Business financial record keeping - financial ratio analysis
http://www.business.govt.nz/tools-and-templates/educational-resources/using-financial-records Get familiar with the various financial information and use of this information to run a successful business. Discuss the principles of ratio analysis with the class and the advantages of using it compared with the direct analysis of financial records, citing the different ratios that can be used as key performance indicators. Once the class has been familiarised with the concept, ask them to apply the examples of different ratios shown in the student handout to the financial records for A. King in the student worksheet. For further analysis, go online and find real final accounts and balance sheets they can perform ratio analyses on before reporting back to class on their analysis of that company’s health. If they struggle for ideas, suggest a quick Google search for "McDonald’s balance sheet" or "Telecom annual report". ** Resources - Ratio and KPI performance (for the Business.govt.nz Ratio and KPI Performance interactive tool) http://www.business.govt.nz/tools-and-templates/online-training/finance/ratio-and-kpi-performance - Templates and calculators (for the Business.govt.nz ratio analysis template) http://www.business.govt.nz/tools-and-templates/tools/templates ** Student Handout: USING FINANCIAL RECORDS Businesses use financial information to record cash flow, profit and net worth. Every business needs cash, as opposed to money tied up in assets or investments, to pay the bills. They also need to know they are adding value to the business over time, which is where profit and net worth come into play. CASH FLOW RECORDS Cash flow records show the amount of cash that has gone into and out of a business in a given period, plus how much cash is left. They contain records of cash coming in from sales, interest on savings, interest dividends and sold assets, among other things, and cash flowing out in the shape of costs like wages, merchandising and GST (sales tax). A cash flow record highlights any cash surpluses (extra cash) or deficits (shortage of cash). It becomes particularly useful in helping businesses plan future investments (use of surplus) or head off any impending deficits. FINAL ACCOUNTS Businesses record profit and value (net worth) by preparing a set of Final Accounts. These normally consist of: • A Trading, Profit and Loss Account – an annual account of business performance • A Balance Sheet – an account of the business’s assets and how they are financed TRADING, PROFIT AND LOSS ACCOUNTS are split into two or three sections, depending on the type of business. Trading Account – This shows GROSS PROFIT (funds before cost of sales, such as manufacturing costs). ** Activity Answers Gross profit ratio 60% Net profit ratio 27% Return on capital employed (ROCE) 13.72% Current ratio 19.6 : 1 Acid test ratio 18.1 : 1 Rate of stock turnover 91.25 days Asset turnover $0.50 per
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Business financial record keeping - financial ratio analysis
- 2. Cash flow and Final Accounts Every business needs to record… - Cash Flow - Profit - Net Worth www.business.govt.nz
- 3. Cash Flow Records… Note: -cash going in -cash going out -and the cash left for a given period, such as a month or a year www.business.govt.nz
- 4. Cash in… … (otherwise known as Receipts) can be anything from sales, to interest earned on savings, the return on an investment or cash from selling an asset, such as a car www.business.govt.nz
- 5. Cash out… … Can be anything from accounting and consultancy costs, to general bills, sales tax (GST) and drawings – the owner’s own wage www.business.govt.nz
- 6. Final Accounts Record… -Profit -Net Worth (the business’s value) www.business.govt.nz
- 7. Final Accounts are made up of: • A Trading, Profit and Loss Account • A Balance Sheet www.business.govt.nz
- 8. Trading, Profit and Loss Accounts Show… -Gross Profits (funds before sales costs) -Net Profits (funds after sales costs) www.business.govt.nz
- 9. Balance Sheets Are split into two sections: Net Worth – showing the value of assets after debts Financed By – showing how the assets are paid for www.business.govt.nz
- 10. Ratio Analysis… …Is a method of analysing a company’s performance and health …Gives business owners easily understandable results in percentages or ratios www.business.govt.nz
- 11. The Results… …Are used as Key Performance Indicators (KPIs) to compare business health with previous years or other competitors www.business.govt.nz
- 12. Ratio Analysis primarily focuses on… - Profitability - Liquidity - Efficiency www.business.govt.nz
- 13. Profit Ratios… ...Provide percentage margins - the higher the percentage, the more profit/return on investment is being made www.business.govt.nz
- 14. Liquidity Ratios… …Provide real ratios calculated to analyse changes in the ability to pay debts Two main liquidity ratios are the Current ratio and the Acid Test Ratio www.business.govt.nz
- 15. Efficiency Ratios… …Analyse how well a business uses its assets - the higher the ratio, the more efficient a company is www.business.govt.nz
Editor's Notes
- The first slide establishes the three key elements businesses must track with financial records: Cash flow, Profit and Net Worth. Types of cash flow are outlined in the next slide; profit can be described as any funds left over once all costs are paid and Net Worth is the end value of a business after debts.
- Other examples of cash in include: stock dividends, cash from loans, GST refunds and capital (extra money invested in the business).
- Other examples of cash out can include: merchandising costs, business purchases, PAYE (tax on staff wages) and withdrawn capital (to pay back an investor).
- This slide describes the two goals of a set of final accounts. Many examples for large corporates, such as Telecom, can be found online as part of publicly available annual reports.
- KPIs can include: Return on Capital Employed (ROCE), Gearing Ratios (measuring long-term liabilities for lenders), Profitability Ratios, Liquidity Ratios and even Expenditure on the Environment, and many, many more depending on the group analysing the company. Environmental groups, for example, would primarily use Expenditure on the Environment to measure business ethics.
- Ratio results are shown – depending on the analysis – in a number of different ways, including percentages, days and items sold. ‘Real ratios’ are primarily reserved for liquidity ratios.
- The Current Ratio shows a company’s ability to pay its debts, while the Acid Test Ratio – the most famous ratio analysis – goes further by showing a company’s ability to pay its debts when it can’t sell stocks.