m2- topic 3 part 2 Flashcards
what do financial statements do
summarise the activities of the business
what things are analysed in financial statements (4)
liquidity
gearing (solvency)
profitability
efficiency
what is liquidity
the extent to which a business can meet its short term debt commitments
what is working capital
the amount of money the business will have access to for its day to day operations
how is working capital calculated
current assets - current liabilities
what is used to asses liquidity
the current ratio
what is the current ratio equation
current assets/current liabilities
what is the minimum industry standard for a current ratio
1.5 : 1
what is solvency
the ability for a business to pay off its long term debt
what is used to assess solvency
gearing
what is gearing
how the business is financed through debt and equity
what is is used to measure gearing
debt to equity ratio (total liabilities/total equity)
why is high gearing bad
business is more open to the influence of interest rates
what is profitability
the earning capacity of the business
how is profitability calculated (3)
gross profit ratio
net profit ratio
return on equity ratio
what is the equation for the gross profit ratio
gross profit/sales
what is the equation for the net profit ratio
net profit / sales
what does return on equity show
how effective funds contributed by the owner are being generated into profits
what is the equation for the return on equity ratio
net profit/total equity
what form is gross profit, net profit and return on equity ratios calculated in
as a percentage
is it better to have a higher or lower gross profit, net profit and return on equity ratio
higher
what is efficiency
the ability of the business to use resources effectively
how is efficiency calculated (2)
expense ratio
accounts receivable turnover ratio
what s the equation for the expense ratio
total expenses / sales
what does accounts receivable turnover ratio determine
measures the effectiveness of the firms credit policy
what is the accounts receivable turnover ratio equation
365/sales/accounts receivable
what is the average credit period
30 days
should the efficiency ratio be high or low
low
what are the limitations of financial reports (6)
Debt repayments Capitalising expenses Normalised earnings Timing issues Notes of financial statements Assets valuation
why are normalised earnings misleading
they remove one time influences (eg sale of land)
why is capitalising expenses misleading
they reclassify expenses as assets
how can valuing assets be misleading
inaccurate calculation of asset
how can debt repayments be misleading
financial reports don’t disclose information about debt repayments
how can notes to financial statements misleading
may not be easy to understand
why do businesses over estimate expenditure and underestimate revenue
to allow a margin for error so the investor doesnt feel they invested in a bad business
what types of audits are there (2)
external
internal
what are external audits
when a outside accountant checks all financial information to ensure the business is not lying and misleading investors
what are internal audits
when someone within the business checks
what is tax evasion
when a business doesn’t declare revenue to lower tax
