chapter 26 - analysis of account

Question 1

definition of:

analysis of account

Answer 1

using the data contained in the account to make useful observations abt the performance and financial strength of business

Question 2

definition of:

profitability

Answer 2

measurement of the profit made relative to either value of sales achieved or capital invested in the business

• measured in %
• it’s a measure of efficiency and can be used to compare the business performance over num of years with other businesses

Question 3

importance of measuring profitability

Answer 3

• investors deciding which business to invest in
• assess whether business is becoming more/ less successful
• assess whether business needs to change operations of business to improve profitability

Question 4

definition of:

return of capital employed

Answer 4

shows the profit earned for every amount of money invested

ROCE= (net profit/ capital employed) x 100%

Question 5

definition of:

gross profit margin

Answer 5

assess the amount of money that they have spent on purchasing goods for resale (variable costs)

GPM= (gross profit/ sales revenue) x 100%

Question 6

definition of:

net profit margin

Answer 6

calculate the average net profit made for the worth of sales; business trying to find out whether they have overspend on fixed costs

NPM= (net profit/ sales revenue) x 100%

Question 7

how to write analysis of accounts?

Answer 7

if given to compare 2 companies, compare the ROCE, GPM, NPM and state what does it suggest for each

e.g. if ROCE increases: use capital employed efficiently
if GPM decreases: ,made lesser profit from sales of goods
if NPM increases, earn higher profit by controlling fixed costs

Question 8

definition of:

liquidity

Answer 8

ability of business to pay back its short term debts

Question 9

definition of:

illiquid

Answer 9

assets are not easily convertible into cash (when business cannot pay its supplies/ repay overdrafts)

Question 10

definition of:

current ratio/ working capital ratio

Answer 10

it compares the assets which are in the form of cash, or which can be turned into cash relatively easily within 12 months, with the liabilities which are due for repayment within that period of time

current ratio= current assets/ current liabilities

1:1 is satisfactory
less than 1:1 is unsatisfactory

Question 11

definition of:

quick/ acid test ratio

Answer 11

it compares the assets which are in the form of money, or which will convert into money quickly, with the liabilities which are due for repayment in near future

acid ratio= (current assets - inventories)/ current liabilities

it shows the immediate cash available to pay back; exclude inventory as business doesn’t have assurance that they can sell the inventory, look at financial position more realistically

Question 12

how to analyse liquidity ratios?

Answer 12

if given two companies to compare

compare current ratio - state whether it has increase or fallen from previous years - state what it suggests (if fallen, business owes more in current year than previous)

compare acid ratio - state whether it has increase or fallen from previous years - state what it suggests (if fallen, business has lesser amount of assets to pay back its liabilities, the ratio excluded inventory as it is regarded as an illiquid assets where it will take longer time to be converted into cash)

write conclusion - e.g. state whether business has purchases too much inventory

Question 13

users of accounts

Answer 13

other businesses
managers
creditors 
bank
government 
workers & trade unions 
shareholders

Question 14

bank’s use of account

Answer 14

look at business’s balance sheet, assess its total value of debt and its cash position; see if business is struggling to pay - offer overdraft

Question 15

workers and trade unions’ uses of account

Answer 15

• assess whether future of company is secured

- trade union go through financial statement if business claims cannot afford for pay rise

Question 16

other businesses’ uses of account

Answer 16

• look at company’s cash position - compare business performance
• consider takeover/ merging

Question 17

manager’s uses of account

Answer 17

• keep control over performance of product or division of business
• identify which part of business is performing well/ poorly

Question 18

shareholders’ uses of account

Answer 18

-worth of profit; look into ROCE

Question 19

creditors’ uses of account

Answer 19

• look at business’ working capital, acid/ current ratio - see if business has sufficient assets to pay its liabilities
• look at business’s cash position

Question 20

government’s uses of account

Answer 20

check on profit tax paid by company

Question 21

limitations of using account & ratio analysis

Answer 21

• managers have access to all accounts data; external uses can only use published accounts which contain only data required by law
• ratio based on pass account data may not indicate the performance of business in future
• account data over time affected by inflation; comparison between years might be misleading
• different companies, diff account method - difficult to compare