Unit 7 - Section 2: Analysing The Financial Position Of A Business Flashcards
Balance sheet
A statement of what a business owes and what it owns
Assets
Items a firm owns that are worth money
Liabilities
Financial commitments the firm has to pay
Consolidated balance sheet
This is a balance sheet that covers all of a firms operations put together
Inventories
Stock
Total equity
The total amount of money used in a firm made up of share capital and retained profit
Non-current assets
Items of value owned by the business in the long term
Current assets
Recourses owned who’s value changes daily. Likely to be cash or near cash. Their value will be realised in the short term
Intangible assets
Items of value without physical form such as goodwill from customers or staff or brand names
Current liabilities
Financial obligations the firm has payable within 12 months
Short term
Non-current liabilities
Long term financial obligations. These debts will take more than a year to pay back
Net current liabilities (working capital)
Current assets minus current liabilities.
if liabilities exceed assets this will be a minus figure - shown in brackets
Net assets
Total assets minus total liabilities
This figure will balance the equity in the firm
Depreciation
The fall in value of a non current liability over time
Mortgages
Long term loans, secured on property
Debentures
Loans with fixed interest usually long term and with a fixed repayment date
Ratio analysis
A technique for analysing a firms financial performance by comparing one of data with another
Profitability
A measure of the ability of the firm to earn revenues above the level of its costs
Liquidity
A measure of how easily the firm turns its assets into cash to pay its bills
Financial efficiency
How well the firm manages its money
Inventory turnover
A measure of the firms success in converting stock to sales
Receivable days
Measures the firms success in collecting money it is owed
Receivables (balance sheet) divided by revenue (income statement) x 356
Measures the amount of days it takes to turn debts into cash
Payables days
Measures the firms speed in paying its suppliers
Payables (balance sheet current liabilities) divides by cost of sales (income statement) x365
Number of dahs it takes the form to pay what it owes to it’s suppliers
Income statement
A record of how the firms trading activity for one year calculating profit and loss
Sales revenue
The value of goods and services sold
Cost of sales
The direct cos of making sales (Rae materials)
Gross profit
Sales revenue minus cost of sales
It is the raw profit the firm makes
Overheads
The indirect cost such as rent and mangers salaries
Operating profit
The profit from the normal operations of the business.
Gross profit minus overheads
Exceptional items
Amounts the firm has paid put or made that are unusually big. For example large overtime payments to staff
Financial expense
The cost of the firms finance
Finance income
Interest the firm has earned on savings or investments
Net profit before tax
The total amount of money that the firm has made in a year; the amount the firm will be taxed on
Corporation tax
The money paid to the government. It is a percentage of profits
Profit for the year
The amount the fit has made net of tax. It is the amount that is shared between rewarding the shareholders and retains for future expansion
Who looks at balance sheet and income statement (internally)
Mangers: to better control the firm and work on achieving objectives
Employees: to assess job security and pay
Shareholders: to see whether their investment is returning
Who looks at balance sheet and income statement (externally)
Creditors: can the firm pay its bills
Government: can the firm pay its tax and will it continue
Competitors: for comparison
Potential investors: is the firm worth investing in
How to improve financial situation
Reduce time from production to sale
Reduce terms of credit offered to customers
Increase credit taken from suppliers (depends on solidity if the relationship)
Income statement benefits (what you can see)
Values of sales in a year
Value you do profit
The profit the firm have retained for further investment
Dividend payments
Income statement problems
Only useful if you have comparison e.g data from other years, industry averages, data from similar firms
Profit quality
High quality profit is that which is sustainable in the future - usually comes from the firms day to day activities
Low quality profit comes from one off source such as selling assets or short term investments in other businesses
Profit utilisation
Describes how profit is being used
Retained profit is kept in the firm for future expansion
Dividends are paid to the shareholders usually every 6 months
Gross profit margin
Gross profit (sales revenues - direct costs) divided by sales x 100
For every £1 of sales the firm makes, how much raw profit does it make
Operating profit margin
Operating profit (gross profit- overheads) divides by sales x 100
Allows the firm to monitor its profitability year on year and compare it with other firms or the industry average
Generally if it is declining it indicates poor cost management
Return on capital employed (ROCE)
Operating profit (gross profit - overheads) divides by total equity + non current liabilities x 100
Shows for every £1 invested in the firm the amount of profit being made
Measuring liquidity
Current ratio:
Current assess divided by current liabilities
e.g 350000 divided by 250000 = 1.4:1
For every £1 of short term debt the firm has £1.40 of cash or near cash to pay it
What is considered safe (liquidity)
Depends on the nature of the business
Supermarkets have very Low ratios as they operate with high levels of trade credit but they know they turnover their stock quickly
Safe level - 1.5 -2:1
Very high ratios could mean that the firm is failing to use their cash effectively
Cause of liquidity problems
Over investment in non current assets often, as a firm expands
Solution: sell assets and rent or hire them back
Overtrading when the firm fails to secure sufficient long term finance and has high interest cost (businesses not being confident)
Solution: pay off short term borrowing with 1 long term loan
Gearing
Examining the capital structure of a firm and so assessing the likelihood of its continuation financially
Gearing ration: non current liabilities divided by total equity + non current liability (capital employed) x 100
Gearing interpretation
Shows the amount of money the firm has borrowed in the long term as a percentage of its overall worth
Shows the amount of money that is borrowed for every £1 that is earned
High gearing (borrowed a lot of money)
If loans are equal to more than 50% of the firms worth it has borrowed a lot of money and is very dependent on the goodwill and support of its lenders and could put pressure in to repay loans if things aren’t going well
Could put investors off and limit the firm in borrowing more money
Borrowing will be expensive as if they could borrow more it would be high risk
High amounts of interest effects cash flow
Benefits of high gearing
Fewer shareholders so closer control
Firms have taken advantages of cheap finance
Interest rates may be lower than dividends demand/expected by shareholders so loans can be used to relieve short termist shareholders pressure
Investment allows the business to expand and grow
Low gearing
This is usually expected as being less than 25%
The company has a high percentage of its capital provided by shareholders
The firm will not be paying high levels of interest
That the firm has four shareholders seeking dividend
Control of the business more diluted
Raising gearing
Buy back shareholders
Issue more debentures
Obtain more loans
In an economic climate where interest rates are low geared firm could be seen to be over cautious
If the bank or lender is owed more than a firm could pay back from the sale of its assets, it is in the banks interest to keep the firm trading rather than force it in to liquidation (argument)
Reducing gearing
Issue more shares
Buy back debentures
Retain more profit
Repay loans
Financial efficiency ratios
They measure the effectiveness with which businesses control their internal operations
e.g how well the stock is managed, how well is credit controlled
Inventory or stock turnover
It measures how quickly inventory is converted into sales
Cost of goods sold (income statement) divided by average inventories held (balance sheet) = inventory turnover
A value of four would mean that the firm sells its stock four times per year so it will on average take three months to convert stock to cash
Factors influencing the rate of inventory turnover
The range of products sold will affect the amount of stock held
The production method
The efficiency of stock management systems
Whether or not the product is perishable, seasonal or times specific
The length of the product life-cycle
The quality of market research and sales forecasting
Recession positives and negatives
Demand: +cheaper brands will see increase in demand
- decrease dramatically especially luxury products
Investment/stock levels: + shares cheaper,
Shareholders will want to invest,
Innovation room
- less investment, hold lower stock levels, slower speed of response, less flexibility
Employment: + more workers to chose from, less training needed, low wage cost
- makes selections long process, high skilled workers may not work for low wages
Start ups/ liquidations: + might help small businesses start up
- less money moving around businesses, less liquid
Boom positives and negatives
Demand: + Demand will be up so you can increase prices
- Some businesses may not be able to meet high demand quality decrease
Investment/ stock levels: + Faster stock turnover, hold more stock, investment higher
- Could overtrade (growing without sufficient change), costs will increase
Employment: + quicker selection easier to gain, skilled workers with the money, higher motivation
-How did to keep staff, invest into training and rewards
Start ups/liquidations: + More start-ups lay liquidations , more jobs, more choice for consumers
- More competition
Measures of economy performance
Employment
Incomes
Spending
Gross domestic product (GDP)
Business cycle
Periodic that a regular up-and-down movements in economic activity Boom Recession Slump Recovery
Causes of cycle
Stock building and de stocking (confidence)
Patterns and expenditure and consumer durables
Confidence in the banking sector
Surviving recessions
Focus on parts of market where businesses has advantage (core competencies)
Accurate up-to-date financial information
Tighter credit control
Realistic planning
Move into niche markets, less affected by income elasticity, gain and keep hide demand, more likely to survive
Move into international markets
Innovation
What controls the value of the pound
Supply
Demand
Speculation - Foreign currency dealers will try to buy pounds when our currency is weak and sell them when it gets stronger
Government influence – I will given out will buy and sell to adjust the exchange rate
Interest rates
Government objectives (economy)
Low unemployment
Positive balance of trade (exports seven imports)
Stable, low inflation (2%)
Rising steady GDP (2%)
Stable exchange rates
Measuring inflation
Until 2003 RPI (X) what’s the measure
Retail price index this was usually shown as an index number with the base year being identified as a rate of 100 if inflation had gone up 8% more than the previous year the following year it would be shown as 108
Since 2005 it has been measured using CPI – consumer price index this measure excludes interest on loans and mortgage payments
What causes inflation
Increase in transport costs
Cost of money goes up e.g week pound
Big increase in demand (short-term)
Peoples wages increase – you can charge more
Access to cheap imports is restricted
Minimum wage increase businesses charge more
Falling inflation
This is not a fall in prices
If the percentage inflation next year is forecast to be lower than this year it is still an increase in prices unless it is a minus figure
Deflation
A fall in the general price of goods and services (not happened since 1930s)
Negative effects of high inflation on business
Increasing costs – all materials, components, wages and salaries. This reduces profits
Customer price sensitivity increases. They are less willing to pay for branded goods and will watch prices more carefully
There are costs associated with frequent price changes
Poor industrial relations – workers are less happy
Positive effects of high inflation on businesses
It is an opportunity to conceal price increase
The outstanding capital amount of loans is reduced and it is easier to pay them off
The value of fixed assets rise – firms valuation rise easier to borrow
Consumers may spend now so their spending isn’t subject to price rises in the next period of time
This can result in the stimulation of short-term investment
Government response to inflation
By far the most significant effect of high inflation on firms is the impact of the actions the government may take to control it. The impact will depend on the course of action chosen: Raise interest rates Control bank Lending Increased taxes Cut public spending
However only work on demand pull inflation
Impact of government action
This will depend on:
The industry and location
Time lack of some political changes, the impact of changes in the April budget often don’t take affect until the following April
Type of action chosen
Time to election and therefore likelihood of the policy lasting
The gearing of the firm
Low inflation
Increases the outstanding capital value of a loan making it harder to pay off
Customer price sensitivity decreases – this is good for the big brand owners but bad for budget retailers
Few price increases in general mean that firms putting up prices will be easily noticeable to consumers
There will be fewer wage claims and stability in wage rates – allowing better business planning
It may reduce unemployment and help stimulate economic growth
Direct taxation
Levied on a person or organisation
Income tax
Corporation tax
Effects of changes are foreseeable
Indirect taxation
Charged on goods and services
VAT
Customs and excise duty
Effects of changes hard to predict
Deficit
In the UK, fiscal policy has centred around reducing the deficit recently
This is the difference between what the government raise from its tax and it’s spending in the economy
Supply – side policy
A range of long-term measures to increase the amount of economic activity
Labour market measures: limiting benefits and providing training
Better education with a focus on enterprise skills
Privatisation
Competition regulation
Competitive tender
Requires contractors to bid for the work for public sector organisations
Supplies compete
Deregulation
Reduction of elimination of restrictions on industries often with the goal of making it easier to do business
Financial deregulation
Reduction or elimination of Government power
Within an industry to create more competition
Reasons for globalisation
Support of governments
Falling costs of transport – easier to do business
Growth of trade blocks e.g EU
Growth of multinational companies e.g starting in America, big place, bigger market
Increasing global incomes
Increasing global awareness (social media)
Specialisation
Communication
Containerisation
Benefits of globalisation
Inward investment – bringing jobs and skills and creating demand for local products and services
Sharing of ideas and lifestyles creates new markets for products
Increases chances of maintaining place as countries have a better understanding of each other
Awareness of global issues like pollution increases
Businesses have to be more innovative to compete
Problems of globalisation
People believe it’s mainly benefits the richer countries and leads to a huge businesses with too much
Transnational companies can drive local firms out of business due to their huge economies of scale
There are fewer laws in less-developed countries that big firms may exploit
Importance of globalisation
Downward pressure on prices
New producers
Increased pressure for investment to develop products and processes
Threat of takeover
Why target emerging markets
Enormous cheap labour resources
Large untapped market of consumers who are rapidly getting richer
Benefits of emerging markets
Take advantage of natural resources
Cheap labour
Huge opportunity for sales, and standards of living
Ability to quickly establish brands in market that are developing
Emerging markets Risks – economic
The growth can be very uncertain
More unemployed
Danger of over heating (growth too quickly supply can’t keep up to demand) – high inflation
Emerging markets risk- political
E.g Russia’s actions in Ukraine have caused economic sanctions
Emerging markets risk to firms brand or image
Suppliers of Apple fox con slave labour it in China (Apple didn’t know)
