• Join over 1.2 million students every month
• Accelerate your learning by 29%
• Unlimited access from just £6.99 per month
Page
1. 1
1
2. 2
2
3. 3
3
4. 4
4
5. 5
5
6. 6
6
7. 7
7
8. 8
8
9. 9
9
10. 10
10
11. 11
11
12. 12
12
13. 13
13
14. 14
14
15. 15
15
16. 16
16
17. 17
17
18. 18
18
19. 19
19

# Interpretation of Financial Statements.

Extracts from this document...

Introduction

Nottingham University Business School N111223 FINANCIAL ACCOUNTING Lectures 9 and 10 Workshop 6 Interpretation of Financial Statements Weetman - Chapter 13 (Ratio Analysis) Chapter 14 (Analysis of Corporate Performance) There are three main aids to the analysis of financial statements: HORIZONTAL and TREND ANALYSIS VERTICAL ANALYSIS RATIO ANALYSIS HORIZONTAL and TREND ANALYSIS Horizontal analysis involves a line by line comparison of one set of data with another - for example, the current year's accounts with last year's, or with this year's budget. It is based on the fact that isolated figures are seldom of much use by themselves. Trend analysis is horizontal analysis extended over several years, often indexing the data to express the first set of figures as 100 and later periods related to that base. For example, profit is �10,000,000. Is this good or bad? (a) Profit for the previous 4 years was: �6,000,000 �7,000,000 �8,000,000 �9,000,000 (b) Profit for the previous 4 years was: �14,000,000 �13,000,000 �12,000,000 �11,000,000 (c) Profit for the previous 4 years was: �10,000,000 �10,000,000 �10,000,000 �10,000,000 The comparison shows fairly clearly how the company is doing - but even this can be improved upon. One way is to calculate the percentage increase/decrease from year to year: (a) 16.7% 14% 12.5% 11% (b) -7% -7.7% -8.3% -9% (c) 0% 0% 0% 0% Using indexation: (a) 100 117 133 150 167 (b) 100 93 86 79 71 (c) 100 100 100 100 100 VERTICAL ANALYSIS This technique requires all of the profit and loss account and balance sheet to be expressed as a percentage of critical components (generally total sales and total assets respectively). This is also called common sizing. For example, if debtors are �25 m and total assets are �100m, then debtors represents 25% of total assets. If this is compared with last year's figure of, say, 20%, it can be seen that debtors are increasing in relative importance, and may indicate a worsening credit control situation. ...read more.

Middle

By removing stock from the equation, the acid test ratio highlights the immediate liquidity of the company. Again, not too much alarm must be taken of a low figure, as with a cash business, and rapidly turning over stocks, the situation may not be drastic. As with the current ratio, the quick ratio has no 'ideal' or standard answer. Traditionally a ratio of 1:1 would have been considered highly desirable. In other words all current liabilities could be paid at least from the generation of cash from the quick assets. The ratio is influenced by a variety of factors including the type of business and the nature of the firm's debtors and creditors. Nowadays, operating on the premise that all of a company's current liabilities do not normally have to be paid immediately - a figure of 0.7:1 or even 0.6:1 will not normally cause undue alarm. In a predominantly cash-based business this ratio can fall even lower. An important point to remember is that these liquidity ratios vary tremendously between industries, depending on the nature of the business. It is important therefore not just to consider the company in isolation, but to compare it with other companies occupied in similar activities. EFFICIENCY RATIOS Traditional financial statements do not tell us how efficiently the Company has been managed - i.e. how well its resources have been looked after and utilised. While profitability gives some indication, accounting profit is subject to so many arbitrary adjustments that it is somewhat less than reliable. Efficiency ratios primarily examine how productively companies utilise assets but they can also include creditors and other business aspects. Efficiency ratios can be calculated from any financial information relating to the company. But it is crucial to remember that whatever efficiency ratios are calculated, they must be relevant and meaningful. Stock Turnover (cost of sales /average stock) The stock turnover ratio is important in the measuring of the length of time that the firm has, on average, stock in its warehouse. ...read more.

Conclusion

In these circumstances the company would hope that maintaining a dividend of �4m would be sending a positive message about its future prospects. It is important to remember that dividends represent only a part of the shareholders' return. Any profits not distributed (retained in the business) should increase the size of the business and therefore lead to enhanced profits in future years. Another factor to be considered in the dividend decision is the availability of cash. If all the assets of the business are tied up in buildings, stock, debtors, etc. then it may be necessary to borrow in order to find the cash to pay shareholders - another cost. LIMITATIONS OF RATIO ANALYSIS It must be emphasised again that ratios are merely an indication or pointer. They can highlight particularly favourable or adverse figures in a business. By themselves ratios are not definitive or absolute statements. Ratios form a basis for further investigation and research. They must not form the sole foundation or only criteria for decision-making. The ratios must be treated with a considerable degree of caution and apprehension. The user / analyst frequently requires forecast information that has predictive value, but most information obtained from the financial statements is historical in nature. Information from financial statements is often in summarised form and details regarded by the company as confidential will not be published. Furthermore the underlying statistical assumptions applied in ratio analysis may not be valid. Assumptions may be made that ratios are normally distributed for companies within a particular sector or that the ratio is proportional for all sizes of companies and has a zero intercept. The analysis may be particularly prone to error if these assumptions are applied to companies with unusual absolute values applied in ratio analysis; e.g. computing ROCE for a company with a very small total of capital or net assets in its balance sheet. Nevertheless, provided the ratios are used with a discriminate application, they can provide a useful analytical tool and act as a starting point to conduct further investigation into a business. 1 ...read more.

The above preview is unformatted text

This student written piece of work is one of many that can be found in our AS and A Level Structures, Objectives & External Influences section.

## Found what you're looking for?

• Start learning 29% faster today
• 150,000+ documents available
• Just £6.99 a month

Not the one? Search for your essay title...
• Join over 1.2 million students every month
• Accelerate your learning by 29%
• Unlimited access from just £6.99 per month

# Related AS and A Level Structures, Objectives & External Influences essays

1. ## Marketing Management - Swisher Mower and Machine Company.

5 star(s)

The private proposal would offer stable orders to SMC. * SMC could fully utilize its currently idle production capacity. Without acceptance of this private label proposal, the idle manufacturing capacity is 5,800 units per annum, more than 50% of total capacity. The high opportunity cost incurred could not be neglected.

2. ## ASDA's Ownership

4 star(s)

their customers views and opinions and also the views and opinions of employees. These two stakeholders have the biggest influence on the businesses. (iii) ASDA and Wines Plus have responded to the stakeholder's interests by, issuing questioners and ask them regular questions about their shopping trip.

1. ## The Business Environment Coursework. Describe the type of business, purpose and ownership of ...

American banks in particular lent money to people for home mortgages that proved unable to repay their obligations. These loans were often repackaged and sold onto other banks, many of which still do not know what they are worth. As a result, banks are unwilling to lend even to each

2. ## Describe the legal and financial aspects that will affect your business start-up.

The most important legal provisions are: * The business must provide secure and safe working environment * All employee must receive written contract within two months of starting work * All employees have the right to the national minimum wage * The business has to deduct the income tax and

1. ## For my portfolio, I was asked to do an assignment on two businesses. I ...

Tesco plc is a United Kingdom - based global supermarket chain with annual revenues of �20 billion. Tesco is also the world's most successful and profitable online grocer Tesco is the number one retailer in the United Kingdom with 1982stores.

2. ## Btec National Business Level 3 Year 1 - Exploring Business Activity

what they are searching or looking in the future, marketing and design work together to agree new goods. Yes Yes Procurement In procurement it is necessary to develop lists of suppliers on a database. Procurement is vital. It is concerned with getting important resources such as raw materials and office supplies to keep the business running smoothly.

1. ## Investigating Business. Tesco PLC. I will be describing the aims and objectives of ...

This contributes to the success of Tesco?s in achieving their objective ?To be as strong in everything we sell as we are in food?, because when Tesco?s sells their products they obviously need to make profits, if they are producing products that cost?s less than the price to make the

2. ## Political, legal and social factors impact on businesses The two businesses I will compare ...

written statement of the conditions within two months of the date the job starts. Easy jet is subject to numerous technical directives and regulations as well as legislation or a more legal nature. The legislation covers areas such as competition law, intellectual property law, consumer protection and taxation, and emissions (air quality and fuels from air craft).

• Over 160,000 pieces
of student written work
• Annotated by
experienced teachers
• Ideas and feedback to