Chapter 4: Analysing financial performance

• What is a fixed asset?

  Something of value to the company that last longer than a year. (Eg. machinery, vehicles, buildings, etc)
• What is a current asset?

  Something of value to the company that last less than a year (E.g stock, debtors, cash in the bank/till)
• What is a current liability?

  Money that the business owe and must be paid back within a year (overdraft, creditor)
• What is a long term liability?

  Money that the business owe and takes longer than a year to pay back (mortgages, loans)
• Gross profit

  Sales - Cost of sales
• Cost of sales

  Opening stock + Purchases - closing stock
• Net Profit

  GP - expenses
• Sales revenue

  Selling price x Number sold
• What is a shareholders' fund?

  The money that has been invested into the business by the owners. This is because the business' net worth would be given back to the shareholders in business liquidity after paying off the debts.

  Shareholder fund = Total assets - Total liabilities
• Working Capital

  current assets- current liabilities
• Net assets

  Net assets = fixed assets + working capital - long term liabilities
• What is liquidity?

  The ability to convert an asset into cash quickly without significant loss in value.
• What is current ratio?

  Current ratio is a financial ratio that measures a company's ability to pay off its short-term liabilities with its short-term assets. It is ideal for the ratio to between 1.5:1 and 2.1:1
• Current ratio formula

  Current assets/current liabilities

  For every £1 the business owes, they have _p to pay back.
• What is acid test ratio?

  Acid test ratio, also known as quick ratio, is a measure of a company's ability to pay off its current liabilities using its most liquid assets. 1:1 is usually ideal to businesses
• Acid test ratio formula 


  (current assets - stock) / current liabilities

  For every £1 the business owes, they have _p to pay back.
• What is gearing?

  Measures the proportion of assets invested in a business that are financed by long term borrowing. Businesses ideally want this to be 50%
• Gearing formula

  (long term liabilities / capital employed) x 100

  For every £1 borrowed for the business, _p is external to the business.
• What are drawings

  Any money that is taken out from the business account for personal use.
• NP %

  (NP/ sales) x 100

  For every £1 worth of sales is _% of NP
• GP %

  (GP/ sales) x 100

  For every £1 worth of sales is _% of GP
• What is return on capital employed (ROCE)?

  A financial ratio that can be used to assess a company's profitability and capital efficiency
• ROCE formula

  (NP/Capital employed) x 100

  For every £1 invested, there's a return of _%.
• What is window dressing?

  The practice of making a company's financial statements or performance appear better than they actually are.
• Purpose of window dressing

  • To protect from takeovers
  • To improve share valuation
  • To encourage shareholders approval
  • To increase revenue from take-overs
  • To win or retain institutional support
  • To retain or gain lines of credits
• What is sale and leaseback?

  When bad liquidity, businesses will sell their fixed asset to a third party then pay a sum of money per year to lease it back. They still have assets, but they don't own it.
• Presentation of financial data

  To use graphs with distorted scales to give the appearance of bigger or smaller changes in sales. Businesses might highlight only certain data or use certain examples in their reporting document.
• Overstating brand valuations

  By increasing the brand value, it gives the impression that it will be more difficult to take over the business.
• Hiding poor investments

  By manipulating financial reports, it makes the business appear more stable than it actually is. This is done by hiding debt, understating and inflating earnings.
• Exceptional items

  They are costs and revenues to the business that arise from normal business activity but are unusual in some way. (E.g redundancy cost - they can arise for time to time)
• Extraordinary items

  Revenues or costs that occur, but not as a result of normal business activity. They should be highlighted in the accounts, and inserted after the calculation of profit before tax and interest.
• What is depreciation?

  The difference between what the value was and now. It represents the fall in the value of fixed assets, either due to their use, time or obsolescence.
• Purpose of depreciation

  • Profit is not overestimated
  • Value of fixed assets is not overestimated
  • To make accounting provision for replacement purchase of new fixed assets in the future
• Straight line depreciation

  It assumes that a fixed assets depreciates an equal amount to each month of its expected useful life
• Depreciation formula

  (original cost - residual value) / expected life in years
• Benefits of depreciation

  
  

  • Knows exactly how much will be expense on the item each year until it reaches the end of its useful life
  • Simplifies financial forecasting
  • Provides a way to show greater business income in the early parts of the asset's life
• Drawbacks of depreciation

  
  

  • It can be complex to calculate and understand compared to straight line
  • It may result in greater fluctuations in depreciating expenses from period to period based on usage or production
  • It may not be appropriate for assets that have a more consistent rate of decline in value over their useful life
• What is a budget?

  A budget is a financial plan that outlines expected income and expenses over a specific period of time.
• What is favourable variance?


  Favourable variance refers to the difference between the actual performance and the budgeted or expected performance, where the actual performance is better than expected.
• What is adverse variance?

  When actual income is less than budget, or actual expenditure is more than budget.