financial statements analysis Flashcards
profitability
ability of a business to generate excess income to cover its expenses
importance of being profitable
- continue or expand operations
- distribute profits to reward owners
- attract investors
consequences of not being profitable
face difficulties in continuing operations, in attracting investors, in competing with competitors
improve GP or GP margin
sell goods at higher selling price, buy goods at lower cost price by looking for cheaper suppliers
improve profit or profit margin
increase sources of other income such as subletting excess space to earn rental income
reduce operating expenses such as negotiating for lower rental, paying lower salaries, etc
gross profit formula
net sales revenue-cost of sales
profit for the year formula
gross profit + other income - other expenses
GP margin
GP/net sales revenue x 100%
mark up on cost
GP/cost of sales x 100%
profit margin
profit for the period/net sales revenue x 100%
return on equity
profit for the period/average equity x 100%
intepret profitability ratio (between years)
(p.s. between busines change the improved/worsened to better/worse)
GP margin improved/worsened from to
This could be due to business charging higher/lower selling price for its products
or buying goods at a lower/higher cost price or both in —–,
as shown buy a better/worse mark up on cost from to
Profit margin improved/worsened from to
This could mean that the business is more/less efficient in managing its expenses in —-.
Return on equity improved/worsened from to
This means that the business is more/ less efficient at generating profits for its owners/shareholders in —-.
In conclusion, the business has become more/less profitable in —-.
liquidity
measures ability of business to repay its CL when they fall due. also the ability of business to convert its CA into cash to pay for CL
importance of being liquid
cash needed for daily operations such as paying for goods or expenses
cash needed to pay short-term debts when they are due
possible consequences of not being liquid
daily operations affected, unable to pay immediate debts, if persists - business may eventually close down
ways to improve liquidity
cash contribution from owners/shareholders, sale of excess NCA, bank loan
working capital
total CA-total CL
current ratio
total CA/total CL
quick ratio
total CA-inventory-prepayments
/total CL
interpret liquidity ratio (between years)
(p.s. between business, better/worse)
working capital improved/worsened from to
this means that business has greater/lower excess of CA to pay its CL
current ratio improved/worsened from to
it is above/below general benchmark of 2
means that business has sufficient/insufficient CA to pay its CL
quick ratio improved/worsened from to
it is above/below general benchmark of 1
means that business has sufficient/insufficient quick assets to pay its CL
extra support:
inventory position worsened as it has increased. increasing inventory means more cash is tied up.
cash in hand/bank balance worsened as it has decreased
TP position worsened as it has increased. an increase in TP may affect its ability to obtain credit.
in conclusion, the liquidity has improved/worsened over the years.
efficiency in inventory management
ability of the business to manage its inventory to meet customer demand
importance of being able to manage inventory efficiently
business needs to manage sufficient inventory to prevent stock-out situation often resulting in loss of sales.
however, if business buys too much goods and unable to sell them, it will incur high storage cost and increase risk of goods becoming obsolete.
ways to improve efficiency in inventory management
sell inventory faster by:
-reducing selling price for slow-moving goods
-give trade discounts to encourage customers to buy in bulk and regularly
-attract more customers through marketing campaigns
rate of inventory turnover (times)
cost of sales/average inventory
days sales in inventory
average inventory/cost of sales x 365 days
interpret efficiency ratio (between years)
(p.s. between business, better/worse)
rate of inventory turnover improved/worsened from to
days sales in inventory improved/worsened from to
this means that the business is selling its goods more quickly/slowly and has become more/less efficient in managing its inventory over two years.
efficiency in TR management
ability of the business to collect its debts quickly
importance of being able to manage inventory efficiently
when business takes longer than usual to collect payment from its credit customers. it would have lesser cash, causing liquidity position to worsen
ways to improve rate of tr turnover or tr collection period
offer cash discounts to encourage credit customers to pay early
increase debt collection efforts by sending regular reminders to credit customers or engaging professional debt recovery agencies to collect payment
rate of tr turnover
net credit service fee revenue/average net tr
net credit sales revenue/average net tr
tr collection period
average net tr/net credit sales revenue x 365 days
interpret efficiency ratios
rate of tr turnover improved/worsened from to
tr collection period improved/worsened from to
this means that the business is collecting payment from its credit customers on a more/less timely basis.
it has become more/less efficient in managing its trade receivables over two years.
