complete statements of comprehensive income and financial position and evaluate business performance Flashcards
learning aim F
what is a statement of comprehensive income
statement that calculates whether the firm has made a profit or a loss by deducting all expenses from the sales revenue
what is the purpose and use of a statement of comprehensive income
provide an accurate calculation showing how much profit or loss the business has made. This is done by recording sales, costs and profit
how do you calculate gross profit
sales turnover - cost of goods sold
how is the cost of goods sold calculated
opening inventories + purchases - closing inventories
what is the cost of goods sold
the cost directly linked to providing that trade (production of product for example)
what is gross profit
the amount left once the cost of goods sold is deducted from the sales turnover
how do you calculate the profit or loss for the year
gross profit - expenses + other income
how would profit be transferred to a statement of comprehensive income
the business must decide what to do with profit after tax is deducted (issued to shareholders, retained profit?). Retained profits are transferred from the statement of comprehensive income to the statement of financial position
what is depreciation
used to spread the cost of an asset over its useful life.
why is it important for fixed assets to be recorded in the statement of financial position
so that they can be depreciated on an annual basis and this amount they are depreciated by is then shown as an expense in the statement of comprehensive income
what should the statement of financial position show in terms of depreciation of fixed assets
historic cost of the asset, the amount the asset has depreciated and the current value of the asset. This final figure is the net book value of the asset, which represents the value of the asset at that point in time
what are the two ways in which depreciation be calculated
straight line and reducing balance
how is straight line depreciation calculated
(historic value - residual value (end of life)) / expected life
what is straight line depreciation
the asset’s value loses a fixed amount each year
what is the reducing balance method of depreciation
the asset loses value of a set percentage each year
what is the calculation for reducing balance depreciation
starting value - set percentage
what are prepayments
when an expense is made in advance of the periods to which it relates (phone line paid in advance)
how are prepayments shown in statement of comprehensive income and financial position
expense is taken from the expenses within the statement of comprehensive income and shown as a current asset in the statement of financial position
what are accruals
when an expense is paid after the periods in which it relates (electricity bill paid quarterly after use)
how are accruals shown in the statement of comprehensive income and financial position
added as an expense in the statement of comprehensive income and shown as a current liability in the statement of financial position
what can be interpreted from the statement of comprehensive income
interpret internally by managers to help measure the performance of the business and externally by potential investors to decide if they want to invest or not and by creditors to determine if they want to offer trade credit or not
how can a statement of comprehensive income be analysed
comparisons between figures (profit and sales revenue), comparisons between years (profit comparisons), intrafirm comparisons to see how different aspects of the business are performing, and interfirm comparisons to see how the business is performing in relation to its competitors
what should be considered when interpreting and analysing the statement of comprehensive income
profit quality (how sustainable the profit is), is it because of a one-off event or is the business growing
how can profit quality evaluate the statement of comprehensive income
information may not be absolutely accurate, due to considering the profit quality and also as businesses may manipulate data to make them look more favourable and to meet laws and regulations
what is a statement of financial position
statement that calculates the net worth of a business by balancing what the business owns against what the business owes
what is the purpose and use of a statement of financial position
snapshot of the business’ net worth at a point in time, which provides a summary of everything the business owns (assets) and owes (liabilities). This states the value of the business
what are non-current assets
assets that will stay within the business for over a year that provide value to the business
what are the examples of non-current assets
tangible assets (can be touched) and intangible assets (cannot be touched)
what is an example of a tangible asset
machine, vehicle or premises
what is an example of an intangible asset
trademark, good will or brand name
why is it important that tangible assets are shown on the statement of financial position
So that they can be given a realistic value and are therefore depreciated annually to show the historical cost of the asset, the amount it has depreciated by over its useful life and the current value, therefore providing a net book value of the asset
how are intangible assets shown on the statement of financial income
amortisation is used to make a one-off change to the value of the asset. The statement of financial position should show the cost, amortisation and net book value of the intangible asset
what are current assets
items of value owned by a business whose likely to stay in the business for less than a year (inventory, trade receivables, prepayments, cash in hand and cash in bank)
explain inventory as a current asset recorded on the statement of financial position
inventory is the value of the stock held at that moment in time, a business should give stock realistic value and not overvalue it (out of date items)
explain trade receivables as a current asset shown on a statement of financial position
people or businesses who owe the business money and although the business does not yet have the money it is still owned by the business. For example, credit terms should be monitored to ensure payments are made on the due date
explain prepayments as a current asset shown on a statement of financial position
when an expense is made in advance to a period in which it relates. Therefore it is classed as an asset and is transferred from the statement of comprehensive income
what are current liabilities
something owed by the business that should be paid back in under one year (overdrafts, accruals, trade payables)
what are net current assets/liabilities
represents the business’s ability to meet short-term debts. A business with more liabilities than assets is unable to meet demands which can be disasterous
how is net current assets/liabilities calculated
current assets - current liabilities
what are non current liabilities
something that the business owes that will be paid back over more than a year (mortgage).
what are net assets
figure representing the total value of all the assets minus the liabilities
how is net assets calculated
(non-current assets + current assets) - (current liabilities + non current liabilities)
what is capital employed
total amount of capital tied up in a business at a point in time
how is capital employed calculated
owner’s or shareholder’s capital + retained profit - drawings
what is opening capital in terms of statement of financial position
the capital in the business at the start of trading. This is money invested in the business by owners
what is retained profit on a statement of financial position
profit kept in the business plus the net profit from the current year. This is transferred from the statement of financial position
what are drawings in terms of statement of financial position
withdrawals made by owners from the business. For the statement of financial position to balance, the net assets must be equal to the capital employed
What are the adjustments made to depreciation in the statement of financial position and comprehensive income
annual depreciation is shown as an expense on the statement of comprehensive income and as an asset in the statement of financial position
what are the adjustments made to prepayments in the statement of financial position and comprehensive income
Taken out of expenses in the statement of comprehensive income and shown as a current asset in the statement of financial position
what are the adjustments made to accruals in the statement of financial position and comprehensive income
added as an expense in the statement of comprehensive income and shown as a current liability in the statement of financial position
how can the statement of financial position be interpreted
internally by management to help measure the financial health of the business and inform future decision making and externally by potential investors and creditors to see if they want to offer capital or investments to the business or not
how can the statement of financial position be analysed
comparisons between figures within the statement (current assets in relations to current liabilities), comparisons between years (value of fixed asset in different years), intrafirm comparisons to see how different aspects of the business are performing and interfirm comparisons to see how the business is performing against competitors
what should be considered when analysing and interpreting statement of financial position
the working capital should be considered as this is a measure of the firm’s ability to meet day-to-day expenses.
what can both the statement of comprehensive income and statement of financial position be interpreted by
ratios
how can ratios be used to measure profitability
allows comparison between one figure with another, it allows both intrafirm and interfirm comparisons
who uses ratios
internal and external stakeholders
what is profitability
measure of the profit of a firm in relation to another factor
what are the 4 profitability ratios
gross profit margin, mark-up, net profit margin, return on capital employed (ROCE)
explain gross profit margin as a profitability ratio
looks at gross profit as a percentage of sales turnover
what is the calculation for gross profit margin ratio
gross profit / revenue (X100)
explain mark-up as a profitability ratio
looks at profit as a percentage of cost of sales
what is the calculation for mark-up ratio
gross profit / cost of sales (X100)
explain net profit margin as a profitability ratio
looks at net profit as a percentage of sales turnover
what is the calculation for net profit margin ratio
net profit /revenue (X100)
explain return on capital employed (ROCE) as a profitability ratio
shows the percentage return a business is achieving from the capital being used to generate that return
what is the calculation for ROCE ratio
net profit before interest and tax / capital employed (X100)
what is liquidity
how solvent a business is (ability to meet its short-term debts)
what are the liquidity ratios
current ratio and acid test/liquidity ratio (liquid capital ratio)
explain the current ratio as a liquidity ratio
shows the amount of current assets in relation to current liabilities and is expressed as x:1
what is the calculation for current ratio
current assets / current liabilities
explain the liquid capital ratio as a liquidity ratio
shows the amount of current assets in relation to current liabilities but it does not include inventory
what is the calculation for liquid capital ratio
(current assets - inventory) / current liabilities
what do efficiency ratios access
how well management is controlling key aspects of the business, stock and finances
what are the efficiency ratios
trade receivable days, trade payable days and inventory turnover
explain trade receivable days as an efficiency ratio
measures on average how long it takes for debtors to pay, expressed as a number of days
what is the calculation for trade receivable days ratio
(trade receivables / credit sales ) X365
explain trade payable days as an efficiency ratio
the ratio measures on average how long it takes a firm to pay for goods and services bought on credit, expressed in a number of days
what is the calculation for trade payable days ratio
(trade payables / credit purchases) X365
explain inventory turnover as an efficiency ratio
measures the average amount of time an item of stock is held by a business, expressed in a number of days
what is the calculation for the inventory turnover ratio
(average inventory / cost of sales ) X365
what is the calculation for average inventory
(opening inventory + closing inventory) / 2
what are the limitations of ratios
calculated on past data and therefore may not be a true reflection of the business’s current performance, ratios do not consider qualitative factors, records may have been manipulated and may be misleading, ratios indicate a problem but does not directly identify the cause of the problem
