KT 16: 3.5.1 Interpretation of Financial Statements, 3.5.2 Ratio Analysis

Question 1

Interpretation of financial statements

Answer 1

there are two key financial statements: the profit and loss account and the balance sheet. The balance sheet shows an organisation’s assets and liabilities at a precise point in time, usually the last day of the accounting year. A profit and loss account shows a firm’s sales revenue over a trading period and all the relevant costs involved in generating that revenue.

Question 2

Corporation tax

Answer 2

a tax levied as a percentage of a business’ profits.

Question 3

Cost of sales

Answer 3

all the costs arising from sales to customers, including raw materials, supplies and packaging.

Question 4

Dividends

Answer 4

regular payments to shareholders as a reward for their investment.

Question 5

Gross profit

Answer 5

revenue less cost of goods sold; profit made on trading activities.

Question 6

Liability

Answer 6

a debt, i.e. a bill that has not been paid or a loan that has not been repaid.

Question 7

Liquidity

Answer 7

a measurement of a firm’s ability to pay its short-term bills.

Question 8

Operating profit

Answer 8

gross profit minus expenses.

Question 9

Prudent

Answer 9

an accounting term meaning cautious (safe).

Question 10

Reserves

Answer 10

a business’ accumulated, retained profit; it forms part of the business’s total equity.

Question 11

Revenue

Answer 11

sales revenue, i.e. the value of sales made; also know as turnover.

Question 12

Ratio analysis

Answer 12

an examination of accounting data by relating one figure to another. This approach allows more meaningful interpretation of the data and the identification of trends.

Question 13

Bad debts

Answer 13

money owed to the business that will never be repaid; perhaps a customer has gone into liquidation.

Question 14

Inter-firm comparison

Answer 14

comparisons of financial performance between firms; to be valuable, these comparison should be with a firm of similar size within the same market.

Question 15

Net realisable value

Answer 15

the price that can be obtained for second-hand stock after deducting the selling costs.

Question 16

Profit quality

Answer 16

this assesses the likelihood of the source of the profit made by a business continuing in the future. High quality profit is usually that which is generated by a firm’s usual trading activities, whereas low quality profit comes from a one-off source.