Assessing Competitiveness

Question 1

What is a balance sheet?

Answer 1

A balance sheet is a financial document showing a businesses assets and liabilities at a point in time.

Question 2

What is a profit and loss account?

Answer 2

A profit and loss account shows a firms revenue for a time period along with all the costs associated with generating that revenue.

Question 3

What is an asset?

Answer 3

And asset is any item owned by a business.

Question 4

What are non-current assets and name some examples?

Answer 4

Long-term assets that are used over and over again by a business to generate profit.
Examples include: land and buildings, machinery and equipment, vehicles, patents or copyright.

Question 5

What our current assets and name the three main types?

Answer 5

Current assets are short-term assets that change regularly. There are three main types:
Inventories - this is the value of any stocks of raw materials, partially finished goods or finished products owned by the business.
Receivables -this is money owed to the business usually by customers who have bought on credit.
Cash: this is the money available in the bank that can be immediately accessed along with physical cash.

Question 6

What does liquidity mean?

Answer 6

Liquidity is the term used to describe a firm’s ability to pay its bills and finance short-term spending.

Question 7

What are the three sources of capital shown on the balance sheet?

Answer 7

Banks: loans from banks carry interest payments and must be repaid.
Shareholders: when the company sells shares, it receives share capital in return. This is theoretically owed to shareholders but is very rarely ever repaid.
Profits: the reserves figure on a balance sheet shows the total amount of retained profit that has been kept in the business as a source of finance.

Question 8

What is another term for balance sheet and what does a balance sheet show?

Answer 8

Another term for a balance sheet is the statement of financial position.
It shows how wealthy a business is, they do this by listing everything the business owns. In addition, a balance sheet lists the money owed by the business - its liabilities.
The final part of the balance sheet details the shareholders contribution to the business - the capital they have provided.

Question 9

What are the interests of stakeholders such as bankers in balance sheets?

Answer 9

Bankers are keen to understand a business’s reliance on debt for its long-term finance, bankers will study the relationship between long-term borrowings and total equity.

Question 10

What are the interests of stakeholders such as suppliers in balance sheets?

Answer 10

They’re more interested in the short-term financial health of the business, suppliers considering offering credit want to see the relationship between the companies available cash and its existing short-term debt.

Question 11

What are the interests of stakeholders such as staff in balance sheets?

Answer 11

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 a fair wage for their effort if reserves have rocketed.

Question 12

What’s else are profit and loss accounts called and what does it show?

Answer 12

A Profit and loss accounts is also called a statement of comprehensive income.

It’s the record of how well a firm has done, financially, in a given period of time. The financial measure of performance is profit, therefore the profit and loss account has a variety of different types of profit to help stakeholders studying the account understand the businesses performance.

Question 13

How does a profit and loss accounts show a profit or loss?

Answer 13

A profit and loss account starts with annual revenue, then deducts different costs and expenses to calculate different types of profit.

Question 14

What is gross profit and how do you calculate it?

Answer 14

Gross profit is a real measure of basic trading profit. It shows what is left from revenue wants the cost of making or buying the goods sold has been deducted.

Revenue - cost of sales = gross profit

Question 15

What is the cost of sales?

Answer 15

Cost of sales is the cost of buying or making the product sold to generate the revenue for the year.

Question 16

What is operating profit and how do you calculate it?

Answer 16

Operating profit shows the amount of profit left after deducting the normal costs of operating for the business year. Overhead expenses are deducted from gross profit, these expenses include items such as wages, salaries, rent, heating, lighting, distribution and marketing costs.

Gross profit - expenses = operating profit

Question 17

What are overheads or expenses?

Answer 17

They are payment for something that is of immediate use to the business, other than the actual products they sell.

Question 18

How do you work at the profit before and after tax?

Answer 18

Interest earned on money held by the business - interest on money borrowed by the business

This figure is deducted from operating profit to calculate the profit before tax is deducted.
With corporation tax taken away, the business is left with profit after tax also referred to as net profit for the year.

Question 19

What is net profit for the year and who does the profit belong to?

Answer 19

Net profit of the year is the profit after tax. This is the profit that ‘belongs’ to the shareholders.

Question 20

What happens with the profit after tax?

Answer 20

Shareholders are left to decide whether they withdraw profit after tax for their own benefit, or leave that money in the business to finance extra spending by the firm.

Directors recommend the balance between the two uses of profit and if the majority of shareholders are unhappy with the recommendation, they can vote against this at the annual general meeting.

Question 21

What are the three types of ratio analysis?

Answer 21

Profitability: this shows the relationship between gross/operating/net profit and revenue, assets and capital.
Liquidity: this shows the ability of a firm to meet its short-term debts with cash or near cash assets.
Gearing: this shows the proportion of the long-term finance in a business that has come from loans.

Question 22

What are the two liquidity ratios you can calculate to understand the balance between a companies short-term debt and the assets it can use to meet that debt.

Answer 22

Current ratio and acid test ratio

Question 23

How do you work out current ratio?

Answer 23

Current ratio = current assets ÷ current liabilities

Question 24

How do you work out the acid test ratio?

Answer 24

Acid test ratio =
current assets (excluding inventories/stock) ÷  current liabilities

Question 25

What is the ideal value for the current ratio? What does it mean if the ratio feels too high or too low?

Answer 25

The ideal value for the current ratio is 1.5
If the current ratio is too high it might mean that too many resources are being held in unproductive forms, they could be better invested elsewhere.
If the ratio falls too low, this may indicate that the firm is suffering from a liquidity crisis, so is unable to find enough cash to settle debts as they become due.

Question 26

What is the ideal value for an acid test ratio?

Answer 26

The ideal value for this ratio is one.

Question 27

What might a current ratio value of 1.5 mean?

Answer 27

This is the ideal value for a business it means that the business would have £1.50 of current assets for every £1 of short-term debt.
Which is deemed enough to be able to cover the debts comfortably without holding too many resources in unproductive forms where they could be better invested elsewhere.

Question 28

What does capital employed mean?

Answer 28

Capital employed adds shareholders capital (total equity) to loan capital (long-term liabilities) to work out the total long-term finance in the business.

Question 29

What does the gearing ratio measure? And how do you work it out?

Answer 29

It measures the long-term financial health of a business, it expresses long-term liabilities as a percentage of the total amount of long-term capital in the business.

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

Question 30

What are the methods to reduce unhealthily high gearing ratios?

Answer 30

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

Question 31

What is the problem with a high gearing ratio?

Answer 31

The problem is the cash drain it represents: with interest payments to make, as well as loan repayments, high levels of debt can suck the life blood from a company business rapidly.

Question 32

How can you assess how profitable a business has been?

Answer 32

By using the actual figures for profit over several years, or it could be assessed by calculating profit margins which show profit as a percentage of revenue.
These include gross profit margins, operating profit margins and net profit margins.

Question 33

What is the formula for the gross profit margin and what does it show?

Answer 33

Gross profit ÷ sales revenue x 100

It shows gross profit per £ of sales.

Question 34

How can you improve the gross profit margin and what is the problem if it’s too low?

Answer 34

You can improve it by putting prices up depending on the price elasticity of demand.
Or by putting unit variable costs down by changing supplier, recycling or having less wastage

A problem if it’s too low is that the business may not have enough gross profit to cover overhead expenses.

Question 35

What is the formula for the operating profit margin and what does it show?

Answer 35

Operating profit ÷ sales revenue x 100

It shows the operating profit per £ of sales.

Question 36

How can you improve the operating profit margin and what problems may occur if it’s too low?

Answer 36

You can improve operating profit by increasing sales, boosting the gross profit margin or cutting overheads per £ of sales.

A problem if it’s too low is that there may not be enough operating profit to reinvest into the business and allow the business to grow

Question 37

What is the formula for the net profit margin and what does it show?

Answer 37

Profit after tax ÷ sales revenue x 100

Net profit per £ of sales

Question 38

How can you improve the net profit margin and what problems may occur if it’s too low?

Answer 38

You can improve the net profit margin by boosting the operating profit margin or cutting the corporation tax bill (legally).

A problem that may occur if it’s too low is that you may not be able to provide shareholders with acceptable annual dividends.

Question 39

What is return on capital employed (ROCE), what does it show and what is the formula to work it out?

Answer 39

It is another measure of profitability, this ratio expresses operating profit as a percentage of the capital that has been invested in the business.
Therefore it shows a return on the capital that is comparable with other potential uses of capital, such as simply leaving money in the bank to earn interest.

Return on capital employed =
operating profit ÷ capital employed x 100

Question 40

What is a good value for the return on capital employed and what may a business question when ROCE falls below current interest rates.

Answer 40

The higher the better the value for this ratio, since a higher return means the money invested in the business is generating a higher return on that investment.
Where ROCE falls below current interest rates, a business may question whether it would be better off if they liquidate its assets and put all the money in a risk-free bank for a higher return than the risky option of running a business.

Question 41

What are the two options of boosting the ROCE ratio?

Answer 41

Find a way to increase operating profit,

Reduce capital employed without damaging operating profit.

Question 42

When can you use the ratios to help make key business decisions?

Answer 42

Gearing and liquidity ratios help to identify whether a business can afford to invest money in new projects.

Return on capital employed can help to assess the attractiveness of a new investment (alongside ARR) or identify underperforming parts of a business.

Gross margins can help decide whether a business needs to put their prices up (price elasticity of demand must also be considered here).

Question 43

What are the limitations of ratio analysis?

Answer 43

The major issue is the lack of detail provided within financial accounts.
E.g. money may be owed by reliable and regular customers and this could be turned into cash which will be received on time, however if the receivables figure on the balance sheet consists of bad debts from failing customers the acid test and current ratio results will paint a misleadingly healthy picture.

If stock is about to go out of fashion and become virtually worthless, the current ratio will again present a misleading picture of health.

Question 44

How can HR management find ways to assess the effectiveness of the way that people are managed in the business?

Answer 44

By using HR indicators that are regularly monitored such as:
Labour productivity,
Labour turnover,
Absenteeism.

Question 45

How do you work out labour productivity and what is the benefit of having a high labour productivity for a business?

Answer 45

Output per period ÷ number of employees per period

A business that is able to boost labour productivity without increasing pay will enjoy lower labour costs per unit. This should boost its competitiveness, allowing prices to be cut if needed, or a higher profit margin.

Question 46

What is labour turnover, what can it indicate and how do you work it out?

Answer 46

It measures the percentage of the workforce that has left during a year, it can indicate staff discontent with how they are treated if it increases.

Number of staff leaving the firm in a year ÷ average number of staff during the year x 100

Question 47

What are the internal causes of increasing labour turnover?

Answer 47

Poor recruitment and selection, resulting in the wrong people being appointed,
Poor motivation or leadership,
Wage rates below the local norms.

Question 48

What are external causes of increasing labour turnover?

Answer 48

More local vacancies arising, tempting staff to look for better opportunities.
Better transport links allowing staff to look for the alternative jobs further away.

Question 49

What are the negative effects of a high labour turnover?

Answer 49

Extra recruitment costs to find replacements,
Extra training costs for replacements,
Time taken for replacements to settle in and become productive,
Loss of productivity while replacements are found, trained and find their feet.

Question 50

What are the potential positive effects of a high labour turnover?

Answer 50

New workers with new ideas and enthusiasm,
New workers with appropriate skills may be brought in to prevent the need to retrain existing staff with skill requirements have changed,
A new way of looking at problems in the business could bring solutions to long-standing issues.

Question 51

What is absenteeism, what does is indicate and what’s the weakness of this measure?

Answer 51

Absenteeism measures the amount of time missed by workers who do not come to work when they are supposed to.
It can indicate discontent in the workplace.
However the weakness of this measure is that it fails to distinguish between avoidable and unavoidable absences.

Question 52

How can you work out absenteeism and what effect does it have on a business?

Answer 52

Total days (or hours) of absence in a period ÷ possible total days (or hours) that could have been worked x 100

A high level of absenteeism causes extra costs and lost productivity that damages a firms competitiveness.

Question 53

How can you use employee performance data to help make business decisions?

Answer 53

It can highlight areas where problems exist. The data’s unlikely to provide the cause or solution to the problem however it can uncover major areas where improvements need to be made. This is especially useful where comparative data for rivals is available. Where a businesses HR data shows it’s lagging behind rivals, competitiveness will suffer.

Question 54

What are the three human resource strategies they can improve employee performance?

Answer 54

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

Question 55

What would be Herzberg’s opinion on financial rewards to improve employee performance?

Answer 55

Trying to use a hygiene factors such as pay to motivate staff will only create a temporary improvement in performance, which will disappear if the reward disappears. A further problem is in deciding how performance will be measured, before awarding a bonus. Employees may adapt what they do simply in order to boost their bonus, perhaps in an unexpected and harmful way.

Question 56

How does employee share ownership work as a strategy to improve employee performance?

Answer 56

Share ownership should work by aligning the goals of the business with those of staff. If staff work better, the company will make more profit allowing higher dividends to be paid to shareholders, including the employees.

Question 57

What is consultation?

Answer 57

Consultation means seeking and listening to the views of employees as part of a decision making process.

Question 58

Why does the challenge of consultation grow as a business grows?

Answer 58

In a small business, the boss can consult each member of staff personally however as a business grows this becomes more difficult. The use of technology can help by setting up internal chat rooms or a forum where staff can have their say.

Question 59

What does empowerment mean?

Answer 59

Empowerment means giving staff the authority not just to decide how to do a task, but to decide what tasks need doing in the first place.

Question 60

What motivational theorists argue that empowerment strategies can improve employee performance?

Answer 60

Maslow and Herzberg

Question 61

What are the key conditions required if empowerment is to be effective?

Answer 61

Clear corporate aims and objectives,
A strong culture of trust,
A skilled and talented workforce.