Analysing the accounts

• Profitability


  A measure of how successful a business is
• Profitability (definition 1)


  A measure of how effectively a business converts sales revenue into profit
• Profitability (definition 2)

  A measure of how well capital resources invested in the business generates profit
• Profitability is expressed in percentage form, which allows comparison of business performance over time and also comparisons with other businesses
• Stakeholders interested in profitability

  • Investors
  • Directors and managers
  • Employees
• Liquidity


  The ability of a business to pay back its short-term debts
• If a business cannot pay its suppliers, raw materials or components may not be delivered and production will be delayed
• If a business cannot repay an overdraft, banking facilities may be withdrawn, and its credit rating will suffer
• If a business cannot pay its debts, creditors may force it to stop trading and sell its assets so that the debts owed to them are repaid
• Stakeholders interested in liquidity

  • Suppliers
  • Financial providers such as banks
  • Customers
• Gross Profit Margin


  The proportion of revenue that is turned into gross profit
• Improving the Gross Profit Margin

  1. Increase the sales revenue

  2. Reduce the direct costs
• Net Profit Margin


  The proportion of revenue that is turned into profit before interest and tax
• Improving the Net Profit Margin

  1. Increase the Gross Profit Margin

  2. Reduce overhead costs
• Return on Capital Employed (ROCE)


  Measures how effectively a business uses the capital invested in the business to generate profit
• Improving ROCE


  1. Increase the level of profit generated without introducing new capital into the business

  2. Maintain the level of profit generated whilst reducing the amount of capital in the business
• Current Ratio


  A quick way to measure liquidity, indicating how many units of current assets are available to cover each unit of short-term debt
• Acid Test Ratio


  A precise and realistic way to measure liquidity, excluding the least liquid form of current assets (stock)
• Improving Liquidity Ratios


  1. Reduce the credit period offered to customers

  2. Ask suppliers for an extended repayment period

  3. Make use of Overdraft facilities or short-term loans

  4. Sell off excess stock

  5. Sell assets and lease fixed assets instead

  6. Introduce new capital and reduce drawings out of the business
• How stakeholders use the financial accounts

  • Investors/Shareholders
  • Management
  • Lenders/Creditors
  • Suppliers
  • Employees
  • Regulatory bodies/Tax authorities
  • Local community
• Balance Sheet


  Provides information on the capital structure of the business and its solvency
• Income Statement


  Provides information on revenues, costs, profits earned, business growth and dividend payments