Survey
* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
Rate of return wikipedia , lookup
Investment fund wikipedia , lookup
Internal rate of return wikipedia , lookup
Modified Dietz method wikipedia , lookup
Investment management wikipedia , lookup
Stock trader wikipedia , lookup
Global saving glut wikipedia , lookup
Short (finance) wikipedia , lookup
Public finance wikipedia , lookup
Reporting on Accounts This topic is known also as Assessing the Business and is only for the Higher Level students. The final accounts are examined in detail to identify the strengths, weaknesses and trends of the business using ratios (Calculations). Summary of main points of information provided by the final accounts for a given year: Turnover (Net Sales), Cost of sales, Gross Profit, Net profit or loss, Appropriation of net profit, Dividends paid to shareholders. The following are the main groups of people who would be interested in finding out information about the performance of a firm. These groups of people will examine the accounts and the ratios for their own reason: 1. Management They are looking at the firms performance. They identify any changes good or bad since last year e.g. sales, increased costs 2. Shareholders Has the company made a big profit Will they receive a good dividend? Should they sell their shares now? 3. Bank Will loans be repaid? Is it safe to lend to this business? 4. Creditors Will our money be repaid? If so, when? Should we give any more credit? 5. Workers Are their jobs secure? Is a pay rise possible? Is the business expanding? 6. Potential Investors Is this firm a worthwhile investment? E.g. A good return? Limitations of the Final Accounts in Assessing a Business The final accounts and balance sheet give a certain amount of information about the performance of a company but this information is limited in that it does not take into account certain factors Future changes in fashion, which may make the firm’s products unattractive A change in the exchange rates, which makes materials or goods more expensive Industrial relations problems in the firm, which may lead to a loss of production due to strikes The figures for the fixed assets in the balance sheet may not be correct. They may be over or under-valued Future changes in the economy, for example higher inflation or interest rates Some important staff members may leave the firm Because the information from the final accounts and balance sheet is limited, it is necessary to use ratios to analyse the information and compare the information with the accounts and balance sheet of other years and other companies. Ratios Ratios are used to extract precise information from the final accounts to identify the strengths, weaknesses and trends of the business. In examining the accounts and calculating ratios, we will look at four main areas: 1. Profitability 2. Solvency 3. Activity 4. Liquidity Profitability Ratio’s The aim of profitability ratio is to see if the company is getting a good return on its sales and investment. People get involved in business to make a profit. The following ratios are used to examine the profitability of the business: Gross Profit Margin (Gross profit percentage) This shows the rate of profit made on sales before selling expenses are deducted. It should normally be the same but may drop due to: (a) Increases in cost of sales- goods stolen, damaged or destroyed (b) Goods being sold off cheaply Gross Profit X Sales 100 1 Example Sales: €600,000 Gross Profit: €420,000 Calculate the gross margin. Name of Ratio Formula Workings Answer Gross Margin Gross Profit x 100% €420,000 x 100% 70% Sales €600,000 The business made 70% gross profit (before expenses) on everything it sold. Net Margin (Net profit percentage) This shows the rate of profit made on sales after allowing for all the expenses and gains of a company. The higher the percentage, the lower the net margin. Expenses may rise due to: (a) Increased overtime (b) Higher charges for electricity, telephone, advertising Net Profit X Sales 100 1 Example Sales: €600,000 Net Profit: €180,000 Calculate the net margin. Name of Ratio Net Margin Formula Net Profit x 100% Sales Workings Answer €180,000 x 100% 30% €600,000 The business made 30% net profit on everything it sold i.e. after all expenses were paid Return on Investment (Return on capital employed percentage) The return on investment (ROI) shows the return obtained on the total amount of money invested (shares, reserves and long term liabilities). It should be greater than the cost of the long-term loan and greater than what a bank deposit account will give. Net Profit X 100 Capital employed 1 Example Net Profit: €180,000 Capital Employed: €900,000 Calculate the Return on Investment. Name of Ratio Formula Workings Answer Net Profit Net Profit x 100% €180,000 x 100% 20% Capital Employed €900,000 This ratio shows the business and the shareholders how much the business is making on the investment. The answer can be compared with other investments e.g. bank interest rates to see if it is making a worthwhile return. Liquidity Ratio’s Current Ratio Current Assets: Current Liabilities Example: €60,000 : €30,000 = 2:1 Ideal ratio is 2:1. If the ratio is too high – Might suggest that too much of its assets are tied up in unproductive activities – too much stock, for example. Too low - risk of not being able to pay your way. Acid Test (Quick Ratio) Current Assets-Closing Stock : Current Liabilities The omission of closing stock gives an indication of the cash the firm has to pay its debts. Example: €60,000-€15,000 (closing stock) : €30,000 = 1.5:1 Ideal Ratio is 1:1. A ratio of 3:1 therefore would suggest the firm has 3 times as much cash as it owes – very healthy. A ratio of 0.5:1 would suggest the firm has twice as many liabilities as it has cash to pay for those liabilities. This might put the firm under pressure but is not in itself the end of the world. Solvency Ratio A business is solvent if its total assets are greater than its external debt. Example: Fixed Assets = €160,000 Current Liabilities = Current Assets = €60,000 Long-term loans = Total Assets = €220,000 External Debt = €75,000 €100,000 €175,000 This business is solvent as its total assets are greater than its external liabilities by €45,000. The opposite of being solvent is ‘insolvent’ when the business owes more than it can afford to repay. Activity Ratio’s Stock Turnover Example: Opening Stock: €12,000 Closing Stock: €18,000 Cost of Goods Sold: €120,000 Name of ratio Formula Workings Stock Turnover Cost of Goods Sold Average Stock = Average Stock €12,000 + €18,000/2 = €15,000 (Opening +Closing /2) Stock Turnover = €120,000/€15,000 Answer 8 times This ratio shows the number of times a year that a business will sell its average stock. A high stock turnover might mean increased efficiency? But this is dependent on the type of business, i.e., supermarkets might have high stock turnover ratios whereas a shop selling high value musical instruments might have low stock turnover ratio. Creditors Payment (Creditor Days) Example: Creditors = €13,000 Purchases = €120,000 Name of Ratio Formula Workings Answer Creditors Payment Creditors x 365 €13,000 x 365 39.5 days Purchases €120,000 This ratio shows how long on average the business takes to pay its debts. Debtors Payment (Debtor Days) Example: Debtors = €20,000 Sales = €200,000 Name of Ratio Formula Workings Answer Debtors Payment Debtors x 365 €20,000 x 365 36.5 days Sales €200,000 This ratio shows how long on average the firm takes to recover its debts. The business should always be paid by its debtors quicker than the business has to pay its own creditors. This will help to prevent cash shortages, i.e., liquidity problems. Report When an accountant is asked to assess a business, he/she examines the accounts, prepares ratios and looks at all the financial dealings. Then he/she writes a report based on the results. The report will highlight the information required by those for whom the report was written. Students should revise the Business Letter chapter for the correct layout of a Report.