3.5 Assessing Competitiveness

Question 1

What are the two types of financial statements?

Answer 1

Statement of comprehensive income (profit and loss account)
Statement of financial position (balance sheet)

Question 2

What are is the basic structure of a profit and loss account?

Answer 2

Revenue
- Cost of sales
= Gross profit
- Overheads (expenses)
= Operating profit
- Financing costs
= Profit before tax
- Tax
= Profit after tax for the year

Question 3

What is the formula for gross profit?

Answer 3

Gross profit = revenue - cost of sales

Question 4

What is the formula for operating profit?

Answer 4

Operating profit = gross profit - expenses

Question 5

What is the formula for profit before tax?

Answer 5

Profit before tax = operating profit - financing costs

Question 6

What is the formula for profit after tax?

Answer 6

Profit after tax = profit before tax - tax

Question 7

What is the formula for retained profit?

Answer 7

Retained profit = profit after tax - dividends paid to shareholders

Question 8

What are financing costs on a profit and loss account?

Answer 8

Interest on loans

Question 9

What are overheads on a profit and loss account?

Answer 9

Payments for things that are of immediate use to the business other than the products they sell.

Question 10

Why are shareholders interested in profit and loss accounts?

Answer 10

Particularly interested in profit figures, and the proportion of profit after tax paid out to retained profit.

Question 11

Why are employees interested in profit and loss accounts?

Answer 11

What proportion of costs are wages, in relation to profit, to assess whether demanding a pay rise is justified.

Question 12

Why is the government likely to be interested in profit and loss accounts?

Answer 12

HMRC (the taxman) is interested in how much profit is made to ensure the right amount of corporation tax is paid.

Question 13

What three main things does a statement of financial position (balance sheet) show?

Answer 13

What a business owns.
What a business owes.
How much capital has been provided by shareholders.

Question 14

What is a non-current asset?

Answer 14

Used over and over again by a business to generate profit e.g. buildings, equipment, vehicles, patents, copyright.

Question 15

What is a current asset?

Answer 15

Short-term assets that change regularly e.g. inventories, receivables, cash.

Question 16

What is a current liability?

Answer 16

Payable within 12 months e.g. overdraft

Question 17

What is a non-current liability?

Answer 17

Payable in more than 12 months e.g. loans or mortgages.

Question 18

Why might bankers be interest in a business’ balance sheet?

Answer 18

Keen to understand a business’s resilience on debt for its long-term finance.
Banks will study the relationship between long-term borrowings and total equity.

Question 19

Why might suppliers be interest in a business’ balance sheet?

Answer 19

Short-term financial health of the business.
Suppliers considering offering credit will want to see the relationship between the company’s available cash and its existing short-term debt.

Question 20

Why might staff be interest in a business’ balance sheet?

Answer 20

May be looking at reserves to assess whether the ‘wealth’ of the business has gone up or down over time, perhaps wondering whether they are receiving fair reward for their efforts if reserves have increased.

Question 21

What are the five main financial ratios?

Answer 21

Gross profit margin
Operating profit margin
Profit for the year margin
Current ratio
Acid test ratio
Gearing ratio
Return on capital employed (ROCE)

Question 22

What is return on capital employed (ROCE)?

Answer 22

Adds shareholders’ capital (total equity) to loan capital (long-term liabilities) to work out the total long-term finance in a business.

Question 23

What is the formula for gearing ratio?

Answer 23

Gearing ratio = (long-term liabilities / capital employed) x 100

Question 24

What are the implications of a gearing ratio greater than 50%?

Answer 24

This is worrying as the firm may have too many loans, the interest on which could drain the business of cash.

Question 25

How can a business reduce its gearing ratio?

Answer 25

Issue more shares.
Retain more profits.
Repay some loans.

Question 26

What is meant by capital employed?

Answer 26

The amount of money invested in a business.

Question 27

What is the formula for ROCE ratio?

Answer 27

ROCE = (operating / capital employed) x 100

Question 28

What does a higher ROCE ratio figure suggest?

Answer 28

The higher the better since this shows the business is generating more profit per pound invested in it.

Question 29

What are the limitations of ratio analysis?

Answer 29

If inventories are about to got out of fashion, the current ratio will be misleadingly high/healthy.
If a large proportion of money owed to the business is owed by unreliable payers, acid test and current ratios will be misleadingly high/healthy.
In a one-off transaction, such as selling a property, is shown on the P&L account, operating profit margin and ROCE will receive an artificial boost.

Question 30

What is the formula for calculating labour turnover?

Answer 30

Labour turnover = number of staff leaving the firm in a year / average number of staff during the year x 100

Question 31

What are the internal causes of increasing labour turnover?

Answer 31

Poor recruitment and selection.
Poor motivation or leadership.
Wage rates below local norms.

Question 32

What are the external causes of increasing labour turnover?

Answer 32

More local vacancies.
Better transport links, allowing staff to find work further away.

Question 33

Why is high labour turnover a problem?

Answer 33

Additional recruitment costs.
Training costs.
Time taken for replacements to settle and become productive.
Loss of productivity whilst replacements are found and trained.

Question 34

What are the potential positives of a controlled level of turnover?

Answer 34

New workers with new ideas and enthusiasm.
New workers with appropriate skills, which remove need to re-train existing staff where skill requirements have changed.
New way of looking at problems that could solve long-standing issues.

Question 35

What is the formula for calculating the rate of absenteeism?

Answer 35

Rate of absenteeism = total days of absence in a period / possible total days that could have been worked x 100

Question 36

What are the main effects of high absenteeism?

Answer 36

Extra costs of cover staff.
Lower productivity.

Question 37

What HR strategies can be employed to address performance problems?

Answer 37

Financial rewards.
Employee share ownership.
Consultation strategies.
Empowerment strategies.