Operations- Financial Reports Flashcards
Outline the purpose and function of the balance sheet (position statement).
A balance sheet is one of the three annual financial statements that all companies are legally required to produce for auditing purposes. It contains information on the value of an organisation’s assets, liabilities and the capital invested by the owners. As it shows the financial position of a business on one day only, it is often described as a ‘snapshot’ of a firm’s financial position.
It is called a balance sheet because the document states a firm’s sources of finance (shown as the capital employed) and where that money has been spent (shown as the assets employed), i.e. it reveals where a firm’s money has come from (capital and liabilities) and what it has been spent on (assets). This helps to ensure that all monies within the organisation are properly account for.
Uses of balance sheets
• Uses – working capital is an indication of the short-term liquidity position of the business.
o The asset structure can be analysed.
o The capital structure can be examined to see sources of finance.
o The firm’s capital employed can give an indication of its size.
Limitations of balance sheets
• Limitations – as balance sheets are static documents, the financial position of a business might be very different in subsequent periods. The value of capital and reserves can change the next day to different factors.
o The figures are only ‘accurate’ estimates of the value of assets and liabilities.
o Since there is no specific format required, different businesses will produce accounts in different formats and include varying assets and liabilities. This can make it difficult to compare.
o Not all assets are included in a balance sheet. E.g. football clubs do not include the market value of their players in their balance sheet. Intangible assets are primarily what are unaccounted for. If the saying ‘workers are a firm’s most valuable asset’ is true, this means that the financial position of a business is not accurately represented in a balance sheet.
Describe the financial information that would be found in a balance sheet.
A balance sheet must contain three essential parts: assets, liabilities and capital and reserves.
Assets – items owned by or owed to a business that hold a monetary value, such as cash or buildings. To purchase assets, firms will need different sources of finance, which can also be inferred from a balance sheet. Assets can be classified as fixed assets or current assets.
• Fixed asset – any asset purchased for business use, rather than for selling, and is likely to last for more than 12 months from the balance sheet date.
• Current asset – refers to cash or any other liquid asset that is likely to be turned into cash within twelve months of the balance sheet date. Three main types; cash, debtors and stocks.
Liabilities – a liability is a legal obligation of a business to repay its lenders or suppliers at a later date. The balance sheet records this which can be interpreted as the amount of money owed by the business. There are two main classifications of liabilities: long-term liabilities and current liabilities.
Capital and Reserves – this section of the balance sheet appears towards the bottom. It may appear in a balance sheet as Shareholders’ Funds or as Owners’ Equity. There are three main sections to this part of the balance sheet;
Outline the purpose and function of a budget.
A budget is a financial plan for the future operations of the business. Budgets are used to set targets, to monitor performance and control operations. Shows how much money a business plans to spend or receive in a future time period. Budgets are usually produced to forecast every 6 or 12 months, and monitored monthly. Three main types of budgets;
- Sales – what a business sells determines how much it needs to produce. Sales are the main areas of generating cash inflows. Sales budgets are affected by consumer tastes.
- Production – A production budget sets out how many units need to be made. Too few customers? Too many goods?
- Purchases and labor – Once a business decides how much it needs to produce, they need to make sure they have enough raw materials, components and employees.
Overall, budgeting will improve planning and guidance, coordination of employees and business, control and motivation.
Explain what is meant by variance analysis.
Variance Analysis – the amount that your budgeted figure differs from your actual figures.
A favorable variance leads to a higher than expected profit.
An adverse variance leads to a lower than expected profit.
State the stakeholders that would be interested in balance sheets and budgets.
- Competitors may be interested to see how large a firms expenses are in comparison with their own business. This may encourage them to find alternate production methods, which are more affordable.
- Employees may be interested in a balance sheet in order to feel confident about their job security.
- Managers would have a strong interest in balance sheets and budgets, because they ultimately reflect the strength of a business at a particular point in time.
- Financial planners/advisers may be able to identify trends or have specific advice that would reduce or eliminate adverse variance, thus benefiting a business.
