Information Revealed by Business Accounts - LGS 15

Question 1

Reasons to read accounts

Answer 1

1. Assess how business is performing
   - find profitability
   - can it meet current liabilities
   - see how business is doing in relation to other business
   - assess how business is doing in economic conditions
2. Predicting future prospects of business
   - Identify trends in performance

Question 2

Who reads accounts

Answer 2

• Investors = good return?
• Managers = performing potential
• Lenders = will loan interest be paid?
• HMRC = profits liable to tax
• Purchaser = buying the business
• Employees = improve pay and terms of contract

Question 3

Limitations on account information

Answer 3

• Accounts produced after event - all payments would have been made/received.
• only gives financial information

Question 4

Other information required ?

Answer 4

• nature of business
• business growing or contracting
• market expanding or contracting
• dependant on one product or has it diversified
• how business is managed

Question 5

Due diligence

Answer 5

Addressing clients questions and concerns:
- reputation of business
- busy
- right area
- what are employees/management like
- what are customers like

Question 6

Reading Accounts

Answer 6

• Obtain accounts from several years = tell us amount of profit and borrowing from previous years so we can compare.
• Check date of BS = results only valid on day it is made
• seasonal business = how it varies throughout year
• check how closing stock valued = should be lower of cost or current market value
• check when figures in BS last valued? = truly reflect current value ? depreciation calculated ? realistic?
• how debtors treated? = bad debts written off ? debts realistic.
• unusual items? = sudden increase in borrowing ? reason for this?

Question 7

Profitability

Answer 7

• May be profitable but lack cash
• May have large amount of debtors
• Large amount of unbilled WIP (WORK IN PROGRESS manufacturing inventory)
• profits are falling if they increase at a lower rate than inflation

Question 8

Solvency

Answer 8

• few liquid assets is bad - don’t have way to easily pay debtors

Question 9

Return on capital

Answer 9

return business makes on capital invested
Compare with:
- other businesses
- amount person would get putting his money in other investment
If return on capital is not good see if net profit can be increased.

Question 10

Net profit percentage

Answer 10

Amount of profit made on each item sold
- increase profit by selling more items or selling items for more money ( reducing expenses or putting up prices)

Question 11

Current ratios

Answer 11

the current assets and liabilities of the company should be at least 1.5:1
- doesn’t consider how easy to turn current assets into cash

Question 12

Acid test/Liquid ratio

Answer 12

only considers liquid assets of company (NOT include stock/WIP)
- 1:1 means business has £1 of liquid asset for every £1 of current liability
- any lower and the business will find it hard to pay its debtors
- if this test has worsened compared to previous ones = business is failing financial difficulty.
- if new machinery purchased with cash may worsen the current ratio but improve profitability.