3.3 balance sheets


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3.3 balance sheets

  1. 1. A2 Unit 3:A2 Unit 3: Strategies for successStrategies for success 3.3 Using financial3.3 Using financial accounts to measureaccounts to measure and assessand assess performanceperformance
  2. 2. Balance sheetsBalance sheets A balance sheet is a ‘photograph’ of the financial position of a business at a particular point in time There are three main sections to a balance sheet: Assets resources a business owns that have financial value current assets are used up in production (raw materials) fixed assets are used again and again (machinery) Liabilities what the business owes to others (its debts) they can be short term (overdrafts) or long term (loans) they are a source of funds Capital the money put into the business by the owners it is another source of funds
  3. 3. Balance sheets balance!Balance sheets balance! A balance sheet must ‘balance’ because an increase in total assets must be funded from somewhere So: Assets = capital + liabilities
  4. 4. Layout of the balance sheetLayout of the balance sheet A typical balance sheet would be laid out as follows. The figures relate to Morrisons supermarket for 2008 and are in £ million Non-current assets 6826 Current assets: Inventories (stock) 451 Receivables (debtors) 191 Cash and cash equivalents 368 Total current assets 1010 Non-current assets are assets with a lifespan of more than one year and include buildings, equipment, vehicles etc Current assets are assets that are likely to be changed into cash within one year. They are liquid assets.
  5. 5. Layout of the balance sheetLayout of the balance sheet Current liabilities Payables (creditors) (2063) Net current assets (working capital) (1063) Non-current liabilities (200) Net assets (net worth) 4417 Capital share capital 2907 reserves and retained earnings 1510 Total equity 4417 Capital employed 5763 Current liabilities are debts that have to be paid within 12 months. They might include money owed to suppliers, dividends, taxation, overdrafts etc Net current assets (working capital) = current assets – current liabilities. This indicates whether a business will be able to pay its day-to- day bills Non-current liabilities are amounts which do not have to be paid for at least 12 months – they are the long term liabilities of the business and include loans, mortgages etc Net assets (net worth) = (total assets – current liabilities) – non-current liabilities It is an indication of how much the business is worth were it to be sold Capital is made up of money put into the business by shareholders (share capital) profit which has been kept in the business rather than given to shareholder (reserves and retained earnings) Capital employed = non-current assets + net current assets
  6. 6. Using the balance sheetUsing the balance sheet The balance sheet is useful to assess performance and potential and allows • analysis of asset structure how money raised has been spent on different assets • analysis of capital structure reliance on different sources of funds • analysis of liquidity position (working capital) can the business pay its everyday expenses? • calculation of the value of the business given by value of net assets
  7. 7. Paired taskPaired task Choose a PLC and find its balance sheet in its latest financial report to shareholders Read pages 73 and 76 – 77 of your textbook to find out about the range of financial ratios that can be used to analyse the financial performance of a business Use what you have learnt in lessons and at least two financial ratios to analyse and comment upon the financial performance / ‘health’ of your chosen PLC Present your findings to the rest of the class using a PowerPoint presentation prepared on your notebook Email your presentation to stephenwalton@kingschester.co.uk
  8. 8. Working capitalWorking capital Working capital is the amount of money needed to pay for the day-to-day trading of a business In the balance sheet it is calculated as • working capital = current assets – current liabilities Struggling businesses are likely to have low levels of working capital Rule of thumb • a typical business will need current assets to be 1.5 to 2 times its current liabilities to operate safely ? why might a supermarket be able to operate with negative working capital ?
  9. 9. The working capital cycleThe working capital cycle Business Suppliers (payables) Products Customers (receivables) Cash drains -dividends -loan repayments -new assets -tax Cash injections -loans -fresh capital -sale of assets Lag! Lag!Lag Lag!
  10. 10. The working capital cycleThe working capital cycle The working capital cycle is commonly calculated as length of working capital cycle = length of time that goods are held + time taken for receivables to be paid - period of credit received from suppliers Calculate the working capital cycle if • goods are held in stock for 14 days • receivables are given 30 days to pay • suppliers give the business 28 days to pay
  11. 11. Importance of working capitalImportance of working capital Too little working capital (current assets too low and current liabilities too high) • production may be interrupted due to shortage of stocks of raw materials • may be unable to pay bills if there is too little cash • may be unable to pay invoices if holds too much trade credit
  12. 12. Importance of working capitalImportance of working capital Too much working capital (current assets too high and current liabilities too low) • may suffer from high storage costs • money is tied up in stock – this could be used to reduce borrowing • cash holdings could be used to earn interest (opportunity cost) or pay off debts • too high payables involves an opportunity cost of lost interest and exposes the business to problems of late payment • estimated to cost £20 billion to UK business
  13. 13. Reasons for working capital problems Poor control of debtors Poor control of debtors Over and under stocking Over and under stocking OvertradingOvertrading OverborrowingOverborrowing Downturn in demandDownturn in demand Seasonal demand Seasonal demand