Chapter 3: Using Financial Data to Measure and Assess Performance

Part 1 of Chapter 3

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  • Using Financial Data to Measure and Assess Performance
    • The Income Statement
      • Purpose of Income Statement
        • comparisons can be made within the business
        • can be used to show potential investors that the firm is successful and able to repay loans or provide a good return on investment
        • comparison can be made between different firms
        • enables people to see if profit is of high quality
        • enables people to see if profit is being utilised in a sensible way
        • allows shareholders to assess whether their investment is beneficial
        • to satisfy legal requirements
      • Structure of Income Statement
        • Expenses
          • rent, depreciation, general admin costs
          • takes gross profit and deducts cost not directly related to producing product of service
          • this section calculates operating profit
        • Finance and Income Expenses
          • includes information on any interest payments made by business and any interest received on money lent or saved
          • profit before tax is shown here
        • Revenue & cost of sales
          • records revenue of company and cost of sales
          • cost of sales includes raw materials, wages, cost of stock
          • this section calculates gross profit
        • Tax paid on profits made
          • earnings per share
          • profit for the period
      • Useful Income Statement formulae
        • profit before tax = operating profit + finance income - finance costs
        • operating profit = gross profit - expenses (+/- exceptional items)
        • profit for the year = profit before tax - taxation
        • gross profit = revenue - cost of sales
        • earnings per share = profit for the year / number of shares issued
      • shows profit and loss made by the busines
      • describes the income and expenditure of a business over a given period od time
    • The Balance Sheet
      • Elements of Balance Sheet
        • Assets
          • non- current; owned by organisation for longer than a year
          • current assets; owned for less than a year
        • Liabilities
          • non-current; debts due for repayment after more than one year
          • current liabilities; debts scheduled for repayment within one year
        • Capital
          • share capital; funds provided by shareholders through purchase of shares
        • Reserves and Earnings
          • items that arise from increases in the value of the company, which are not distributed to shareholders as dividends, but are retained by the business for future use
      • Purposes of Balance Sheet
        • gain understanding of nature of the firm
        • show sources of capital
        • recognise the significance of change over time
        • identify the company's liquidity position
        • calculate net assets of a business
        • recognise scale of business
      • Useful Balance Sheet formulae
        • capital employed = total equity + non-current liabilities
        • assets employed = capital employed
        • assets employed = net current assets + non-current assets
        • working capital = current assets - current liabilities
        • net assets = non-current assets + working capital (or net current assets) - non-current liabilities
        • current assets = inventories + debtors + cash and other equivilants
      • looks at the accumulated wealth of a business
      • lists resources business owns (assets) and the amount that it owes to others (liabilities)
      • shows equity (capital) provided by owners or shareholders
    • Depreciation
      • the fall in value of an asset over time, reflecting the wear and tear of the asset as it becomes older, the reduction in its economic use or its obsolescence
      • Causes of depreciation
        • Time
          • some assets will last longer than others
          • if in doubt, business should use a shorter period of time
          • useful life of asset which is important
        • Obsolescence
          • wwhen asset is still functioning but is no longer considered useful because it is out of date
          • changes in technology may mean that assets need to be replaced as it becomes inefficient compared to newer alternatives
        • Use
          • more an asset is used, the quicker it will wear out
          • careful use and regular maintenance can extend useful life of an asset
          • correlation between amount of use and level of depreciation
      • Straight line method of depreciation
        • rate of depreciation = initial cost - residual value / useful lifetime
      • Reducing balance depreciation method
        • a set percentage is taken off the value of the asset every year it is owned
    • Working Capital (net current assets)
      • Factors influencing the level of working capital
        • The time taken to sell inventories
          • nature of the product
          • durability of the product
          • efficiency of the suppliers
          • lead time
          • customers expectations
          • competition
        • The time taken by customers to pay for goods
          • nature of the market
          • bargaining power
          • type of product
      • Causes of working capital difficulties
        • Poor control of debtors
          • firms that allows debtors to delay payment needs to hold high levels of other current assets
        • Failure to control inventory levels
          • high levels of inventories tie up resources unnecessarily and cost business money in storage costs
        • Poor internal planning and co-ordination
          • if individual departments of a firm are unable to meet targets, working capital problems will occur
        • Poor control of creditors
          • frim pays its creditors too quickly will damage its working capital
        • Cash flow problems
          • cash is a major part of net current assets
        • External factors
          • unforeseen changes can affect consumer's tastes

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