Chapter 2.3 - Calculation and assessment of performance indicators Flashcards
Name 3 financial accounts you can use to conduct financial reviews on suppliers
- Profit and loss account/income statement
- Balance sheet
- Cash flow statement
What does a profit and loss/income statement show
Income (or revenue), costs and expenses that an organisation has incurred within a financial period
What is the formula for gross profit
Gross profit = total revenue - cost of sales
What does a balance sheet show?
Highlights things than an organisation owns (assets) and things that an organisation owes (liabilities).
What shows shareholder equity / shareholder funds
Balance sheet
Shareholder equity
The owners of organisations residual claim once all debts have been paid
Formula for shareholder equity
Shareholder equity = total assets - total liabilities
What can a cash flow statement be used for?
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
What is the aim of a cash flow statement
To assess how well an organisation is managing its cash in relation to paying its creditors and funding new investments such as fixed assets
Accrual
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
Profitability
The organisations revenues minus its total costs
Liquidity
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
Gearing
A measure of how the business is being funded, based on its ratio of debts to equity, quality of debt or cost of debt
Debtor days
A measure of how quickly an organisation gets paid
Creditor days
A measure of how quickly an organisation pays its suppliers
Stockturn
How quickly an organisation uses its inventory
Bad debt
An invoice which is not paid and which is considered a lost cause
Name the 2 main objectives of financial ratio analysis
- To track company performance in order to track trends and raise awareness of any potential concerns
- To compare the supplier’s performance against those of other organisations in order to gain a competitive advantage
How can you get a full financial picture of a supplier
Ratios can be used together with a credit score from a credit rating agency
Name 3 documents that contain the information required to calculate ratios
- Statement of comprehensive income/profit and loss statement
- Cash flow forecast
- Statement of financial position/balance sheet
What do profitability ratios measure
The extent to which an organisation has traded profitably over a period of time
Equity
Funds invested by shareholders, which is generally non-repayable and on which there is usually no definitive commitment to pay a dividend
Shareholder
An individual who owns a share or portion of an organisation
Formula for gross profit margin
Gross profit margin = (gross profit / sales revenue) x 100
Formula for net profit margin
Net profit margin = (net profit / sales revenue) x 100
What does EBITDA stand for
Earnings
Before
interest
Taxes
Depreciation
Amortization
Name 3 ratios that demonstrate an organisations ability to generate money for its shareholders
- Return on assets
- Return on equity
- Return on capital
Name 5 reasons why its important to understand whether a potential supplier is making a profit
- It shows all of its costs have been covered
- Shareholders desire an ROI and if an organisation is making a profit they will get one
- If its making a profit it can return money to the business to protect its longevity
- A supplier may not be able to trade in the long term without profit
- A lack of profit could result in lower quality product being supplied
Whats the calculation for operating profit
Operating profit = (operating income / revenue) x 100
Whats the calculation for net profit
Net profit / revenue x 100
Current assets
Assets which will be sold, consumed or exhausted within the financial year of normal business operations
Current liabilities
Debts which are payable in the next 12 months
Whats the formula for current ratio
Total current assets / current liabilities
Whats the formula for acid test ratio / quick ratio
(total current assets - stock (inventory)) / current liabilities
What can liquidity ratios be used for
To gauge if an organisation has enough money to pay its debts in the short to medium term
What is the desired outcome from a current ratio
More than 1
Whats the desired outcome from a quick ratio
Less than 1
What does high gearing mean?
There is a lot of long term or high cost debt within the company, which may present a risk in the long term
What does low gearing mean?
The organisation is relying on equity capital or low cost debt option and should therefore have less difficulty coping during tough economic times
Give the long example of a gearing ratio formula
(long term debt + short term debt + bank overdrafts) / shareholders’ equity
Give the short example of a gearing ratio formula
Long term debt / shareholder’s equity
What suggests that an organisation is either low or high geared
A percentage result below 50% suggests an organisation is low geared and a percentage result above 50% suggests an organisation is highly geared
Does high gearing = high risk?
Yes
Name 4 benefits of calculating performance indicators from financial statements
- Security and continuity of supply
- Access to innovation and investment
- Avoidance of supplier dependency
- Ability to negotiate
Name 4 limitations of using ratio analysis to asses performance indicators from financial statements
- Figures are historic
- Inflation / interest rates / exchange rates
- Operational changes
- Variation
Fixed costs (FC)
Business costs that remain the same irrespective of the volume of activity of a business
Variable costs (VC)
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
Firm costs
Firm costs are fixed to some extent, but can move in line with predetermined criteria such as through being tied to a particular index
Addressability of spend
Spend that is influenceable through negotiations or application of other savings effort or leverage with suppliers
Why is it important to understand a suppliers fixed and variable costs?
To help manage the addressability of spend
Mark up
The amount of profit expressed as a percentage of cost
Margin
Profit given as a percentage of the sales price
What is the formula for mark up (%)
Mark up (%) = (price - cost)/Cost x 100
What is the formula for margin (%)
Margin (%) = (Price - Cost) / Price x 100
Breakeven point (BE)
The level of output of a business at which revenue equals total costs
Name three things you will need to know to find your breakeven point
- Fixed costs
- Variable costs
- Selling price
What is the formula for BE
Breakeven point (volume) = fixed cost / contribution
What is the formula for contribution
Contribution = Price - Variable cost
Name 4 benefits of a breakeven analysis
- 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
- Gives organisations insight into practical selling costs for an item or service
- Can be useful in negotiations
- Encourages organisations to map, track and categorise different types of costs
Name 8 limitations of a breakeven analysis
- Assumes that all costs are known
- It is an analysis of prices at a fixed point in time and does not account for price fluctuations
- For an accurate breakeven point all costs will need to be mapped in the same currency
- Calculating all the fixed and variable costs required to build or supply a product or service is time consuming and therefore impractical
- It can be difficult to categorise fixed and variable costs clearly
- There are firm / semi-variable costs which have both fixed and variable elements such as utilities
- Doesn’t account for any waste
- Assumes that all products will be sold at the same price and does not account for any pricing strategies
