Interpretation of financial statements 3.5.1

Question 1

What is a statement of comprehensive income?

Answer 1

Income and expenditure for a business in a period of time and profits of a business.

Question 2

What is the key information in a statement of comprehensive income?

Answer 2

• Revenue
• Cost of sales
• Gross profit
• Selling expenses (advertising, etc)
• Operating profit
• Net profit before and after tax
• Admin expenses

Question 3

What is revenue?

Answer 3

Sales during the period. Sometimes referred to as top line.

Question 4

What is cost of sales?

Answer 4

Direct costs of generating revenues go into the cost of sales. Includes the cost of raw materials, components, goods bought for resale and direct labour costs of production.

Question 5

What is gross profit?

Answer 5

The difference between revenue and cost of sales. A simple but very useful measure of how much profit is generated from everyone pound of revenue before overhead and other expenses are taken into account.

Question 6

What is overheads?

Answer 6

Operating costs and expenses that are not directly related to producing the goods or services are recorded here. Includes distribution costs and a wide range of administrative expenses that the overheads of business incur.

Question 7

What is operating profit?

Answer 7

A key measure of profit. Operating profit records how much profit has been made in total from trading activities of the business before the account is taken of how the business is financed.

Question 8

What is finance costs/income?

Answer 8

Interest paid on bank what are the borrowings, left interest income received on cash balances. A useful figure for shareholders to assess how much coffee is being used up by the funding structure of the business.

Question 9

What is profit before tax?

Answer 9

Calculated as operating profit - finance expenses.

Question 10

What is tax?

Answer 10

An estimate of the amount of corporation tax as likely to be payable on the recorded profit before tax.

Question 11

What is profit attributable to shareholders?

Answer 11

The amount of profit that is left after the tax has been accounted for. Shareholders then decide how much of this is paid out in dividends and how much is left in the business.

Question 12

What interest does a shareholder have in the comprehensive income statement?

Answer 12

• Interested in the profit after tax.
• To look at the performance of the business.

Question 13

What interest does a manager have in the comprehensive income statement?

Answer 13

Interested in key information that monitors performance, e.g inc in revenue show how fast a company is growing.

Question 14

What interest does an employee have in the comprehensive income statement?

Answer 14

When asking for wage increases it may be key to have information on profits etc.

Question 15

What interest does a supplier have in the comprehensive income statement?

Answer 15

Check creditworthiness, this could be done by looking at the profits and if they are consistent.

Question 16

What interest does the government have in the comprehensive income statement?

Answer 16

It is a law to produce one so the government can see how much tax a business must pay and evidence of profits and losses.

Question 17

What is a statement of financial position?

Answer 17

Also known as a balance sheet, and is a firm’s assets, liabilities and capital at a point in time.

Question 18

Why do assets = the value of capital and liabilities?

Answer 18

Because an inc in assets must be funded by an equal increase in capital or liabilities, e.g a reduction in credit from supplier 9a liability) may mean a reduction in stock (an asset).

Question 19

What are the key features in a statement of financial position?

Answer 19

Net assets:
- Non-current assets
- Current assets
- Current liabilities
- Non-current liabilities

Equity ( Capital and reserves):
- Share capital
- Reserves (profit)

Question 20

3 examples of current assets?

Answer 20

• Inventories
• Trade and other receivables
• Cash

Question 21

3 examples of current liabilities

Answer 21

• Current tax liabilities
• Trade and other payables
• Dividends payable

Question 22

3 examples of non current liabilities?

Answer 22

• Loans
• Provisions
• Retirement pension

Question 23

3 examples of non current assets?

Answer 23

• Goodwill
• Intangible assets
• Property

Question 24

3 examples of equity

Answer 24

• Share capital
• Share premium account
• Retained earnings (reserves)

Question 25

What interest do shareholders have in statement of financial positions?

Answer 25

• Shareholders might look at net assets, roughly the business’s value.
• To assess the solvency of the business, done by using the working capital.

Question 26

What interest do managers have in statement of financial positions?

Answer 26

Monitor working capital and raise finance. The amount of profit or loss and current and non-current assets and liabilities allows managers to make better decisions in terms of spending and investing money. Seeing the value of these variables, they can assess what a business can afford and what it cannot.

Question 27

What interest do suppliers have in statement of financial positions?

Answer 27

The solvency of the business and working capital to see if they should offer trade credit. A business that is very profitable and has a lot of assets will definitely be attractive to suppliers. This is because it has money to pay for suppliers of raw materials and components. It is simply able to pay for the products it purchased from a supplier.

Question 28

What interest do employees have in the statement of financial position?

Answer 28

Employees have an interest in the financial performance of a business because it allows them to earn their living and get their salaries and wages paid. Employees can be particularly interested in the amount of profit or loss found on the income statement.

Question 29

What is solvency?

Answer 29

A business is a solvent when it has enough liquid assets to pay its bills, solvency can be determined using working capital.

Question 30

Evaluating current ratio:

Answer 30

The industry or market matters.

• Firms have different requirements for holding inventories, or approaches to trade debt and credit
• How does the current ratio compare with competitors?
  The trend is more important
• A sudden deterioration in the current ratio is a good indicator of liquidity problems

Question 31

Evaluating acid test ratio?

Answer 31

Interpreting the results
- A better indicator of liquidity problems for businesses that usually hold inventories
- Significantly less than 1 is often bad news
Look out:
- Less relevant for businesses with high stock turnover (e.g. supermarkets)
- Trend: significant deterioration in the ratio can indicate a liquidity problem