Interpreting Financial Statements 1

Question 1

what does it mean to interpret a financial statement

Answer 1

evaluate financial information and make judgement about issues such as profitability, efficiency, liquidity, gearing, cashflow

Question 2

what are the different users of the financial statement

Answer 2

shareholders, debt providers, customers, suppliers, competitors, governments

Question 3

what different questions are being asked of the financial statement

Answer 3

will they go bankrupt, where will they be in a number of years time, is it a good investment/loan, how does the company benefit society

Question 4

what does CORE analysis stand for

Answer 4

context, overview, ratios, evaluation

Question 5

why do we use ratios

Answer 5

ratios help with comparisons between different sized businesses
they give a relative measure

Question 6

what might profit be compared to to assess performance

Answer 6

size of business, capital investment, revenue

Question 7

how might we interpret a result as being good or bad

Answer 7

comparing creates meaning
compare with same ratio from the past, the budgeted or planned ratio, similar businesses, industry averages

Question 8

what five categories of ratio might be considered the most meaningful

Answer 8

profitability, efficiency, liquidity, financial structure, investment

Question 9

what does a profitability ratio tell us

Answer 9

what return is being made from capital and assets
what profit to use

Question 10

what does an efficiency ratio tell us

Answer 10

is the business making efficient use of resources

Question 11

what does a liquidity ratio tell us

Answer 11

is there enough short term cash and can current obligations be met

Question 12

what does a financial structure ratio tell us

Answer 12

is the company financed by debt or equity and how risky is the financing

Question 13

what does an investment ratio tell us

Answer 13

what return is available to the shareholders and what is the investor confidence

Question 14

operating profit

Answer 14

profit before interest and tax (PbIT)

Question 15

capital employed (equation)

Answer 15

non-current assets + current assets - current liabilities = share capital + reserves + non current liabilities

Question 16

name the four profitability ratios

Answer 16

return on capital employed (RoCE), operating profit margin, asset turnover, gross profit margin

Question 17

what is the return on capital employed ratio

Answer 17

(PbIT/share capital + reserves + long term loans) x 100%

Question 18

what is the operating profit margin ratio

Answer 18

(PbIT/revenue) x 100%

Question 19

what is the asset turnover ratio

Answer 19

revenue/(share capital + reserves + long term loans) times (x 100% usually omitted)

Question 20

what is the gross profit margin ratio

Answer 20

gross profit/revenue x 100%

Question 21

what is the meaning of the gross profit margin

Answer 21

expressing the gross profit as a percentage of revenue
for every £1 of revenue how much was remaining as gross profit
how well have you controlled cost of sales

Question 22

what is the meaning of the return on capital employed

Answer 22

the profit before interest and tax as a percentage of capital employed

Question 23

why is PbIT used

Answer 23

it is the profit earned to pay providers of finance
it is the profit which the managers have the most control over

Question 24

what is the meaning of the operating profit margin

Answer 24

operating profit as a percentage of revenue
for every £1 of revenue how much was operating profit

Question 25

what is the meaning of the asset turnover ratio

Answer 25

really an efficiency ratio revenue as a percentage of capital employed how many times was revenue turned over in assets

Question 26

what is another way to think of the return on capital employed

Answer 26

operating profit margin x asset turnover

Question 27

what would an increase in return on capital employed be the result of

Answer 27

increase in operating profit margin and increase in asset turnover

Question 28

what problems are associated with the return on capital employed ratio

Answer 28

the method of calculation can vary, what is considered capital employed, which profits to use are the assets being valued at current prices capital investment often results in low returns in the early years so long term projects can distort short term RoCE

Question 29

what would be the effect of a lower net book value

Answer 29

higher RoCE

Question 30

what would happen if the assets are undervalued

Answer 30

the RoCE may be misleadingly high

Question 31

name the three efficiency ratios

Answer 31

inventory turnover, receivables collection, payables payment

Question 32

what is the inventory turnover ratio

Answer 32

inventory/cost of sales (per day) (days)

Question 33

what is the receivables collection ratio

Answer 33

trade receivables/credit sales (per day) (days)

Question 34

what is the payables payment ratio

Answer 34

trade payables/cost of sales (per day) (days)

Question 35

how do the three efficiency ratios relate to the working capital cycle

Answer 35

WCC = inventory + receivables - payables (days)

Question 36

what is the meaning of the inventory turnover period ratio

Answer 36

measuring the efficiency of stock it is the average number of days that inventory is held based only on the year end balance sheet data

Question 37

in general do you prefer a higher or lower inventory turnover

Answer 37

lower

Question 38

what is the meaning of the receivables collection (debtors) ratio

Answer 38

efficiency of debtors how long credit customers take to pay their bills (on average) could be distorted by one slow paying customer with large credit

Question 39

what is the meaning of the payables payment ratio

Answer 39

efficiency of creditors how long it takes to pay suppliers (on average) can be distorted by slow payment to one large supplier

Question 40

what is the meaning of the working capital cycle

Answer 40

measure of the difference between payments made to suppliers and cash received from customers should be as short as possible to reduce the amount of short term capital required to operate

Question 41

why might inventory days have decreased

Answer 41

efficient control and faster selling

Question 42

why might receivables days have increased

Answer 42

customers are paying slower, may be deliberate to increase revenue

Question 43

why might payables days increase

Answer 43

short of cash, could harm supplier relationships

Question 44

name the two liquidity ratios

Answer 44

current ratio and acid-test ratio

Question 45

what is the current ratio

Answer 45

current assets/current liabilities (times)

Question 46

what is the acid test (quick) ratio

Answer 46

(current assets - inventory)/current liabilities (times)

Question 47

what is liquidity

Answer 47

the ability to meet short term obligations when they are due

Question 48

is there an ideal size for the current ratio

Answer 48

generally the higher the current ratio, the more liquid it is cause for concern might be a decreasing current ratio if CA

Question 49

what is the meaning of the acid test ratio

Answer 49

more stringent assessment of the liquidity because inventory is the least liquid asset can current liabilities be covered without having to sell inventories <1 have to sell inventories to meet current liabilities

Question 50

why might the WC balances not be representative of the liquidity during the year

Answer 50

unexpected events, seasonal business, management manipulation