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Interpreting Accounts Notes

LPC Law Notes > Accounts Notes

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A more recent version of these Interpreting Accounts notes – written by Cambridge And Oxilp And College Of Law students – is available here.

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Core Module: Business Accounts

Business Accounts Interpreting accounts
Financial analysis / Ratio analysis: make comparisons with previous years or with similar types of companies. The calculations must be consistent!

EXAM Technique:

1. 2.

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5. 6.

7. Identify the ratio What is the formula What is the ratio trying to measure Compare 2 different years Is the result going up or down Is this good or bad? What does it mean?
Comment / Observation - be sensible - look at the accounts as a WHOLE!

1. Efficiency and effectiveness ratios (profitability) Gross Profit Percentage (margin)

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Tells us how well the business is operating. It indicates the % of sales which compromises profit Higher the GPP = Higher the profitability of the company's products. Good to have a high percentage

Gross Profit X 100 Sales

= GPP(%)

ANALYSIS:

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Does the figure fluctuate?
If increase GPP a) Closing stock overstated?
b) Some purchase invoices not included?

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1 If decrease GPP a) Not all sales recorded ?
b) Stock theft?

Look at ALL the figures (has sales increased / cost of sales / stock (including work in progress) / new machinery? - has this caused a big / little increase in the GPP - if not - why not - use the above table to suggest reasons why. If GPP is too low - options include putting up prices and / or cutting cost of sales. REMEMBER - profitability is not the same as solvency!

Core Module: Business Accounts

Net Profit Percentage

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Tells us how efficiently the company (or business) is operating - it indicates the profitability of a company after taking into account those expenses EXCEPT loan / debenture interest payments / and tax. More useful than GPP Good to keep as HIGH as possible.

Profit before interest and taxation X 100 = NPP (%) Sales

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Calculating PBIT = add interest back into the figure for profit before tax. (OR add interest and tax to the profit after tax). Have expenses increased whilst sales have not? [Look at any fixed assets bought /
machinery - is rent or depreciation on reducing basis the reason for increase in expense?].

Return on capital employed (ROCE)

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Indicates the return a company is making on the capital invested.

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Capital employed = shareholder funds and LT liabilities)

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Good to have as high as possible

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Tells us how much profit there is before interest and taxation - showing value for money

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Shows how much your business makes on the capital invested in it. PBIT X 100 CAPITAL EMPLOYED Capital Employed = [shareholder funds + LT Loan - usually bottom figure of balance sheet]

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