Component 2 - Analysing financial performance Flashcards
Explain : What is meant by a budget variance
A budget variance is a measure of the difference between a budgeted results and actual results
Calculate : Budget Variances
Projected cost – Actual cost
Explain : How a Budget variance can be used to analyse a business performance
Budget Variance - A Budget Variance can be used to analyse a business’s performance and to determine whether it is operating within the financial constraints established in its budget.
Explain : Current assets, Current Liabilities
Current Assets - Assets that a company expects to convert into cash or use up within one year. E.G Cash, Inventory and Accounts Receivable.
Current Liabilities - Obligations that a company is expected to pay within one year. E.G Accounts payable, Accrued expenses, and Short-term loans. Current liabilities are typically settled using current assets.
Explain : Non-Current assets and Non-Current Liabilities
Non-current assets - Resources that a company does not expect to use up or turn into cash longer than one year. Tangible assets, such as property and equipment, or intangible assets, such as patents and copyrights.
Non-current liabilities - Long-term obligations that a company owes to creditors and other entities that are not expected to be settled within the current accounting year. Such as long-term loans, bonds, and leases.
Explain : 1) Working Capital 2) Capital employed 3) Depreciation
1) Working Capital - The amount of money a business has available to meet its short-term obligations. It is the difference between a company’s current assets and its current liabilities.
2) Capital employed - A measure of a company’s long-term financial resources. It represents the total amount of invested capital used to finance a business.
3) Depreciation - The decrease in value of a fixed asset over time. It is a non-cash expense, reducing the value of the asset over time.
Explain : 5 steps to Interpret and analyse a balance sheet
To interpret and analyse a balance sheet.
1 - (Identify the structure of the balance sheet): A balance sheet has two sections: Assets and Liabilities + Equity. Assets are listed in order of liquidity, with the most liquid assets listed first, while liabilities and equity are listed in order of maturity, with the shortest-term liabilities listed first.
2 - (Review the Assets section) - This section lists the resources owned by the company, including cash, accounts receivable, inventory, investments, Machinery. Analyse the composition of assets, looking for any trends or fluctuations that might indicate changes in the company’s operations.
3 - (Review the Liabilities section) - This section lists the debts and obligations owed by the company, including accounts payable, short-term loans, long-term debt. Analyse the composition of liabilities, looking for any trends or fluctuations that might indicate changes in the company’s financial position.
4 - (Review the Equity section) - This section lists the residual interest in the company after deducting liabilities from assets. It includes common stock, retained earnings, and other equity accounts. Analyse the composition of equity, looking for any trends or fluctuations that might indicate changes in the company’s ownership structure.
5 - (Calculate key ratios) - Several key ratios can be calculated from the information provided in the balance sheet, including the debt-to-equity ratio, the current ratio, and the quick ratio. These ratios provide insight into the company’s financial health, including its ability to pay its debts, the efficiency of its operations, and its liquidity.
Explain : Considerations when comparing accounts in relation to previous years and other businesses, Including;
- Comparative analysis
- Industry comparison
- Economic conditions
When considering business accounts in relation to previous years and other businesses, there are several key considerations
Comparative analysis - Analysing and comparing the financial performance of a business with other businesses in the same industry, it identifies areas of strength and weakness, thus helps making informed decisions about strategies for improvement.
Industry comparison - Comparing a company’s financial performance to that of other businesses in the same industry. This comparison can highlight strengths and weaknesses in the company’s financial performance.
Economic conditions - Economic conditions can have a significant impact on a business’s financial performance. For example, a recession can lead to decreased demand for goods and services.
Explain How accounts can be affected by 1) window-dressing
2) Change’s in demand 3) inflation
1) Window-dressing - Making a company’s financial statements look better than they actually are. This can be done by manipulating accounting policies, such as deferring expenses or recognizing revenue early.
2) Changes in demand - Changes in demand for a company’s products or services. Fluctuations cause subsequent changes in sales volume Etc.
3) Inflation - Inflation is a general increase in prices over time. Higher inflation can result in higher costs, which can lead to decreased profitability. inflation can also erode the purchasing power of a company’s profits.
Explain : Ways to analyse the Income Statement and The balance sheet; Such as 1) Revenue Growth 2) Gross Profit Margin 3) Operating Expenses 4)Debt-to-Equity Ratio 5) Asset Turnover
Revenue growth: A company with consistent revenue growth is generally considered to be performing well, while a company with declining revenue may be facing financial difficulties.
Gross profit margin: The gross profit margin represents the percentage of revenue that is left after subtracting the cost of goods sold. A higher gross profit margin generally indicates that the company is generating more profit from its sales.
Operating expenses: Higher operating expenses can decrease the company’s profitability and may indicate that the company is not operating as efficiently as it could be.
Debt-to-equity ratio: A high debt-to-equity ratio may indicate that the company is taking on too much debt, which can put its financial stability at risk.
Asset turnover: The asset turnover ratio represents the amount of revenue generated per dollar of assets. A higher asset turnover ratio indicates that the company is using its assets more efficiently to generate revenue.
Explain : What The Income Statement and The Balance Sheet are, what do they both show insight to
The Income Statement, (AKA the Profit and Loss Statement) - Shows a company’s revenues and expenses over a specific period of time. It aides in identifying the sources of revenue and expenses and provides insights into a company’s profitability.
The Balance Sheet - Provides a snapshot of a company’s financial position at a specific point in time, such as the end of a year, It Shows a company’s assets, liabilities, and equity. It shows insight a company’s liquidity, solvency, and financial structure.
Explain : Assets, Liabilities and Equity (balance Sheet)
Assets - Resources owned by a business that have monetary value and can be used to generate income. They can be tangible or intangible.
Liabilities - Obligations that a company owes to creditors or third parties. They can be current or long-term.
Equity - The residual value of a company’s assets after all liabilities are paid off. It is the portion of the company’s value that belongs to the owners or shareholders.
Assets must Equal liabilities plus Equity.
Calculate : Working capital, capital employed
and depreciation (the straight line method only)
Working capital = Current assets - Current liabilities
Capital employed = Long-term liabilities + Shareholders’ capital
Depreciation expense = (Historical Cost - Residual value) / Useful life
Explain: Interpret return on capital employed (ROCE)
A higher ROCE indicates that the company is generating more profit from its capital, which suggests that it is operating more efficiently and effectively, Vice Versa.
Explain: 3 ways of Comparison in ROCE
Industry comparison - Compare the company’s ROCE to its competitors within the same industry to see how it is performing relative to its peers.
Time period comparison - Compare the company’s ROCE over different time periods to assess its financial performance and stability.
Capital structure - Consider the company’s capital structure and how it is affecting its ROCE. A company with a higher level of debt may have a lower ROCE because it is paying more interest on its debt.
