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Accounting U2..

Unit 2 - Evaluating Performance and ICT ch17-18

QuestionAnswer
Analysing examining the financial reports in detail to identify changes or differences in performance.
Interpreting Examining the relationships between items in financial reports in order to explain the cause and effect of changes or differences in performance.
Profitability the ability of the business to earn profit, as compared against a base such as sales, assets or Owner's Equity
Liquidity the ability of the business to meet its short term debts as they fall due
efficiency the ability of the business to manage its assets and liabilities
stability the ability of the business to meet its debts and continue its operations in the long term
trend the pattern formed by changes in an item over a number of periods
variance the difference between an actual figure and a budgeted figure, expressed as 'favourable' or 'unfavourable'
benchmark an acceptable standard against which the firm's actual performance can be assessed
financial indicator a measure that expresses business performance in terms of the relationship between two different elements of that performance
3 benchmarks: same business over different reporting periods______budget_____similar business over time/industry standards
ROI (return on owners investment) a profitability indicator that assesses how effectively a business has used the owner's capital to earn profit
ROI formula Net Profit/ Av Capital x100
Gearing the extent to which the business relies on borrowed funds to finance the purchase of its assets
Debt Ratio measures the proportion of the firm’s assets that are funded by external sources
DR Formula Total Liabilities/Total Assets X100
ROA (Return on Assets) a profitability indicator that assesses how effectively a business has used its assets to earn profit
ROA formula Net Profit/Av Total Assets X100
ATO (asset turnover) an efficiency indicator that assesses how productively a business has used its assists to earn revenue
ATO formula Sales/ av Total Assets
Expense Control the firm’s ability to manage its expenses so that they either decrease, or in the case of variable expenses, increase no faster than sales revenue
NPM (net profit Margin) a profitability indicator that assesses expense control by calculating the percentage of sales revenue that is retained as Net Profit
NPM formula Net Profit/ Sales Rev X100
GPM (Gross Profit Margin) a profitability indicator which assesses the average mark-up by calculating the percentage of sales revenue that is retained as Gross Profit
GPM formula Gross Profit/Sales Rev X100
Vertical Analysis a report which expresses every item as a percentage of a base figure (in this case, sales revenue)
Cash Budget an accounting report that predicts future cash receipts and payments, determines the expected cash surplus or deficit, and thus estimates the cash balance at the end of the budget period
WCR (working capital ratio) a liquidity indicator that assesses the firm’s ability to meet its short-term debts as they fall due by measuring the ratio of current assets to current liabilities
WCR formula CA/CL
QAR (quick asset ratio) a liquidity indicator that assesses the firm’s ability to meet its immediate debts by measuring the ratio of quick assets to quick liabilities
QAR formula Current assets (excluding stock and prepaid expenses) //////Current liabilities (excluding bank overdraft)
STO (Stock Turnover) an efficiency indicator that measures the average number of days it takes for a business to convert its stock into sales
STO formula AV Stock //// COGS X365
DTO (debtors turnover) an efficiency indicator that measures the average number of days it takes for a business to collect cash from its debtors
DTO formula Av Debtors///Credit Sales X365
CTO (creditors turnover) an efficiency indicator that measures the average number of days it takes for a business to pay its creditors
CTO formula AV creditors///Credit Purchases x365
non-financial info any information that cannot be found in the financial statements, and is not expressed in dollars and cents, or reliant on dollars and cents for its calculation
diff between analysing and interpreting analysing identifies changes/differences in performance, interpreting involves examining reports in order to explain the cause and effect of those changes.
profitability indicators: ROI, ROA, ATO, NPM, GPM
liquidity indicators: WCR, QAR (and STO and DTO and CTO have effect on liquidity)
ability to earn profit is dependent on 2 Basic Factors: ability to earn rev ________control expenses
assessing business performance, evaluate profitability not profit: Profitability is the ability to generate profit with the assets it has. Assessing profitability assesses the firm's capability/ability to earn profit taking into account: firm size, size of O.E and lvl of sales compared to diff periods and similar firms.
ROI will always be higher than ROA? Assets will always be higher then O.E
summary of ATO, NPM and ROA ATO and ROA assess ability to use assets, ROA relates to profit, ATO-revenue. higher ATO means more sales rev per $ of asset should mean increase in ROA more net profit per $. NPM measures expense control.
Relationship between ATO, NPM and ROA ROA depends on firms ability earn rev (as measured by ATO) and control expenses ( measured by NPM)
2 reasons some expenses increase in pursuit of profit: some must increase as sales increase e.g. COS, wages __________ some increase to generate sales e.g. ads
2 ways to increase average mark up: lower cost price (buy in bulk...cheaper wholesaler , but make sure quality is not inferior) _______ higher selling price
Why may an increase in mark-up could actually lead to a decrease in Gross Profit? By increasing the s.p, mark-up will also increase. however, it runs the risk of lowering demand, and thus reducing the volume of sales. If the drop in demand outweighs the increase in the s.p, then Gross Profit in dollar terms will actually fall.
If Predicted Cash Deficit Owner could arrange: defer purchase of NCA___reduce cash drawings___organise/extend overdraft___defer loan repayments___make capital contribution
If Predicted Cash Surplus Owner could arrange: purchase more/newer NCA___increase loan repayments and cash drawings___expand trading facilities (employ more staff..ads)
if WCR is too high DO: use cash to repay debts ___ expand business___increase drawings or loan repayments trading facilities___allow stock levels to drop before reordering____contact debtors for debts outstanding
WCR may be too high because: large cash at bank could be invested for greater return___extensive debtors mean ageing debts could go bad___extensive stock lead to increase theft, damage or storage costs.
If WCR is too low DO: make cap contribution___seek additional finance___take out a bank loan for purchase of NCA
what is excluded for QAR? stock, B/O and prepaid expenses
why is stock excluded fro QAR? stock is excluded as it is highly unlikely stock can be liquidated immediately.
why is prepaid expenses excluded fro QAR? may not be liquidated (due to contracts etc)
why is Bank overdraft excluded fro QAR? unlikely to be called for repayment (if not exceeded it may be a source of finance)
why may WCR be satisfactory but QAR not? likely that liquidity is ok but firm has over investment in stock which when removed in QAR calc makes it unsatisfactory. together indicators suggest that firm must sell its stock to be able to meet its debts. if not liquidity problems will result.
high turnover avoids liquidity problems as assets are quickly being converted into cash which is used to pay off debts but may have unsatisfactory WCR if the business has more CL than CA. e.g. loan repayments down the track
3 limitations of relying solely on financial statements and indicators to evaluate performance historical data (do not guarantee future)___rely on averages (conceals details on individual items)___reports contain incomplete info (many items not stated in the financial statement) ___ certain firms use different accounting methods (no comparability)
3 limitations of relying solely on financial statements and indicators to evaluate performance historical data (do not guarantee future)___rely on averages (conceals details on individual items)___reports contain incomplete info (many items not stated in the financial statement) ___ certain firms use different accounting methods (no comparability)
2 measures used to assess firms relationships with customers surveys, no. repeat sales, customer complaints,
2 measures used to assess firms suitability of stock no. sales, no. purchase returns, no. customer complaints
2 measures used to assess firms relationships with employees performance appraisals, staff turnover, av length of employment,
2 measures used to assess state of economy examining interest rates, unemployment rate, level of inflation
Created by: 96