3.5 assessing competitiveness

statement of comprehensive income

• aka the profit and loss account

• shows the income & expenditure of a business over a period of time

• calculates amount of profit made

stakeholder interest in the statement of comprehensive income

• shareholder: interested in profits earned, business growth & divided payments

• employees: interested in profits earned and potential for wage increase & job stability

• managers & directors: interested in key performance data such as an improvement in sales revenue & net profit

• suppliers: interested in the continued success of the company that they are supplying. used to determine the level of trade credit offered to businesses

• government: used to determine how much tax is payable

• local community: interested in the stability of the business and what this may mean for jobs in that community. interested to see if the firm is generating enough profit to perhaps approach them for local sponsorship

statement of financial position

• aka balance sheet

• contains info to draw conclusions about the liquidity of a business

• shows the financial structure of a business at a specific point in time

• identifies a business’ assets and liabilities & specifies the capital used to fund the business

stakeholder interest in the statement of financial position

• shareholder

  • used to identify the asset structure of the business & how their investment has been put to use

  • used to calculate working capital

  • used to determine the rough value of a business

• managers & directors

  • used to identify the financial position of a business at a given point in time

  • useful to assess the working capital position of the business & determine if there are enough liquid current assets to pay its bills

  • provides info on the capital structure of the business which helps guide decisions on wether to raise further funds through borrowing or via other means e.g share issue

• suppliers & creditors

  • used to judge the solvency of the business to determine the risk when offering trade credit

  • businesses with low levels of capital may find it difficult to pay short term debts and so suppliers may offer trade credit with stricter terms

• employees

  • question if the business is financially stable and make sure jobs aren’t at risk, performance improved or worsened, what business is spending money on, how much tax business is paying

gearing ratio

• shows long term financial structure of the business

  • shows balance of non current liabilities to shareholder capital used to fund a business

• non current liabilities / capital employed x 100

  • capital employed = non current liabilities + total equity (share capital + reserves)

return on capital employed

• compares the profit made by a business to the amount of capital invested in the business

• measure how effectively a business uses the capital invested in the business to generate rpofit

• performance indicator that can be compared over time

• operating profit / capital employed x 100

  • capital employed = total assets - current liabilities

interpreting ratios to make business decisions

gearing ratio

• measures businesses capital structure

• compares long term loans to share capital

• shows how reliant business is on borrowed money

highly geared business

• more than 50% of capital is from long term loans

• effects: high interest pay, lower profits available for dividends, less profit to reinvest, seen as riskier by investors, harder to raise more loans

• to reduce gearing: issue more ordinary shares, retain profits instead of borrowing, repay loans to reduce interest costs

low gearing business

• less than 50% of capital is from long terms loans

• effects: may be missing out on cheap finance, important when interest rates are low, banks are more likely to approve loans, can appear risk averse which may deter investors

• to increase gearing: buy back ordinary shares, issue preference shares (less loss of control), take out more loans

ROCE

• measures ability to generate profits from funds invested

• determine most profitable options given level of capital employed

• high ROCE rate = profitable & using its capital efficiently

• stable & rising ROCE rate= low risk growth is being achieved

• ROCE of at least 20% =0.2 good financial position

• to increase roce level: increase level of profit generated without introducing new capital into business, maintain level of profit whilst reducing the amount of capital in the business

limitations of ratio analysis

• overtime nature of business can change, affecting desired level of ratio

  • comparisons are only good where significant similarities exist

• accounts can be manipulated to present a favourable financial picture, making it unreliable

• balance sheet may not represent usual circumstances

• ignore qualitative factors that affect performance