Professional Documents
Culture Documents
Income statement
(revenue statement or profit and loss)
Balance sheet
Snapshot of business at specific point in time.
A = L + OE
Financial ratios
- Liquidity: current ratio (working capital ratio)
Represents ability of a business to meet short term debts
Current assets : current liabilities
Ideal = 2:1
- Gearing: debt to equity
Represents long term viability of business
Total liabilities / owners equity (usually a percentage)
- Profitability: gross profit ratio, net profit ratio, return on equity ratio
Satisfactory level of profitability depends upon industry averages, current
interest rates, historical trends, economic conditions.
GPR: gross profit / sales (percentage)
NPR: net profit / sales (percentage)
ROE: net profit / owners equity
- Efficiency: expense ratio, accounts receivable turnover ratio
Expense ratio: total expenses : sales
A/C receivable turnover: 365 X accounts receivables / sales
Shows on average how long it takes to collect accounts receivables (how
quickly invoices are settled). More efficient = lower average
- Comparative ratio analysis: over different times, against standards, with similar
businesses
To fully understand the profitability, solvency, efficiency and liquidity of a
business, the respective ratios must be compared and analysed. Comparing
ratios is undertaken against the same ratios usually over time periods,
against other businesses within the industry of against common benchmarks
such as industry averages.
Limitations of financial reports
- Normalised earnings, capitalising expenses, valuing assets, timing issues, debt
repayments, notes to the financial statements
Normalised earnings: Earnings being adjusted for cyclical ups and downs in
the economy to remove unusual or one-time influences.
Capitalising expenses: adding a capital expense to the balance sheet that is
regarded as an asset rather than an expense e.g. R&D, development
expenditure.
Valuing assets: assets are valued at historical cost. However this is not
market value. Accountants will depreciate assets over the life of that asset
giving a realistic view of worth and has tax advantages.
Timing issues: Expenses and earnings may be recorded at different times to
that in which they occur in order to massage the accounts to suit the needs
of the business.
Debt repayments: A business needs to make provisions for the repayments
of debts. This is relevant for short term and long term debts.
Notes to the financial statements: Additional information at the end of
financial reports which provide details and a deeper understanding of
Sale and lease back: sale of an owned asset to a lessor and leasing the asset
back through fixed payments for a specified time period.
Profitability management
- Cost controls: fixed and variable, cost centres, expense minimisation
Fixed and variable costs: fixed are costs not dependent upon sales output
(rent). Variables are costs which depend upon sales output (electricity)
Economies of scale can be utilised to lower per unit cost.
Cost centres: individual departments are responsible for their own costs and
aim to lower them as much as they can.
Expense minimisation: measures to reduce expenses.
- Revenue controls
Trying to maximise revenue to increase gross profit.
Marketing (sales) objectives: Setting high but realistic targets for sales and
determining strategies to meet this (e.g. analysis of marketing mix).
Global financial management
- Exchange rates
Exchange rates are ratio of one currency to another. Determined through
foreign exchange market (forex or fx). For exporter, weaker currency is
better as goods will be more desirable to overseas importer.
- Interest rates
Cost of borrowing money. Lower rates overseas can result in businesses
borrowing money from overseas however exchange rate fluctuations make
this very risky.
- Methods of international payment: payment in advance, letter of credit, clean
payment, bill of exchange
Payment in advance: transfer of payment prior to goods being sent. Safest
method for business exporting however can decrease business relationships
with overseas importer.
Letter of credit: Guarantee backed by financial institution that the payment
will be honoured within a certain time up to a specified amount.
Clean payment: All title documents held by parties involved therefore
simple and cost effective. Can be in advance or through an accounts system
where payment is sent but not received before goods are sent.
Bill of exchange: involves exporters bank handling documentation (transfer
of receipts and payment). International banking system offers an established
mechanism for this process.
- Hedging
Risk management strategy aimed to minimise the impact of currency
fluctuation on overseas transactions. A forward contract which fixes the rate
of exchange for goods exported so the business can be sure of the value of
payment. Variations at time of transfer wont affect amount being paid.
- Derivatives
Simple financial instruments that may be used to lessen the risk of currency
fluctuations when exporting. Typically are different types of contracts that
are put together for international transactions.