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Accounting and Entrepreneurship > Interpreting Financial Statements 1 > Flashcards

Interpreting Financial Statements 1 Flashcards

1
Q

what does it mean to interpret a financial statement

A

evaluate financial information and make judgement about issues such as profitability, efficiency, liquidity, gearing, cashflow

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2
Q

what are the different users of the financial statement

A

shareholders, debt providers, customers, suppliers, competitors, governments

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3
Q

what different questions are being asked of the financial statement

A

will they go bankrupt, where will they be in a number of years time, is it a good investment/loan, how does the company benefit society

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4
Q

what does CORE analysis stand for

A

context, overview, ratios, evaluation

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5
Q

why do we use ratios

A

ratios help with comparisons between different sized businesses
they give a relative measure

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6
Q

what might profit be compared to to assess performance

A

size of business, capital investment, revenue

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7
Q

how might we interpret a result as being good or bad

A

comparing creates meaning
compare with same ratio from the past, the budgeted or planned ratio, similar businesses, industry averages

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8
Q

what five categories of ratio might be considered the most meaningful

A

profitability, efficiency, liquidity, financial structure, investment

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9
Q

what does a profitability ratio tell us

A

what return is being made from capital and assets
what profit to use

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10
Q

what does an efficiency ratio tell us

A

is the business making efficient use of resources

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11
Q

what does a liquidity ratio tell us

A

is there enough short term cash and can current obligations be met

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12
Q

what does a financial structure ratio tell us

A

is the company financed by debt or equity and how risky is the financing

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13
Q

what does an investment ratio tell us

A

what return is available to the shareholders and what is the investor confidence

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14
Q

operating profit

A

profit before interest and tax (PbIT)

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15
Q

capital employed (equation)

A

non-current assets + current assets - current liabilities = share capital + reserves + non current liabilities

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16
Q

name the four profitability ratios

A

return on capital employed (RoCE), operating profit margin, asset turnover, gross profit margin

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17
Q

what is the return on capital employed ratio

A

(PbIT/share capital + reserves + long term loans) x 100%

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18
Q

what is the operating profit margin ratio

A

(PbIT/revenue) x 100%

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19
Q

what is the asset turnover ratio

A

revenue/(share capital + reserves + long term loans) times (x 100% usually omitted)

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20
Q

what is the gross profit margin ratio

A

gross profit/revenue x 100%

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21
Q

what is the meaning of the gross profit margin

A

expressing the gross profit as a percentage of revenue
for every £1 of revenue how much was remaining as gross profit
how well have you controlled cost of sales

22
Q

what is the meaning of the return on capital employed

A

the profit before interest and tax as a percentage of capital employed

23
Q

why is PbIT used

A

it is the profit earned to pay providers of finance
it is the profit which the managers have the most control over

24
Q

what is the meaning of the operating profit margin

A

operating profit as a percentage of revenue
for every £1 of revenue how much was operating profit

25
Q

what is the meaning of the asset turnover ratio

A

really an efficiency ratio
revenue as a percentage of capital employed
how many times was revenue turned over in assets

26
Q

what is another way to think of the return on capital employed

A

operating profit margin x asset turnover

27
Q

what would an increase in return on capital employed be the result of

A

increase in operating profit margin and increase in asset turnover

28
Q

what problems are associated with the return on capital employed ratio

A

the method of calculation can vary, what is considered capital employed, which profits to use
are the assets being valued at current prices
capital investment often results in low returns in the early years so long term projects can distort short term RoCE

29
Q

what would be the effect of a lower net book value

A

higher RoCE

30
Q

what would happen if the assets are undervalued

A

the RoCE may be misleadingly high

31
Q

name the three efficiency ratios

A

inventory turnover, receivables collection, payables payment

32
Q

what is the inventory turnover ratio

A

inventory/cost of sales (per day) (days)

33
Q

what is the receivables collection ratio

A

trade receivables/credit sales (per day) (days)

34
Q

what is the payables payment ratio

A

trade payables/cost of sales (per day) (days)

35
Q

how do the three efficiency ratios relate to the working capital cycle

A

WCC = inventory + receivables - payables (days)

36
Q

what is the meaning of the inventory turnover period ratio

A

measuring the efficiency of stock
it is the average number of days that inventory is held
based only on the year end balance sheet data

37
Q

in general do you prefer a higher or lower inventory turnover

A

lower

38
Q

what is the meaning of the receivables collection (debtors) ratio

A

efficiency of debtors
how long credit customers take to pay their bills (on average)
could be distorted by one slow paying customer with large credit

39
Q

what is the meaning of the payables payment ratio

A

efficiency of creditors
how long it takes to pay suppliers (on average)
can be distorted by slow payment to one large supplier

40
Q

what is the meaning of the working capital cycle

A

measure of the difference between payments made to suppliers and cash received from customers
should be as short as possible to reduce the amount of short term capital required to operate

41
Q

why might inventory days have decreased

A

efficient control and faster selling

42
Q

why might receivables days have increased

A

customers are paying slower, may be deliberate to increase revenue

43
Q

why might payables days increase

A

short of cash, could harm supplier relationships

44
Q

name the two liquidity ratios

A

current ratio and acid-test ratio

45
Q

what is the current ratio

A

current assets/current liabilities (times)

46
Q

what is the acid test (quick) ratio

A

(current assets - inventory)/current liabilities (times)

47
Q

what is liquidity

A

the ability to meet short term obligations when they are due

48
Q

is there an ideal size for the current ratio

A

generally the higher the current ratio, the more liquid it is
cause for concern might be a decreasing current ratio
if CA<CL the company can pay short term bills but not good if too large

49
Q

what is the meaning of the acid test ratio

A

more stringent assessment of the liquidity because inventory is the least liquid asset
can current liabilities be covered without having to sell inventories
<1 have to sell inventories to meet current liabilities

50
Q

why might the WC balances not be representative of the liquidity during the year

A

unexpected events, seasonal business, management manipulation

Accounting and Entrepreneurship (9 decks)

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