assessing competitiveness

Statement of comprehensive income

This is a document produced to calculate the profit or loss made by a business over a period of time.  It takes into account the revenues earned and the costs incurred during the period to work out the profit at the end of the period. 

Key terms in comprehensive income

Stakeholders and Why they might be interested in the statement of comprehensive income 

Shareholders

How much profit is our business making? How much profit can be distributed to us in dividends?

Competitors

What is the profit (amount and profitability (% margin)? Is the business more efficient or does it add more value?

Government

How much tax should this business pay on its profits?

Employees

How secure is the business in terms of profit or loss? If bonuses are based on profit, has it been achieved?

Statement of financial position

The statement of financial position provides a summary of a business’s assets, liabilities and capital.  It is like a photograph of the financial position of a business at a particular point in time. 

Key terms of statement of financial position

Stakeholders that would be interest in statement of financial position

• Creditors
  What is the liquidity position of the business?
  Is the business able to pay its debts as they fall due?

• Employees
  Is the business solvent and have a strong liquidity position?
  This may impact on the security needs of employees and whether they get paid

• Banks & other lenders
  How much debt does the business have? Is it able to finance its debt? What cash and other liquid balances does it have?

Gearing ratio and calculation

Gearing and the gearing ratio examines the capital structure of a business - that means the proportion of finance that is provided by debt relative to the finance provided by equity (or shareholders).

The key benefits of calculating the gearing ratio include:

• A useful measure of the financial health of a business

• Focuses on the level of debt in the financial structure of a business

• A high gearing ratio can mean higher risk of business failure (but not always)

The formula to calculate the gearing ratio is as follows:

Gearing = Non-current liabilities/Capital employed x 100

Capital employed = non-current liabilities + total equity

Return on capital employed and calculation

ROCE is a measure of relative profitability.

ROCE tells us what returns (profits) the business has made with the resources available to it.

ROCE is particularly useful as a ratio as it helps:

• Evaluate the overall performance of the business

• Provide a target return for individual projects

• Benchmark performance with competitors

To calculate ROCE, you need information from both the statement of comprehensive income (profit and loss account) and the statement of financial position (balance sheet).

The formula to calculate ROCE is as follows:

ROCE = Operating Profit/Capital Employed x 100

Capital employed = non-current liabilities + total equity

Limitations of ratio analysis

• One data set is not enough; comparisons over time give a much more accurate assessment

• How reliable is the financial data? Financial information can include subjective judgments and different businesses can adopt different accounting policies. There is also the potential for manipulation of accounting information (window dressing).

• Ratios are based on the past - they are not a predictor of the future

• Comparability - be careful with comparing ratios, for example, between different industries

• Financial ratios are only concerned with quantitative (financial) data so they don't provide qualitative information such as competitive advantages), quality ethical reputation or human resource management

Labour productivity and calculation

Labour productivity measures the average output per worker. In other words, how much does each worker produce in a period of time, for example, a day, a week, or a month?

The formula to calculate labour productivity is:

Output per period (units)/Number of employees during period

Labour productivity is important, particularly for labour-intensive businesses, because:

• Labour costs are usually a significant part of total costs

• Higher labour productivity helps to reduce labour costs per unit, which results in lower unit costs and can therefore improve competitiveness (an example of this is shown in the table below)

• Business efficiency and profitability are closely linked to labour productivity

Key factors that influence level of labour productivity

As the labour productivity (output per employee) increases, so the labour cost per unit decreases which can therefore lead to a decrease in unit costs. Key factors that influence the level of labour productivity include:

• The extent and quality of non-current assets (for example, machinery and IT systems)

• The skills, ability and motivation of the workforce

• The methods of production used by the business (for example, job, batch, flow, cell)

• The extent to which the workforce is trained and supported

• External factors (for example, the reliability of suppliers)

Labour turnover and calculation

Every business experiences the departure of employees. This can be due to:

• Retirement/maternity/death/long-term illness

• Unsuitability

• Changes in strategy (e.g. closure of locations)

However, the loss of employees (labour turnover) still needs to be managed carefully if a business is to succeed.

Replacing workers who leave a business is an expensive process; recruitment, training and potential negative impacts on motivation of employees who remain can all add to business costs.

Labour turnover measures the percentage of the workforce (employees) that leave a business within a given period (usually a year).

It is calculated using the formula:

Number of employees leaving during a period / Average number empioyed during period x 100

Labour retention and calculation

Retaining (keeping) staff is, therefore, very important. Retention rates look at the ability of a business to retain its employees.

Labour retention is calculated using the formula:

Number of workers who remained with the business during the period / Average number employed during period x 100

Higher retention rates may allow a business to keep control of trade secrets and key skills whilst also helping to reduce recruitment and training costs.

Absenteeism and calculation

Absenteeism is the proportion of employees not at work on a given day.

Absenteeism can be a significant operational issue in business, particularly in labour intensive operations because:

• It represents a significant business cost (around £600 per worker per year for UK businesses)

• It is difficult to distinguish between genuine absence (bereavement, bullying, stress) and those who 'play the system' and take advantage

• Absenteeism can be predictable, often higher on Monday mornings, Friday afternoons and/or around significant national holidays

Absenteeism can be calculated using this formula:

Number of staff absent during period / Average number employed during period x 100

An alternative formula that focuses on the number of working days lost is

Number of days absent during period / Total days worked by the workforce during the period x 100

Human Resources strats to increase productivity and retention reduce labour turnover and absentees

Possible methods to improve labour productivity, improve retention and to reduce labour turnover and absenteeism include:

• Financial rewards such as commission (for sales staff), piecework (payment per item produced) and/or profit sharing (payment per item produced and/or profit sharing (financial incentives to improve employee performance is covered in Theme 1: 1.4.4)

• Employee share ownership which involves distributing shares to employees. This can act as an incentive for employees as they have a vested interest in the business that they work for

• Consultation strategies are strategies which involve consulting staff on key decisions within the business. This can lead to an increase in motivation as their esteem needs (Maslow) may be met. This may lead to an increase in productivity and a reduction in labour turnover

• Empowerment strategies provide employees with more responsibility to work on their own behalf without necessarily the need to "hand down" specific tasks and projects. This can be a powerful motivator as it gives workers more control over their work which in turn, can lead to an increase in labour productivity and a reduction in labour turnover (empowerment is also covered in Theme 1:1.4.4)

Acid ratio

Current Assets - Inventory / Current Liabilities

The acid test ratio is also known as the "quick ratio" and is the most

commonly used ratio to judge the financial health of a business • Stock is excluded because it may perish or be obsolete or not worth

the stated value • A result of less than 1:1 means that the current assets do not meet

their current liabilities and they will struggle to pay their bills

Curren ratio

Current Assets / Current Liabilities

This is also known as the working capital ratio

• The ideal is around 2:1 • Below 1.5:1 the business might not have enough working capital to cover all their bills. They may be over borrowing or over trading and

will have cash flow problems • Above 2.5:1 and the money in the business is tied up and not being

used efficiently