3.5 Assessing Competitiveness Flashcards
The statement of comprehensive income (profit and loss account) shows a firms revenue, costs and profit. It indicates if a firm is profitable - a positive net profit. Different stakeholders have different interests in a firm, so they’ll be interested in different parts of the account comparing across several years to look for trends.
Shareholders:
>May be more interested in how profitable a firm is, the higher profitability the higher the dividends can be.
>Trends in net profit can show how risky an investment may be a fluctuating one may be more risky then steadily increasing. They might also look out what proportion is payed out in dividends as this follows a similar pattern with level of risk.
>A good firm is one that increases revenue whilst keeping costs low so this maybe a feature to look at.
Managers:
>Will use this account to see the revenue and expenses of the firm overtime. High costs with low revenue may indicate necessary changes.
>They may be compared between departments or competitors to see where they can reduce costs.
>Comparing with competitors may show a loss and market share so new tactics need implementing to raise revenue.
Loan providers: Interested in operating profit as this is where interest on loans is paid from. Risky loaning to firm with low operating profit as they may not be able to pay the interest.
Suppliers: Suppliers may check past revenue they wont sell to a firm uncertain of receiving payment.
Employees: Interested in profitability a profitable business may have higher job security. Also net profit to see whether they’re likely to receive a pay rise or bonus
Statements of financial position (Balance sheets) show the assets, liabilities and how much firm is worth at a given particular time. Comparing the statement at the same date between different years allows stakeholders to pick out trends and assess financial performance.
Shareholders can use this to see whether profit within a firm is likely to increase or decrease. An increase in reserves or cash could result in higher dividends. They may also be interested in their sources of capital a firm with lots of loans has to pay back the interest on top so may make little profit after its been paid. Managers might look at ability to acquire capital. They may consider loans if the business can cope with these. It can cope if total assets exceed non current liabilities when taking out the loan.
Balance sheets show a business’ liquidity and solvency. Liquidity is the ability to turn assets into cash - current assets are more liquid than non current assets so a business with low value of currents assets has low liquidity. Solvency is business’ ability to pay off its debts. If current assets are larger then current liabilities it is solvent if the other way round it is unable to pay debts and insolvent.
Stakeholder groups are effected by these.
Managers: Can look at these to see whether they will go bankrupt. They can make changes to prevent this.
Suppliers: Can see how liquid their assets are also its solvency. A solvent firm with liquid assets is likely to be able to pay bills so credit at different levels may be offered
Loan providers: A firm with higher solvency is likely to be able to repay loans so less risky to lend to.
Gearing shows where a business gets its capital from. To work out the gearing ratio you must first calculate Capital employed = non-current liabilities + total equity. Gearing ratio (%) = non current liabilities / capital employed X 100. A gearing ratio above 50% shows more then half a business finance is from long term debts. Below 50% shows a low geared business.
Gearing shows how vulnerable a business is to changes in interest rates. When a business borrows they have to pay back interest on their loans. The amount of interest to pay back is determined by interest rates and changes in them. The amount a firm can borrow depends on the value of it assets the more assets it can offer as security the more it can borrow.
High gearing has rewards for a business.
>Ideally a loan is invested in projects to increase profits by more than enough to pay off the re-payments.
>A firm may borrow during a growth phase to become market leader through expansion giving a competitive advantage.
>During growth times after repayments the business can maintain this level at a lower cost increasing profits.
High gearing also has risks for the business.
>The risk is the business might not be able to afford repayments.
>Low interest rates at the time of the loan are risky as they can always go up and a business has already committed to repaying the loan.
>A firm borrowing allot is likely to be effected allot by a rise in interest rates as this rises repayments considerably.
Rewards for investors:
Investors will receive rewards through interest on their loans. Shareholders will receive rewards through dividends often paid twice a year and selling shares if share price increases. The more a firm borrows the more it has to pay. High gearing can lead to high profits shareholders might expect to see large dividends and share price increase so will be likely to invest in a high geared business.
Risks for investors:
The risk to a shareholder is a business may fail and not be able to keep up with repayments. When a business goes into liquidation the lenders will probably get the money their owed however shareholders could lose all the money they’ve invested. Investors may look into why a business has borrowed to decide whether it is worth investing in.
Return on capital employed (ROCE) is a profitability ratio. This is considered the best way of analysing profitability. ROCE (%) = Operating profit / Capital employed X 100. The ROCE tells you how much money is made by the firm compared to how much is put into the business. The higher ROCE the better.
Its important to compare ROCE against Bank of England base rate this helps investors decide whether they’d be better of storing their money in a bank. ROCE can be improved by paying off debt or increasing operating profit. This is just one measure ARR is also important.
Advantages of Ratio Analysis:
+Useful to assess performance over periods of time stakeholders can spot trends identifying financial strengths and weaknesses.
+Trends need to take into account variable factors such as: Inflation, Market environment, accounting procedures and business activities.
+Its useful to compare ratios across firms especially different sized ones.
Ratio analysis can be used to make business decisions:
+Managers can decide how to finance growth if already high geared they may look at alternate forms of investment such as shareholders.
+Potential lenders may assess risk of lending
+Potential shareholders may compare accounting ratios when deciding where to buy shares from.
Disadvantages of ratio analysis:
- The ratios are only as good as the data they’re based on. Data from a Balance sheet is data from a given day which could change by the next.
- Internal strengths such as quality of staff don’t appear in figures
- Ratios only contain information about the past and present. A firm which has just invested for growth will have poor ratios until the investment pays off.
Disadvantages of ratio analysis:
- External factors such as economic climate aren’t reflected in the figures so a firm might need to compare with competitors to understand them.
- Future changes such as technological advancements and interest rate change can’t be predicted so won’t show up.
Human resource data is analysed before making decisions. There are many figures that human resources (HR) consider when thinking about recruitment and how to treat employees - Labour productivity, Labour turnover, Labour retention and Absenteeism. Figures are used to check they’re being utilised to maximum efficiency. They will be compared with competitors to see if improvements need to be made.
Labour productivity tells you output per employee. Labour productivity = output per period / No. of employees. HR can make sure all employees feel engaged and motivated to work better. HR will ensure staff are productive through incentives and maybe redundancy to get better skilled staff. They should know about a reason if morale is falling and try to fix this.
Labour turnover (LT) measures the proportion of staff who leave. LT = No. of staff leaving / Average no. of staff employed X 100. High LT may mean more recruiting and training costs also losing experienced staff. Internal causes are like poor motivation and low wages. External causes are local firms using similar skilled staff. Increased responsibility higher wages can reduce LT. Some creative firms may want high LT to bring in new ideas.
Labour Retention (LR) Measures a business ability to keep its employees. LR = No. of staff started - number of leavers / No. of staff started X 100. The higher the LT the lower the LR. HR could make employees feel more valued to ensure they stay employed. Different types of firm interpret these differently. An accounting firm may want to retain all its employees whereas a supermarket might want an increased workforce only around say Christmas
Absenteeism is the proportion of days missed by employees over a period. Absenteeism = (No. of days staff are absent / No. of staff employed X time period) X 100. Absenteeism doesn’t distinguish different causes of absence such as: Bullying, Stress, Genuine physical or mental illness, Low morale, Culture or Dangerous work.
Absenteeism can be costly for a business so must be closely monitored by HR. HR needs to consider why its happening and how it can be reduced. It can be checked against competitors to see if rates are not normal. HR should consult with employees before implementing strategies which may just increase this figure.
Firms can use various strategies to increase productivity and retention and reduce turnover and absenteeism.
Financial Rewards: Higher payments are likely to reduce absence and increase retention.
Employee Share ownership: Firms often sell shares to employees below market value for staying longer to increase finance and make them feel more a part of the company. This increases retention as they must stay in order to reap the benefits of lower shares.
Consultation strategies: Involving employees in decision making improving morale and retention while reducing absence and turnover. Consultation can make the decision making process much longer.
Empowerment strategies: Firms can increase productivity by giving employees more control and responsibility over their work. Firms give them power to make decisions etc this wont work if managers distrust employees.
