not paid and which is considered a lost cause

Question 18

Name the 2 main objectives of financial ratio analysis

Answer 18

1. To track company performance in order to track trends and raise awareness of any potential concerns
2. To compare the supplier’s performance against those of other organisations in order to gain a competitive advantage

Question 19

How can you get a full financial picture of a supplier

Answer 19

Ratios can be used together with a credit score from a credit rating agency

Question 20

Name 3 documents that contain the information required to calculate ratios

Answer 20

1. Statement of comprehensive income/profit and loss statement
2. Cash flow forecast
3. Statement of financial position/balance sheet

Question 21

What do profitability ratios measure

Answer 21

The extent to which an organisation has traded profitably over a period of time

Question 22

Equity

Answer 22

Funds invested by shareholders, which is generally non-repayable and on which there is usually no definitive commitment to pay a dividend

Question 23

Shareholder

Answer 23

An individual who owns a share or portion of an organisation

Question 24

Formula for gross profit margin

Answer 24

Gross profit margin = (gross profit / sales revenue) x 100

Question 25

Formula for net profit margin

Answer 25

Net profit margin = (net profit / sales revenue) x 100

Question 26

What does EBITDA stand for

Answer 26

Earnings Before interest Taxes Depreciation Amortization

Question 27

Name 3 ratios that demonstrate an organisations ability to generate money for its shareholders

Answer 27

1. Return on assets 2. Return on equity 3. Return on capital

Question 28

Name 5 reasons why its important to understand whether a potential supplier is making a profit

Answer 28

1. It shows all of its costs have been covered 2. Shareholders desire an ROI and if an organisation is making a profit they will get one 3. If its making a profit it can return money to the business to protect its longevity 4. A supplier may not be able to trade in the long term without profit 5. A lack of profit could result in lower quality product being supplied

Question 29

Whats the calculation for operating profit

Answer 29

Operating profit = (operating income / revenue) x 100

Question 30

Whats the calculation for net profit

Answer 30

Net profit / revenue x 100

Question 31

Current assets

Answer 31

Assets which will be sold, consumed or exhausted within the financial year of normal business operations

Question 32

Current liabilities

Answer 32

Debts which are payable in the next 12 months

Question 33

Whats the formula for current ratio

Answer 33

Total current assets / current liabilities

Question 34

Whats the formula for acid test ratio / quick ratio

Answer 34

(total current assets - stock (inventory)) / current liabilities

Question 35

What can liquidity ratios be used for

Answer 35

To gauge if an organisation has enough money to pay its debts in the short to medium term

Question 36

What is the desired outcome from a current ratio

Answer 36

More than 1

Question 37

Whats the desired outcome from a quick ratio

Answer 37

Less than 1

Question 38

What does high gearing mean?

Answer 38

There is a lot of long term or high cost debt within the company, which may present a risk in the long term

Question 39

What does low gearing mean?

Answer 39

The organisation is relying on equity capital or low cost debt option and should therefore have less difficulty coping during tough economic times

Question 40

Give the long example of a gearing ratio formula

Answer 40

(long term debt + short term debt + bank overdrafts) / shareholders' equity

Question 41

Give the short example of a gearing ratio formula

Answer 41

Long term debt / shareholder's equity

Question 42

What suggests that an organisation is either low or high geared

Answer 42

A percentage result below 50% suggests an organisation is low geared and a percentage result above 50% suggests an organisation is highly geared

Question 43

Does high gearing = high risk?

Answer 43

Yes

Question 44

Name 4 benefits of calculating performance indicators from financial statements

Answer 44

1. Security and continuity of supply 2. Access to innovation and investment 3. Avoidance of supplier dependency 4. Ability to negotiate

Question 45

Name 4 limitations of using ratio analysis to asses performance indicators from financial statements

Answer 45

1. Figures are historic 2. Inflation / interest rates / exchange rates 3. Operational changes 4. Variation

Question 46

Fixed costs (FC)

Answer 46

Business costs that remain the same irrespective of the volume of activity of a business

Question 47

Variable costs (VC)

Answer 47

Costs that change in proportion to the output of the business. they increase as the volume of the product or service produced is increased. As sales increase, variable costs increase. As sales go down, variable costs go down. For example, the amount of materials that are used or the cost of hours worked

Question 48

Firm costs

Answer 48

Firm costs are fixed to some extent, but can move in line with predetermined criteria such as through being tied to a particular index

Question 49

Addressability of spend

Answer 49

Spend that is influenceable through negotiations or application of other savings effort or leverage with suppliers

Question 50

Why is it important to understand a suppliers fixed and variable costs?

Answer 50

To help manage the addressability of spend

Question 51

Mark up

Answer 51

The amount of profit expressed as a percentage of cost

Question 52

Margin

Answer 52

Profit given as a percentage of the sales price

Question 53

What is the formula for mark up (%)

Answer 53

Mark up (%) = (price - cost)/Cost x 100

Question 54

What is the formula for margin (%)

Answer 54

Margin (%) = (Price - Cost) / Price x 100

Question 55

Breakeven point (BE)

Answer 55

The level of output of a business at which revenue equals total costs

Question 56

Name three things you will need to know to find your breakeven point

Answer 56

1. Fixed costs 2. Variable costs 3. Selling price

Question 57

What is the formula for BE

Answer 57

Breakeven point (volume) = fixed cost / contribution

Question 58

What is the formula for contribution

Answer 58

Contribution = Price - Variable cost

Question 59

Name 4 benefits of a breakeven analysis

Answer 59

1. Can provide organisations with a realistic idea of how many units of an item or service they will need to sell in order to make a profit 2. Gives organisations insight into practical selling costs for an item or service 3. Can be useful in negotiations 4. Encourages organisations to map, track and categorise different types of costs

Question 60

Name 8 limitations of a breakeven analysis

Answer 60

1. Assumes that all costs are known 2. It is an analysis of prices at a fixed point in time and does not account for price fluctuations 3. For an accurate breakeven point all costs will need to be mapped in the same currency 4. Calculating all the fixed and variable costs required to build or supply a product or service is time consuming and therefore impractical 5. It can be difficult to categorise fixed and variable costs clearly 6. There are firm / semi-variable costs which have both fixed and variable elements such as utilities 7. Doesn't account for any waste 8. Assumes that all products will be sold at the same price and does not account for any pricing strategies