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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