analysing financial performance

• Explain what is meant by a budget variance


  the difference between budgeted amount and actual amount for each item in the budget
• Variance analysis


  process of comparing the budgeted figures with the actual ones and investigating why there are differences
• Budgets and Budget variances - Advantages 1


  Allows the business to predict income and expenditure needed to meet the business's objectives. Spotting potential problems as they occur.
• Budgets and Budget variances - Advantages 2


  should ensure that resources are used effectively
• Budgets and Budget variances - Advantages 3


  should motivate - all feel involved - a greater commitment to achieving the budgeted figure, may also be performance related pay benefits for employees e.g. rewarded by reducing expenditure by 10% of budget
• Budgets and Budget variances - Advantages 4 


  improve communication - the process will involve communication up and down the hierarchy - help establish sophisticated methods of communication
• Budgets and Budget variances - Disadvantages 1


  inaccurate or unreasonable assumptions can make a budget unrealistic
• Budgets and Budget variances - Disadvantages 2


  budget might be inflexible - may not be able to react to changes in the market. e.g. new competitor comes in and marketing budget doesn't allow for a response
• Budgets and Budget variances - Disadvantages 3


  If managers/employees are excluded from the budget they may not feel committed to it and may be demotivated
• Budgets and Budget variances - Disadvantages 4

  time consuming - larger the business = more time
• Budgets and Budget variances - Disadvantages 5


  can result in the business making the wrong decisions - e.g. may make a short term decision to stay within the budget, when in reality it would have been more beneficial to make a long-term decision which exceeds the budget
• Balance sheet 


  summary of the assets and liabilites of a business at a particular moment in time
• components of the balance sheet


  current assets, non-current assets, current liabilities, non-current liabilities and equity
• components of the balance sheet - current assets 


  cash or other assets that can be turned into cash within 12 months of the balance sheet e.g. stock, money owed to the business ect
• components of the balance sheet - non-current assets 


  assets that can't be converted into cash within 12 months of the balance sheet. e.g. property, equipment
• components of balance sheet - current liabilities 


  the amounts a business is due to pay within 12 months of the balance sheet e.g. trade payables, current tax liabilites ect
• components of the balance sheet - non-current liabilities


  long term financial obligations, usually due more than 12 months after the balance sheet e.g. bank loan
• components of the balance sheet - Equity 


  funds contributed by the owners or stockholders plus any retained earnings. retained earnings = net profits that haven't been given to stakeholders
• working capital


  cash needed to pay for the day-to-day operation of the business. e.g wages, supplies etc
• working capital formula


  wc= current assets - current liabilities
• working capital cycle 


  time between the point at which cash is first spent on production to the collection of cash from the customer
• capital employed


  Measures the total resources the business currently has available. the share capital, retained earnings and long-term borrowing
• capital employed formula


  CE= share capital + retained earnings + long term borrowings
• depreciation 


  the amount deducted from the original cost of an asset to take into account the wear and tear in its use over time
• depreciation formula


  original cost of fixed asset/ useful life of the asset
• interpret and analyse the balance sheet 


  Asses the balance sheet - does the business have sufficient current assets to cover its current liabilities? (enough cash to pay bills) means assessing whether liquidity is satisfactory. (a measure of the extent to which a business has the cash to cover immediate and short-term obligations, or assets that can be quickly converted to do this )
• interpret and analyse the balance sheet p2


  All stakeholders will be able to see current assets and what long-term or non-current assets the business holds
• interpret and analyse the balance sheet p3

  will also show any long-term capital the business has. incudes share capital, loan capital from banks and retained profit. share capital and retained profit are owed to shareholders but don't require repayment so are treated separately, added = total equity
• ROCE (return on capital employed)

  Financial Ratio that measures what returns (profit) the business has made on the resources available to it
• ROCE formula


  operating profit/ capital employed x 100
• ROCE useful for 


  comparing with previous years to see if there is a rising or falling trend.
• ROCE useful for 


  compare to interest rates to see if the risk is worth the return
• want ROCE to be high but it depends on:

  competitors ROCE, industry average.
• ROCE - watch our for 


  is it an artificially high ROCE? - May have made a poor quality profit, meaning one that can't be relied on to be replicated such as selling assets, this may boost profit higher than normal. or business may be leasing equipment meaning that their ROCE is higher due to lower capital employed
• current ratio


  measures businesses ability to pay the bills due within the next 12 months.
• current ratio figure


  1.5-2 is desirable. any lower and the business may struggle to pay for debts quickly
• current ratio formula


  current assets/current liabilities
• current ratio example - interpret

  if a business's current ratio is 0.5, that means that the business has 50 pounds in short-term assets for every 100 pounds in short-term debt. as the figure is less than 1, this may indicate that the business will not be able to cover its short-term debts
• acid test ratio


  it's a more severe measure of a business's ability to cover debts. the formula is the same for the current ratio except it excludes the value of the stock, this is because some businesses may not be confident with their ability to turnover stock in time to pay the debt.
• acid test ratio formula

  current assets-stock / current liabilities