Unit 7 - Topic 2: AQA alevel Business

What is the point of the Balance Sheets & Income Statements

to provide a summary of financial performance

A balance sheet is also known as

a statement of financial position

what does a balance sheet do

a formal financial document that summarizes the net worth (What you have - what you owe) of a business at a specific point in time.

income statement is also known as

profit and loss accounts

what does the income statement do

A formal document that summarises a business’s trading activities and expenses to show whether the business has made a profit or a loss over a specified period of time

why do PLCs publish their annual accounts

they have a legal obligation

what can financial data be used for

to access performance and potential and to make informed business decisions about performance and strategies

what is meant by current assets

Current assets are assets that are expected to be converted into cash or used up within one year. They include cash, inventory, and accounts receivable.

what is non-current assets

Non-current assets are long-term investments that are not expected to be converted into cash within one year. They include property, machinery, equipment, and intangible assets.

what is current liabilities

Current liabilities are obligations that a company is expected to settle within one year. They include accounts payable, short-term debt, and other financial obligations.

what is non-current liabilities

Non-current liabilities are financial obligations that are due beyond one year. They include long-term debt, deferred tax liabilities, and lease obligations.

what is receivables

Receivables are amounts owed to a company by its customers for goods or services delivered on credit. They are classified as current assets on the balance sheet.

what is payables

Payables are amounts a company owes to its suppliers for goods or services received but not yet paid for. They are classified as current liabilities on the balance sheet.

what is share capital

Share capital is the total amount of funds raised by a company through the issuance of shares to shareholders. It represents the equity stake of the owners in the business.

what is equity

the total money invested in a company (since the beginning of the company)

what is capital employed

The total value of all long-term funds and investments used by a business to generate profit

calculation for current assets

inventories + receivables + cash & other cash equivalents

calculation for working capital (or net current assets)

current assets - current liabilities

calculation for net assets

non-current assets + working capital - non-current liabilities

calculation for total equity

share capital + retained profit

calculation for capital employed

total equity + non-current liabilities

why must net assets always be equal to the total equity on a balance sheet

because the net assets show the value of the business and the total equity shows how the business activities have been financed

calculation for operational profit

operational revenue - operational expenses

calculation for gross profit

gross revenue - cost of goods sold

calculation for net profit

operating profit - (trust + tax)

what is meant by sales revenue

money coming in from sales of goods and services before any costs or expenses are deducted.

calculation of sales revenue

quantity sold x selling price

what is meant by cost of sales

costs directly linked to the production of the goods or services e.g raw materials

what is meant by expenses

all other costs associated with the trading of the business e.g salaries

what is the calculation for cost of sales

opening stock + purchases - closing stock

What’s the point of an income statement

• the companies act requires it to be published

• allows shareholders and other stakeholders to see how the money is being managed

• allows stakeholders to see if the company is meeting their needs

• can show potential investors if they are likely to make a profit

where does the profit from a business go

• reinvestment

• dividends for shareholders

why would a business want to pay high dividends to its shareholders

to make shareholders happy and would make shares more valuable for attracting more shareholders)

Why would a business choose to limit the dividends it pays out

to reinvest within the company

why would a business choose to retain profits

to reinvest in growth, reduce debt, or strengthen financial stability

what would be the problems with retaining profits

shareholders would be unimpressed

what are the two main types of analysis of financial data that are beneficial to a business to determine their situation

comparing with other businesses

comparing with own businesses previous performances

why does a business compare there financial performance with other businesses

• Comparing balance sheets to allow comparisons of overall worth and scale of the business

• Comparing income statements to identify industry trends and benchmarks for performance evaluation.

why does a business compare with their own performance over time

• to assess growth

• identify weaknesses

• make informed strategic decisions

• takes time to see full benefits of acquisitions and restructuring

• allows for exceptional circumstances in a particular year to be seen in relation to a normal year

why do businesses do ratio analyses

allows for a more meaningful analysis of published accounts (shows relationship between figures and used for comparisons over time)

inter (inter means between businesses, e.g compare performance to competitors or benchmark) and intra (intra means within a business e.g over time within an organisation or between brands) business comparisons

what are financial ratios used for

financial ratios are used as a way to compare two pieces of financial data, they make it possible to make an informed judgement about a business’s performances

what are profitability ratios used for

a way to show how well a company performs through revenue, assets and equity over a period of time and how effectively it generates profit from its operations.

calculation for operating profit margin

(operating profit / total sales revenue) x 100

what does ROCE stand for

Return on Capital Employed

what does ROCE calculate

The operating profit as a percentage of the capital that the business has at its disposal and measures how effectively a business uses its capital to generate profit

what is ROCE also known as

primary efficiency ratio

what is “the capital that the business has at its disposal” made up of

non-current liabilities

share capital

retained profit

how to calculate the ROCE

(operating profit / total equity + non-current liabilities) x 100

how to determine whether the ROCE is good or bad

relative - expected to be 20-30%

compare with previous years

compare with competitors

analyzing industry benchmarks and trends.

what do liquidity ratios allows

allows managers and other interested parties to monitor a business’s cash position and used to measure a businesses ability to survive in the short term ie its ability to meet short term debts and day to day expenses

calculation for current ratio

current assets / current liabilities

why do some businesses operate successfully with a lower current ratio (e.g food retailers) and some feel safer with a higher ratio (e.g furniture retailers)

due to the price of the product and speed of turnover

what does gearing measure

what proportion of a business’s capital is funded through long-term loans, aka its capital structure (current ratio deals with short term debts while gearing measures long-term liquidity)

calculation of gearing

(non-current liabilities / total equity + non-current liabilities) x 100

why is a highly geared business at greater risk if interest rates go higher

a significant portion of its capital funded by debt, making it more vulnerable to interest rate increases, which can raise borrowing costs and impact profitability.

efficiency ratios look at the management of cash and inventory in terms of

payables days

receivables days

inventory turnover

what does efficiency ratios assess

they assess the internal management of a business i.e how efficient are managers in controlling the current assets

what are payables days

measure of how long it takes on average for the business to pay for supplies it has purchased on credit

whats the link between payables days and cash flow

Payables days indicate the average time a business takes to pay its suppliers, which directly affects cash flow by determining how long cash can be retained before obligations are met.

whats the advantage for long payables days

to ease cashflow problems

What’s the advantage of short payables days

Short payables days can enhance supplier relationships, potentially lead to discounts for early payments, and improve a company's creditworthiness by demonstrating financial reliability.

calculation of payables days

(payables x 365) / cost of sales

long payable days are normally seen as favourable for a business. Explain what a potential negative effect long payable days could have

potentially leading to decreased trust and supply disruptions, as suppliers may become hesitant to extend credit or provide favorable terms

what are receivables days

measure of how long it takes on average for customers to pay the business for goods or services it purchased on credit

whats the link between receivables days and cash flow

Longer receivables days can negatively impact cash flow, as delayed payments from customers mean the business has less cash available for operations and covering immediate expenses

whats the advantage of short recievables days

ease cash flow problems

whats the advantage of long receivables days

may encourage more sales, as customers have more time to pay, potentially leading to increased business.

whats the calculation for receivables days

(receivables x 365) / sales revenue

what is considered the normal amount of receivables days

30 days

why would a business worry about receivables days increasing significantly from previous years

It may indicate potential cash flow issues, as slow payments could hinder the business's ability to meet its financial obligations and invest in growth.

whats the link between payables and receivables days

An increase in payables days may allow a business to retain cash longer, while a rise in receivables days can signal cash flow problems. Therefore, the balance between these two metrics is crucial for maintaining liquidity.

if payables days was 50 days and receivables days were 12 days should the business be concerned

firm minimises their risk of cash flow issues as money is received before payables need to be paid back However, relying on short receivables days might lead to strained customer relationships, indicating a potential imbalance.

what might be the expected receivables days of high street coffee chain

0 - paid straight away

what might be the expected receivables days of a commercial print company

more days as its a b2b business - around 30 days

what does inventory turnover measure

how frequently a business turns over its inventory in a year by turning it into sales, number tells how many times a year that a business goes through inventory

why does inventory turnover vary for different types of businesses

Inventory turnover can vary based on factors such as the nature of the products sold, demand cycles, and the business model (B2B vs. B2C). For example, perishable goods may have higher turnover compared to durable goods.

Calculation of inventory turnover

cost of sales (cost of goods sold) / average inventory held (value £)

explain when an inventory turnover going down is a good thing

A declining inventory turnover can be a good thing if it indicates that a business is investing in higher quality products or expanding its product line, which may lead to increased customer satisfaction and potentially higher sales in the future.

explain when inventory turnover is going down is a bad thing

A declining inventory turnover can signal a business's investment in higher quality or more varied products, suggesting potential for increased customer satisfaction and future sales growth.

whats the value of using financial ratios to assess performance

tool for interpretation of accounts

structure form which comparisons can be made

aids in decision making and trend analysis.

whats the limitations of using financial ratios to assess performance

possibility that accounts have been window dressed

may not account for external factors influencing performance

reliance on historical data may not reflect current market conditions