The document discusses how to analyze balance sheets and income statements to understand a business's financial objectives and performance, examining assets, liabilities, revenues, expenses, profits, and using financial data for comparisons over time and between businesses. It also notes some strengths and limitations of relying solely on financial statements to judge a business.

1. Understanding financial
objectives

2. Key terms
Can you match the key word to the correct definition?
Key word Definition
Assets raw materials and other items necessary
to production to take place. They also
include finished products that have not
been sold
Capital measures the ability of a business to meet
its short term debts
Creditors cash the business has for its day to day
running
Inventories represent money owed by a business
Liquidity people or organisations to which a
business owes money
Working capital money invested into the business and is
used to purchased assets
Liabilities items owned by a business

3. We will examine
• How to analyse balance sheets
• How to analyse income statements
• How to use financial data for comparisons,
trend analysis and decision making
• The strengths and weaknesses of financial
data in judging a businesses performance

4. A balance sheet is a
financial statement
What is a
recording the assets and
liabilities od a business on
balance sheet?
a particular day at the end
of and accounting period

5. A BALANCE SHEET
SHOULD ALWAYS
BALANCE!

6. Balance sheet relationships
1. ASSETS=LIABILITIES
2. TOTAL ASSETS = CURRENT ASSETS+ NON
CURRENT ASSETS
3. LIABILITIES= SHARE CAPITAL+ BORROWINGS
+RESERVES

7. Balance sheets are an essential source of
information for a variety of business decisions
and for a number of stakeholders;
• Shareholders
• Suppliers
• Managers

8. Assets
1. First classification
• Non-current assets (e.g. land, property)
• Current assets (e.g. cash, inventories)
2. Second classification
• Tangible assets (e.g. machinery, equipment)
• Intangible assets (e.g. goodwill, brands)

9. Liabilities
• Current liabilities (e.g. overdraft, tax due)
• Non-current liabilities (e.g. bank
loan, mortgages)
• Total equity (shareholders’ funds)

10. Structure of a Balance sheet
Name of the business and date
Assets
Liabilities
Financed by

11. Structure of the balance sheet
Marks and Spencer’s consolidated balance sheet as at 31st March 2008
2008
£m
In-tangible non-current assets 305.5
Tangible non-current assets 5673.8
Inventories 488.9
Receivables and cash 692.8
Total assets 7167.0
Current liabilities (1988.9)
Net current liabilities (807.2)
Non-current liabilities (3208.1)
Total liabilities (5191.0)
Net assets 1964.0
Share capital 628.0
Reserves and retained earnings 1336.0
Total equity 1964.0

12. Interpreting the balance sheet
Managers , potential investors and accountants
can gain a great deal of information about a
company from reading its balance sheet
It is possible to assess the short-term financial
positions of the business and its longer-term
financial strategy

13. Short term
• Ability to pay bills
• Shows the businesses short term debts (current
liabilities) and also the current assets it has to pay
these debts (creditors)
• This is known as the working capital (current assets-
current liabilities)
• If a business has more current assets than current
liabilities it has a positive figure
• If it has more current liabilities than current assets it
has a negative figure-this causes liquidity problems

14. Long term
• Movement of non-current (fixed) assets-
increase in non-current assets indicates a
rapidly growing company
• Where capital has come from- borrowing
money can be risky
• Reserves- indication of business profits

15. Working capital
Working capital Current Assets Current
Essential for the day to Cash at the bank, trade
LESS Liabilities
day running of the = and other receivables, Debts, trade and other
business inventories payables, tax due
• Measures the amount of money available to a
business to pay its day to day expenses
• Working capital is what remains of a
business’s liquid assets once it has settled all
its immediate debts

16. Too much WC
• Holding excessive amounts of WC is not wise
• Liquid assets e.g. cash has little or no return
for the business
• A well managed business will hold sufficient
liquid assets to meet its need for WC
Factors influencing the amount of WC
• Volume of sales
• Amount of trade credit offered
• If the firm is expanding
• Length of the operating cycle
• Rate of inflation

17. Causes of WC problems
• External changes
• Poor credit control
• Internal problems
• Financial mismanagement

18. How important is WC?
• WC can be described as the ‘lifeblood’ of a
successful enterprise
• If a business becomes insolvent it will be
forced to close down
WC is important for;
1. Small businesses
2. Businesses wishing to expand
3. Businesses with a long working cycle

19. Depreciation
The reduction of the value of an asset over a
period of time
Year Value of asset on Amount
Balance Sheet at depreciated
end of year (£) annually (£)
2008 60000 20000
2009 40000 20000
2010 20000 20000
2011 0 20000
Depreciation of brewing equipment in ‘The Norfolk Ale Company’

20. Why do firms depreciate assets?
Firms need to spread the cost of an asset over its useful
life
Depreciating assets ensures the value of the business is
relatively accurate
It allows firms to calculate the true cost of production
Resale value declines for a number of reasons;
• Wear and tear
• Availability of modern equipment
• Poor maintenance

21. Depreciation: A non-cash expense
• It is an expense or a cost that is recorded on
the income statement
• However, it is not a cash expense- it doesn’t
require the business to make any cash
payment

22. Effects of depreciation
Too much Too little
Balance sheet Value of the business will be Will give a false impression
understated of the company’s worth
Income statements Expenses are over Reduces expense incurred
estimated, reducing the by the business, this will
level of profits over estimate profit
Wider effects Business may look May make the company
unattractive to possible look more attractive to
investors. Tax liability on possible investors but will
profits which HMRC might also increase its tax liability
investigate. Business may
record a surplus when the
asset is sold

23. Income Statements
An accounting statement showing
a firms REVENUE over a trading
period and all the relevant COSTS
generated to earn that revenue

24. Key phrases
A LOSS is a situation where a business’s
expenditure exceeds its revenue over a specific
trading period.
PROFIT can be defined in a number of ways, but
is essentially the surplus of revenue over costs.

25. What is profit?
1. Gross Profit- calculated by deducting direct costs
from a business’s sales revenue. It gives a broad
indication of a company’s performance without
taking into account costs such as overheads
(indirect costs).
2. Net profit- a further refinement of the concept of
profit and is revenue less direct costs and indirect
costs. It gives a better indication of the performance
of a business.

26. Quality of profit
• Firms regard profit that is likely to continue onto the
future as high quality profit e.g. a successful new
product
• Selling off an asset may add to a company’s overall net
profit, however will not continue into the future- this is
known as low quality profit
• The amount of trading or operating profit earned is
more likely to represent high quality profit
• Shareholders are interested in the quality of profit as it
gives an indication of the company’s potential to pay its
dividends

27. Structure of an income statement
Name of business
Revenue
LESS direct costs Usually referred to as COGS
Gross Profit
LESS indirect costs
Operating profit An indicator of a firms performance
PLUS financing costs
Net profit before tax Profit on which the Inland Revenue
bases its tax calculations
LESS corporation tax
Net profit after tax Important form of tax as the firm
can decide what to do with this

28. Income statements and PLCs
• PLCs are required by law to publish their accounts
Group Income statements
• In The last 25years many companies have been taken over by others to
form groups. Each company within such a group retains a separate legal
identity. But the group is also legally obliged to produce a group income
statement (and balance sheet)
Income statements and the law
• The legal requirements relating to income statements are set out in the
Companies Act 2006. (see book pg 26-27)

29. Interpreting Income Statements
Managers Shareholders
• Cost of sales • Operating
and expenses and net
• Turnover and profits
operating profit • Turnover
• One-off items • Retained
profit
Income • dividends
Statements
Employees
• Expenses(especially HM Revenue and
wage costs) Customs
• Profits after tax • Net profit
• Retained profits v before tax
dividends • Depreciation

30. Financial data for comparisons, trend
analysis and decision-making pg28-29
Balance sheets
• The business’s working capital position
• The extent of the business’s long term debts
Income statements
• Trends
• The period to which the income statement relates
• Comparing gross and net profit
• The Business(es) to which the income statement relates

31. Strengths and weaknesses of financial
data in judging performance
• Window dressing
• Financial statement is a historical document- not
necessarily a good indication of what will happen in
the future
Balance sheet Income statement
Provides a measure of the value/worth of a Offers valuable information to
business stakeholders- it indicates growth
Shows sources of capital used by a Provides details of costs
business
Shows net profit (interested stakeholders)
Shows if the business has used expensive
sources of capital
Illustrates cash/liquidity

32. Limitations of financial data
• Quality of leadership is not shown by financial
data
• What is the position of the business in the
market?
• What about the motivation and performance
of the workforce?