Analysing the financial performance of a business

• What is the primary purpose of financial statements?

  To allow shareholders, managers, and investors to make informed future business decisions and understand business performance over time.
• How do financial statements help businesses improve their finances?

  By interpreting financial statements, businesses can move in a direction to improve their finances and secure their future.
• What types of business ownership are legally required to produce financial statements?

  Public and private limited companies.
• What are the consequences of failing to produce financial statements for certain businesses?

  Severe sanctions, such as fines.
• What are the two main financial statements used in business?

  The income statement and the statement of financial position (balance sheet).
• What do the income statement and balance sheet provide to stakeholders?

  An understanding of the financial performance of a business at a given point in time.
• What are gross and net profit margins?

  Key pieces of financial information required to understand business performance.
• What are the advantages of financial statements?

  • They allow a business to spot trends.
  • They allow comparison with other businesses.
  • They give a clear financial overview of the business.
• What are the drawbacks of financial statements?

  • They can be time-consuming to prepare.
  • They make it difficult to hide financial information from competitors or potential investors.
• What is the purpose of an income statement?

  To demonstrate the financial performance of a business over a period of time
• How does the income statement help shareholders and owners?

  It allows them to monitor business performance in line with business objectives and industry standards
• What is typically the time frame covered by an income statement?

  Usually 12 months
• What key information is shown on an income statement?

  • Revenue
  • Cost of sales
  • Other expenses
  • Gross profit
  • Net profit
• What are the main components of financial performance reflected in an income statement?

  Revenue, cost of sales, and expenses leading to gross and net profit
• What is revenue in a business context?

  Revenue is any money received from the sale of goods and services.
• What does cost of sales refer to?

  Cost of sales refers to the variable costs incurred as a direct result of making a product or providing a service.
• Give an example of a cost of sales.

  An example of a cost of sales is raw material costs.
• What is an expense in a business context?

  An expense refers to any other business costs, such as wages, rent, bills, and advertising.
• How is gross profit calculated?

  Gross profit is calculated as revenue minus the cost of sales.
• If a business has revenue of £1000 and cost of sales of £400, what is the gross profit?

  The gross profit is £600, calculated as £1000 - £400.
• What does net profit represent in a business?

  Net profit allows a business to measure their overall financial performance to see if they are successful or not in a given time period.
• How is net profit calculated?

  Net profit is calculated as gross profit minus total expenses.
• If a business has a gross profit of £600 and total expenses of £200, what is the net profit?

  The net profit is £400, calculated as £600 - £200.
• Why are figures often rounded in financial statements?

  Figures are often rounded to a consistent level of accuracy, for example to the nearest pound or to one decimal place.
• What is another name for a statement of financial position?

  Balance sheet
• What is the primary purpose of a statement of financial position?

  To monitor where the money comes from and where it has been spent, along with the overall value of a business
• What does a statement of financial position represent?

  A snapshot in time of business performance and value
• What is the overall aim of a balance sheet?

  To get the assets and capital employed to match, thus balancing the sheet
• What are the key elements of a statement of financial position?

  • Assets
  • Liabilities
  • Working capital (net current assets)
  • Capital employed
• How are assets defined in a business context?

  Assets are things that a business owns
• How are liabilities defined in a business context?

  Liabilities are things or money that a business owes
• What are the two categories of assets?

  • Current assets: short-term, owned for less than a year (e.g., stock, raw materials, cash)
  • Fixed (non-current) assets: long-term, owned for more than a year (e.g., vehicles, equipment, buildings)
• What are the two categories of liabilities?

  • Current liabilities: short-term debts due within a year (e.g., overdraft, trade credit, short-term loans)
  • Long-term (non-current) liabilities: debts paid back in more than a year (e.g., mortgages, long-term bank loans)
• How is net current assets calculated?

  By subtracting current liabilities from current assets
• What does net current assets represent for a business?

  The money available for the day-to-day running and operation of a business
• What is net assets in a business context?

  What a business is worth, calculated by adding fixed assets and net current assets together
• How can net assets also be calculated?

  As the difference between total assets and total liabilities
• How is capital employed calculated?

  By adding any equity and reserves to the long-term liabilities
• What should capital employed match in a balance sheet?

  It should match the net assets figure
• Why is it important for the balance sheet to balance?

  To ensure that the assets and capital employed are accurately represented