The 'Statement of Comprehensive Income' or 'Income Statement'
Stakeholder interest in the 'Statement of comprehensive income':
Shareholders.
As a shareholder what would you be looking for in this Income Statement?
Managers and Directors will set themselves targets?
What numbers would you want to grow year on year if you were a company director?
Employees would be looking at profit figures, particularly if they are looking for a pay rise.
Before offering trade credit a supplier may want to see evidence of the past trading history of the business.
The government:
By law a business must provide HMRC with a copy of its statement of comprehensive income.
Why?
The 'Statement of Financial Position' or 'Balance Sheet'
Stakeholder interest in the 'statement of financial position' or 'balance sheet'.
Shareholders will analyse the asset structure of the business.
Shareholders will also be interested in the capital structure of the business - i.e. the different sources of funds.
Shareholders will also be interested to make sure the business is 'solvent' (has enough liquid assets to pay its bills) and definitely not 'insolvent'.
Managers and Directors will also review the amount of working capital in the business.
They will also want to review the capital structure of the business if they were seeking new funds.
Suppliers and creditors will be interested in the liquidity of the business.
Why?
They don't want the business to fail before they are due to be paid.
You also need to be aware of Working Capital.
Working capital is the amount of money needed to pay for the day to day trading activities of a business.
A business needs working capital to:
Pay wages.
Pay rent and business rates.
Pay suppliers.
The working capital of a business is the amount left over after all current debts have been paid.
Working capital (£s) = Current assets (£s) minus Current liabilities (£s)
Managing working capital:
Different businesses have different working capital needs.
Larger businesses are likely to have high levels of working capital.
Retailers are going to require higher working capital compared to businesses that do not have much stock.
The typical business needs around twice the amount of current assets to current liabilities to operate safely.
This means its current ratio is close to 2:1.
Maintaining adequate levels of working capital:
If working capital is too little the business will start to encounter problems.
If a business does not have enough stock then manufacturing or sales will stop.
A business is solvent if it can meet its short-term debts when they are due for payment.
To do this it needs adequate working capital.
Working capital is the amount of money needed to pay for the day to day trading activities of a business.
A business needs working capital to:
Pay wages.
Pay rent and business rates.
Pay suppliers.
The working capital of a business is the amount left over after all current debts have been paid.
Working capital (£s) = Current assets (£s) minus Current liabilities (£s)
Managing working capital:
Different businesses have different working capital needs.
Larger businesses are likely to have high levels of working capital.
Retailers are going to require higher working capital compared to businesses that do not have much stock.
The typical business needs around twice the amount of current assets to current liabilities to operate safely.
This means its current ratio is close to 2:1.
Maintaining adequate levels of working capital:
If working capital is too little the business will start to encounter problems.
If a business does not have enough stock then manufacturing or sales will stop.
If there is not enough cash in the business, it might not be able to pay bills on time.
A business is solvent if it can meet its short-term debts when they are due for payment.
To do this it needs adequate working capital.
On the other hand, a business does not want too much working capital (i.e. current assets are too high and current liabilities are too low.)
Why?
Stocks are costly to keep.
Too much cash is unlikely to be earning high rates of interest and should be being used for more productive purposes.
Ways to improve liquidity:
Liquidity problems can be prevented by keeping a tight control on financial resources.
The use of budgets and cash flow forecasts will improve the financial management of the business.
If a business runs short of cash:
2. Negotiate additional short or long term loans.
3. Encourage cash sales and sell off stocks.
4. Sale and leaseback. An example here.
5. Only make essential payments.
6. Extend credit with selected suppliers.
7. Reduce personal drawings from the business.
8. Introduce fresh capital into the business.
Liquidity ratios:
1. Current Ratio
1. Current Ratio
Formula:
Current assets
Current liabilities Result x:1
A result of 2:1 suggests a business should not have any immediate liquidity problems.
2. Acid Test Ratio
Formula:
Current assets minus stock
Current liabilities Result x:1
A result of 1:1 suggests a business should be able to cover short term debts.
Profitability
1. Gross Profit Margin
2. Operating Profit Margin
3. Profit for the year (net profit) margin
Assessing the value and limitations of ratio analysis. Details here.
