Analysing Balance Sheets Learning Objective – To interpret and analyse the contents of a business’s balance sheet Learning Outcomes To be able to identify the components of a balance sheet (E) To be able to interpret and analyse the data in a business’s balance sheet (C) To be able to evaluate the importance of a balance sheet to a business (A)

Questions What is a balance sheet? Who would use a balance sheet? Why is it called a balance sheet?

Key Terms In pairs find out definitions for the following key terms for this topic. Assets Liabilities Capital Creditors Inventories Liquidity Working Capital Current assets Non-current assets (or fixed assets) Current Liabilities Tangible Assets Intangible assets Non current Liabilities Equity

Balance sheet relationships ASSETS = LIABILITIES TOTAL ASSETS = Current Assets + Non-current assets LIABILITIES = Share Capital + Borrowings + Reserves

Format of a balance sheet

Reading the balance sheet Short term – shows us ability to meet liabilities over the next year with the level of working capital. Long term – Changes in non-current assets, how business is financed and level of reserves.

Business Time Lets have a look at a real balance sheet and analyse what we can see!!

Working Capital What is it? Why is it important? How is it calculated? Where can we find it?

Question: Can you have too much working capital? In short, YES!! Liquid assets do not really work for the business as they are not making a return for the business. A business needs to hold the right amount and this depend upon: – Sales volume – Trade credit offered – Growing?? – Operating cycle – Rate of inflation

Causes of working capital problems There are four main causes of working capital problems. Write a small paragraph explaining how: 1. External Changes 2. Poor Credit Control 3. Internal Problems 4. Financial mismanagement; can cause a problem with working capital.

Importance of working capital Is it important to all businesses? What is the particular importance with manufacturing businesses? Complete the table with how working capital can be improved.

Activity time In the booklet provided complete the balance sheet section

Depreciation What is it? Why do it? Where do we record it?

Income Statements/Profit and Loss Accounts An account that shows the income and expenditure for a business. Using this data it allows us to work out both the gross and net profit for the business. Profit and loss account – a statement of the revenue into a business and expenditure out of a business over a period of time in the past.

Questions Why should a business create a profit and loss account? Who would be interested in using the information contained in the P&L account?

Key Terms Revenue Turnover Gross Profit Cost of Sales Expenditure Operating Profit Net Profit Trading Account P&L Account Appropriation Account Overheads Dividends Retained Profits

IS/P&L Layout

Analysing P&L Should never be looked at in isolation. Is good for looking at how managers have handled costs or how well business has done in terms of revenue. Good for analysing trends along with previous data, especially when looking at gross and net profit. Have to be aware of window dressing.

Real Business!! Have a look at the Income Statements/ P&L accounts of the 5 businesses provided.

Profit Quality High Quality Vs Low Quality

Extraordinary and Exceptional Items What are they? How can they impact the IS/P&L? Evaluate the impact these have on profit quality?

P&L activity Complete the P&L section in the booklet provided.

Homework Please complete homework 2 in the pack using the Invicta Case Study for next week.