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Using financial data to measure and assess
performance
By the end of this lesson you should be able to:
1. Analyse how income statements are used to assess performance and potential.
2. Understand the importance of profit utilisation and profit quality.
Learning Objectives
Sources of financial data
Companies are required to produce an annual report – but what does it contain and why produce it?Income
statementThis measures the business' performance over a given period of time, usually one year. It compares the income of the business against the cost of goods or services and expenses incurred in earning that revenue. It shows if a business has made a profit or loss.
Balance sheet
This is a snapshot of the business' assets (what it owns or is owed) and its liabilities (what it owes) on a particular day - usually the last day of the financial year.
Cash flow statement
This shows how the business has generated and disposed of cash and liquid funds during the period under review. [note: AQA BUSS3 does not require you to study cash flow statements]
60 second challenge…..
List the key users of accounts.
Key users of financial data
Examples include: Investors Lenders Creditors Customers Employees Government Analysts Media
But why would they want this information?
Which club would you invest in?
What is an Income Statement
A historical record of the trading of a business over a specific period (normally one year)
Shows the profit or loss made by the business – which is the
difference between the firm’s total income and its total costs
Example income statement
Profit after tax
Revenue, Cost of Sales & Gross Profit
Category Explanation
Revenue Revenues (sales) during the period.
Cost of sales Direct costs of generating revenues go into “cost of sales”:Cost of raw materials, components, goods bought for resale, direct labour costs.
Gross profit The difference between revenue and cost of sales. Gross Profit = Revenue – Cost of sales.
Gross Profit Margin (%) = Gross Profit/ Revenue x 100• Useful measure showing how much profit is generated from
every £1 of revenue before overheads and other expenses are taken into account.
You did this in AS!
Overheads and Operating Profit
Category Explanation
Distribution & administration expenses
Operating costs and expenses that are not directly related to producing the goods or services are recorded here:Distribution costs (e.g. marketing, transport), administrative expenses and overheads.
Operating profit A key measure of profit. Operating profit records how much profit has been made from the trading activities of the business.
Net profit
Finance expenses
Interest paid on bank and other borrowings, less interest income received on cash balances. A useful figure for shareholders to assess how much profit is being used up by the funding structure of the business.
Profit before tax Calculated as operating profit less finance expenses
Tax An estimate of the amount of corporation tax that is likely to be payable on the recorded profit before tax.
Profit attributable to shareholders
The amount of profit that is left after the tax has been accounted for. Shareholders then decide how much of this is paid out to them in dividends and how much is left in the business.
Complete the handout and learn more about the three parts of the Income Statement.
You may need a calculator.
Practice
Your worksheet
Your task…
Profit or Loss?
Fill in the gaps & calculate: GROSS PROFT margin NET PROFIT margin
Add comments and observations to the ‘definitions’ section.
The answers…
The answers
The answers
What is profit quality?
Profit quality looks at whether the
reported profit can be sustained.
What are the benefits of considering profit in the short, medium and long
term?
High v Low Quality Profit
High quality profit Low quality profit
Profit which can be repeated or sustained
Not reliant on one-off profits
Shareholders can have some confidence in the profit trend
Difficult to repeat
Includes one-off profits (e.g. from the sale of surplus assets or businesses)
Shareholders need to adjust reported profit to assess what the likely profit is for next year
What is profit utilisation?
The way in which profit is being used, i.e. – put back into the business
(retained profit) or distributed to shareholders.
Consider: Long and
short-term objectives
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You should now be able to :
1. Analyse how income statements are used to assess performance and potential.
2. Understand the importance of profit utilisation and profit quality.
Re-cap Learning Objectives