IGCSE Business Studies: Unit 5 Part 5 - Analysis of Accounts

Introduction

• Focus on analysis of financial statements
• Importance of financial data for assessing business performance

Ratio Analysis

• Method used to analyze accounts
• Key focus: Profitability Ratios

Profitability Ratios

1. Return on Capital Employed (ROCE)

   • Measures net profit in relation to capital invested
   • Capital includes shareholders' equity + non-current liabilities
   • Higher ROCE indicates better profitability

2. Gross Profit Margin (GPM)

   • Calculates gross profit as a percentage of sales
   • Formula: Gross Profit = Sales - Cost of Production
   • Higher GPM indicates better profit on sales

3. Net Profit Margin (NPM)

   • Measures net profit as a percentage of sales
   • Formula: NPM = (Gross Profit - Expenses) / Sales
   • Higher NPM indicates better overall profitability

Liquidity Ratios

• Assess the company’s ability to pay short-term debts
• Key to avoid illiquidity, which may force asset sales

Liquidity Ratios

1. Current Ratio

   • Compares current assets to current liabilities
   • Value above 1 is favorable

2. Liquid Ratio (Acid Test Ratio)

   • Similar to current ratio but excludes inventory
   • Provides a clearer picture of liquid assets available

Uses and Users of Financial Accounts

• Managers

  • Control over product performance
  • Identify high expenses leading to low NPM
  • Improve ratios by managing liabilities

• Shareholders

  • Assess profitability and investment potential
  • Compare with industry standards and previous years

• Creditors

  • Evaluate the company's cash position and debt repayment ability
  • Risk assessment for extending credit

• Banks

  • Assess risk for lending decisions

• Government

  • Determine tax rates and business viability

• Employees/Trade Unions

  • Assess job security based on business performance

• Competing Businesses

  • Analyze performance for potential takeovers or competitive strategy

Limitations of Accounts and Ratio Analysis

• Ratios rely on past data, not predictive of future performance
• External users may only see published accounts, lacking full context
• Historical data comparison can be misleading due to inflation
• Different accounting methods may yield inconsistent ratios across companies

Conclusion

• Importance of understanding financial statements and ratios for various stakeholders
• Awareness of limitations in analyzing financial health

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