10. Finance and accounting

Meaning/ purpose of statement of profit or loss

refers to a financial statement that summarizes the revenues, costs, and expenses incurred during a specified period, usually a quarter or fiscal year.

provide information about a company's overall ability to generate profit, either by increasing revenue or decreasing costs, or both.

Contents of statement of profit or loss

revenue, cost of sales, gross profit, expenses, profit from operations (operating profit), taxation, profit for the year, dividends, retained earnings

Meaning and purpose of statement of financial position (balance sheet)

help owners decide whether they can apply for more credit, cut expenses, how they should handle inventory

Role of depreciation in the accounts

loss of values of non current assets over a period of time.

ROCE

Operating profit / capital employed x 100

Capital employed = issued shares + reserves + non-current liabilities

Gross Profit Margin

Gross profit/sales revenue x 100

Trade receivables turnover (days) Interpretation

days taken by debtors to settle debts with bus.

gearing ratio formula

Non-current liabilities / Capital employed × 100

methods of improving gearing

buy back ordinary shares

pay increased dividend out of retained earning

convert short term debts into long term loans

dividend yield: calculation

Dividend per share / Market price per share × 100

dividend yield: interpretation

2 - 6 percent is good

dividend cover: interpretation

2 is healthy

1.5 is that the bus. paying a lot of earning to dividend may be unsustainable

price/earnings ratio: calculation

Market price per share / Earnings per share

need for investment appraisal

1.compare the expected outcomes of competing options

2.estimate the revenue in terms of timescale and size of return

3.asses the possible risk involved in a venture

Contents of a statement of financial position

non-current assets, current assets, current liabilities, net current assets, net assets, non-current liabilities, reserves and equity

Difficulties of valuing inventory

Value of goods, but might have some that are damaged

Determine the amnt, company may have goods in transit and needs to decide whether to include those items in inventory.

Impact of depreciation (straight-line method only) on the statement of financial position and the statement of profit or loss

-

does not accurately reflect the true trend/rate of depreciation (NCA likely to decrease a lot by initial years)

+

simple and easy to calculate

meaning and importance of liquidity

Liquidity is a measure of a company's ability to pay off its loan if not they might be bankrupt

Current Ratio Formula

current assets / current liabilities

ans=ratio

Current Ration interpretation

IR: 1.5-2

too low: firm does not have enough CA to pay back debts=brankruptcy

too high: opportunity cost of investing the cash to generate more profit

Acid Test Ratio

(Current Assets - Inventory) / Current Liabilities

ans=ratio

Acid test ratio interpretation

Based on industries

-normal for 7/11 to have below 0

1-1.2 good

Methods of improving liquidity

1. inventory management - J.I.T

2.sell non-current assests for cash then lease machines = firm is lean

3.switch short-term loan with long term

-decreases liquidity

ROCE interpretation

measures the rate at which assets generate profit

Profit margin

net income/net sales

Operating profit formula

profit from operations/revenue x 100

Methods of improving profitability

1.Increase revenue

= if demand is elastic firms should decrease price vice versa

2.Decrease cost

=choose cheaper raw mat.(state drawbacks)

3.Lower wages for workers

=operating profit increases BUT motivation decreases

4.Lower promotion expenditure

=op increase BUT recog. decrease also cust.

Rate of inventory turnover formula

cost of sales/average inventory

Rate of inventory interpration

measures the rate at which inventory enters and leaves a bus.

Trade receivables turnover (days) formula

Trade receivables / Credit sales × 365 day

Trade payables turnover (days) formula

Trade payables / Credit purchases × 365 days

Trade payables turnover (days) interpretation

days taken for bus to settle debts with ppl they owe

Rate of inventory turnover(times)

Cost of sales / Average inventory

meaning and importance of gearing

Gearing ratios are financial ratios that compare some form of owner's equity (or capital) to debt, or funds borrowed by the company.

highlight the financial risk companies assume when they borrow to fund their operations.

gearing ratio interpretation

dividend cover: calculation

Profit for the year / Annual dividend

price/earnings ratio: interpretation

help understand whether stock is being over or under evaluted.

High PE ratio = high earning or may be overvaluated

Low PE ratio = low earning or undervalued

the meaning, calculation and interpretation of ARR

ARR = (average profit/ average investment) × 100)

comparison of investment appraisal methods, including their limitations

ARR

+

calculate return used by managers and shareholers to make descision

easier to compare (the higher the better)

-

does not reflect the time value of money

ignores the actual cash flows

(300/0/0) vs (0/0/300)

NPV

+

considers the time value of money = making it more accurate evaluating real gain of project

easier to compare (the higher the better)

-

harder to calculate

need financial knowledge to understand what NPV represent

discounting rates are decided by firm

-subjected to DBE, LOWERS the accuracy of NPV

assessment of business performance over time and against competitors

investor use ratios to compare within industry, if not on par they try to see what can be improved and may make bus. decision on this

the impact of accounting data including ratio results on business strategy

1.cost reduction

-reduce operating expense = increase ROCE

2.product development

short term profit : liquidity +roce +return to shareholde fall cause cash need for R&D .

long term : if prod. successful, profit margin +roce +liquidity ratio + return to shareholder INCREASE

3.low price strategy

reduces gross profit + operating profit margins

= roce increase + greater profit margin

the limitations of using published accounts and ratio analyses

1. one ratio is not enough, need to do inter firm comparison; other time period called trend analysis

2.ratios can only HIGHLIGHT PROBLEMS not SOLVE, up 2 good managers to locate these causes aand develop strategies,

3.Only quantitative data is measured but some companies are concerned with qualitative factors such as

-cust. loyalty

-evironmental policy