Financial Reporting (AQA A Level Business): Flashcards
Exam code: 7132
1/650Still learning
Know0
- FrontIncome Statement
Define income statement.
Was this flashcard helpful?
Cards in this collection (65)
Define income statement.
The income statement records a business's revenue, expenses and profit or loss over a set period, usually a year.
True or False?
Income is recorded in the accounts when it is earned, even if the cash has not yet been received.
True.
Income is recorded when it is earned and costs when they are incurred, regardless of when cash actually changes hands.
How do suppliers use a business's profit data?
Suppliers use profit data to decide how much trade credit to offer the business.
What is deducted from sales revenue in the trading account?
The trading account deducts the cost of sales from sales revenue to give gross profit.
Which costs are deducted from gross profit in the profit and loss account?
Operating expenses (such as rent, wages and marketing), finance costs such as interest, and tax are deducted from gross profit.
The ___________ account shows how the profit for the year is divided up between different uses.
The appropriation account shows how the profit for the year is divided up between different uses.
What is retained profit?
Retained profit is the profit kept within the business after dividends have been paid, used to fund future growth or act as a financial reserve.
Define exceptional items.
Exceptional items are significant one-off items of income or expenditure that are unusual but still part of normal trading activities, such as a very large customer order.
What does a healthy gross profit but a very low operating profit suggest?
It suggests that overheads are too high relative to the gross profit being generated.
Define profit quality.
Profit quality measures how reliable and sustainable a company's reported profit really is.
True or False?
A one-off gain from selling surplus land is a sign of high-quality profit.
False.
One-off gains are poor-quality profit because they cannot be repeated. High-quality profit comes from recurrent, cash-backed revenue from core operations.
How is the gross profit margin calculated?
The gross profit margin is calculated using this formula:
Gross profit margin = Gross profit ÷ Sales revenue × 100
What does a rising operating profit margin indicate?
A rising operating profit margin indicates increasing sales revenue and/or falling overheads.
Apart from encouraging sales, what do changes in the profit for the year margin show about managers?
They show how well managers are keeping borrowing costs low and minimising the level of tax paid.
Define statement of financial position.
The statement of financial position is a snapshot of a business's financial position at a given point in time, showing what it owns, what it owes and how it is funded.
The statement of financial position is sometimes called the ___________.
The statement of financial position is sometimes called the balance sheet.
How do lenders use a business's statement of financial position?
Lenders assess the level of liabilities relative to equity to judge how much financial risk the business is carrying.
Define current assets.
Current assets are items a business owns that can be converted to cash quickly, usually within 12 months, such as inventory, trade receivables and cash.
True or False?
A loan that does not need to be repaid for at least 12 months is a non-current liability.
True.
Current liabilities are amounts due to be settled within 12 months, such as trade payables and overdrafts, so a longer-term loan is a non-current liability.
How are net assets calculated?
Net assets are calculated using this formula:
Net assets = (Non-current assets + Current assets) − (Current liabilities + Non-current liabilities)
Define working capital.
Working capital shows whether a business can meet its short-term financial obligations.
Working capital = Current assets − Current liabilities
True or False?
Negative working capital always means a business is in financial difficulty.
False.
Negative working capital can indicate cash-efficient operations, such as being paid by customers before paying suppliers, although it may risk liquidity problems.
What does a high proportion of non-current assets to total assets indicate?
It indicates a capital-intensive business, which is common in primary and secondary sector businesses.
Why are strong reserves useful to a business?
Strong reserves enable a business to pay dividends, fund projects without borrowing and absorb unexpected losses.
Define window dressing.
Window dressing is the use of short-term techniques to make a firm's financial statements look stronger than they really are, even though underlying performance has not changed.
How can the reclassification of items make a business's liquidity look healthier?
Reclassifying a loan due within 12 months as long-term debt makes current liabilities look smaller, which improves ratios such as the current ratio.
Amending a statement of financial position means ___________ the figures when a transaction occurs.
Amending a statement of financial position means recalculating the figures when a transaction occurs.
Define return on capital employed (RoCE).
Return on capital employed (RoCE) measures how effectively a business uses the capital invested in it to generate profit.
RoCE = Operating profit ÷ Capital employed × 100
Return on capital employed is also known as the _____ ratio.
Return on capital employed is also known as the primary ratio.
How is capital employed calculated?
Capital employed is calculated using this formula:
Capital employed = Total assets − Current liabilities
True or False?
Comparing RoCE between businesses in different industries is a reliable way to judge performance.
False.
RoCE rates differ between industries, so it should be compared with businesses in the same industry or with other returns, such as interest rates on savings.
What are the two ways a business can increase its RoCE?
A business can make more profit without using more capital or use less capital to make the same profit, for example by selling off unused equipment.
A branch has capital employed of £2.4m and operating profit of £0.37m. What is its RoCE?
The branch's RoCE is 15.42% (£0.37m ÷ £2.4m × 100).
Define return on investment (ROI).
Return on investment (ROI) evaluates the financial return generated by a specific investment decision, such as purchasing new equipment or opening a new location.
ROI = Net return from investment ÷ Cost of investment × 100
A business invests £50,000 in machinery that generates a net return of £37,500. What is the ROI?
The return on investment is 75% (£37,500 ÷ £50,000 × 100).
What does the gearing ratio show?
The gearing ratio shows the long-term financial structure of a business and how reliant it is on borrowed money.
How is the gearing ratio calculated?
The gearing ratio is calculated using this formula:
Gearing ratio = Non-current liabilities ÷ Capital employed × 100
In a ___________ business, more than 50% of capital employed is long-term loans.
In a highly geared business, more than 50% of capital employed is long-term loans.
Why is a high level of long-term borrowing a risk for a business?
Substantial interest payments reduce the profit available for dividends and retention, and the business may find it harder to raise further loans.
True or False?
Issuing more shares will lower a business's gearing.
True.
Issuing shares increases share capital and so lowers gearing. To increase gearing, a business could obtain more loans or buy back shares.
Why might a low-geared business deter some investors?
An unwillingness to use loan capital may signal a risk-averse business that is missing out on finance that would not dilute shareholders' control.
Define trend.
A trend is a pattern that emerges when the same financial measure is tracked across multiple periods.
Why is looking at figures over time more revealing than a single year's result?
It shows the direction of travel: whether performance is improving, declining or remaining stable.
What might rising revenue but falling profit margins indicate?
It suggests that costs are growing faster than revenue, which could signal an efficiency problem.
True or False?
A consistently rising gearing ratio shows a business is facing growing financial risk.
True.
Rising gearing shows an increasing reliance on debt, which is a growing financial risk.
A falling closing cash balance over several months may mean a business is heading towards a _______ crisis.
A falling closing cash balance over several months may mean a business is heading towards a liquidity crisis.
Define benchmarking.
Benchmarking involves comparing a business's financial performance against a reference point to identify where it is performing well and where it is falling behind.
What is the difference between internal and external benchmarking?
Internal benchmarking compares performance with the business's own past results. External benchmarking compares it with competitors, industry averages or sector-wide standards.
How does comparing with other businesses help managers set targets?
It helps set realistic targets based on what comparable businesses actually achieve, rather than on assumptions.
True or False?
Meeting the industry average always means a business is performing well.
False.
Benchmarks can create complacency: meeting the average is not performing well if the whole industry is underperforming.
Why might external benchmarks be unreliable?
Competitors rarely share detailed internal data, so external benchmarks are often based on published accounts that may not reflect true underlying performance.
Why might a fall in profit during a recession not mean the business is badly managed?
The fall may reflect weak consumer demand across the whole economy rather than a specific failing of the business.
Why might a business with a rapid growth objective accept an operating loss?
It may be investing heavily in areas such as warehousing, technology and customer acquisition, so the loss is a deliberate part of its strategy.
A cost leadership strategy will typically produce lower gross profit margins but higher sales _____.
A cost leadership strategy will typically produce lower gross profit margins but higher sales volumes.
What might falling margins at a premium brand signal?
Margins falling towards industry averages may signal that its premium positioning is weakening, which is a strategic concern and not just a financial one.
Why are financial statements described as backward-looking?
They report what has already happened, so past performance is not a reliable guide to future results.
True or False?
A rise in revenue over several years always means a business has grown in real terms.
False.
Inflation can create a misleading impression of growth. If revenue rises by 10% while prices also rise by 10%, the business has not grown in real terms.
Why do differing accounting policies limit comparisons between companies?
Businesses may use different methods to value assets, calculate depreciation or determine revenue, which makes direct comparisons challenging.
Large companies may publish their accounts several months after the financial year ends, so the data may already be _________ when stakeholders read it.
Large companies may publish their accounts several months after the financial year ends, so the data may already be out of date when stakeholders read it.
Why are non-financial factors a significant limitation of financial reporting?
Many of the factors that determine a business's long-term success cannot be quantified in pounds and pence, so they do not appear in the financial statements.
How might profits achieved through pay freezes or redundancies damage future performance?
They may cause falling staff morale, leading to higher staff turnover, lower productivity and reduced quality.
True or False?
A strong brand reputation does not appear in a business's financial statements.
True.
Brand reputation is one of the most valuable assets a business can have, but it does not appear in its financial statements.
Why might the financial damage from a product safety scandal not show immediately in the accounts?
In the short term the accounts may show only the costs of a product recall, while lost consumer trust and falling sales emerge over subsequent reporting periods.
What future costs might a business causing environmental harm face?
It may face fines and clean-up costs, investment to meet new legislation and the loss of customers who prioritise sustainability.
Customer satisfaction scores and employee surveys should be used _______ financial statements to assess a business's true performance.
Customer satisfaction scores and employee surveys should be used alongside financial statements to assess a business's true performance.
Sign up to unlock flashcards
or