financial statements analysis

Question 1

profitability

Answer 1

ability of a business to generate excess income to cover its expenses

Question 2

importance of being profitable

Answer 2

1. continue or expand operations
2. distribute profits to reward owners
3. attract investors

Question 3

consequences of not being profitable

Answer 3

face difficulties in continuing operations, in attracting investors, in competing with competitors

Question 4

improve GP or GP margin

Answer 4

sell goods at higher selling price, buy goods at lower cost price by looking for cheaper suppliers

Question 5

improve profit or profit margin

Answer 5

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

Question 6

gross profit formula

Answer 6

net sales revenue-cost of sales

Question 6

profit for the year formula

Answer 6

gross profit + other income - other expenses

Question 7

GP margin

Answer 7

GP/net sales revenue x 100%

Question 8

mark up on cost

Answer 8

GP/cost of sales x 100%

Question 9

profit margin

Answer 9

profit for the period/net sales revenue x 100%

Question 10

return on equity

Answer 10

profit for the period/average equity x 100%

Question 11

intepret profitability ratio (between years)
(p.s. between busines change the improved/worsened to better/worse)

Answer 11

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 —-.

Question 12

liquidity

Answer 12

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

Question 13

importance of being liquid

Answer 13

cash needed for daily operations such as paying for goods or expenses
cash needed to pay short-term debts when they are due

Question 14

possible consequences of not being liquid

Answer 14

daily operations affected, unable to pay immediate debts, if persists - business may eventually close down

Question 15

ways to improve liquidity

Answer 15

cash contribution from owners/shareholders, sale of excess NCA, bank loan

Question 16

working capital

Answer 16

total CA-total CL

Question 17

current ratio

Answer 17

total CA/total CL

Question 18

quick ratio

Answer 18

total CA-inventory-prepayments
/total CL

Question 19

interpret liquidity ratio (between years)
(p.s. between business, better/worse)

Answer 19

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.

Question 20

efficiency in inventory management

Answer 20

ability of the business to manage its inventory to meet customer demand

Question 21

importance of being able to manage inventory efficiently

Answer 21

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.

Question 22

ways to improve efficiency in inventory management

Answer 22

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

Question 23

rate of inventory turnover (times)

Answer 23

cost of sales/average inventory

Question 24

days sales in inventory

Answer 24

average inventory/cost of sales x 365 days

Question 25

interpret efficiency ratio (between years)
(p.s. between business, better/worse)

Answer 25

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.

Question 26

efficiency in TR management

Answer 26

ability of the business to collect its debts quickly

Question 27

importance of being able to manage inventory efficiently

Answer 27

when business takes longer than usual to collect payment from its credit customers. it would have lesser cash, causing liquidity position to worsen

Question 28

ways to improve rate of tr turnover or tr collection period

Answer 28

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

Question 29

rate of tr turnover

Answer 29

net credit service fee revenue/average net tr

net credit sales revenue/average net tr

Question 30

tr collection period

Answer 30

average net tr/net credit sales revenue x 365 days

Question 31

interpret efficiency ratios

Answer 31

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.