Analysis and communication of accounting information

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Cambridge International AS & A Level Accounting 9706

Analysis and Communication of Accounting Information

The big idea: Different people read the same financial statements for different reasons, so the accountant has to know who is asking and what they need. Ratios turn the statements into comparable measures of profitability, liquidity and efficiency, and the useful skill is explaining what a change in a ratio means and what the business could do about it.

Summary — What This Chapter Covers

Owners, managers, employees, investors, lenders, suppliers, customers, government and public or environmental bodies each need different information from the financial statements.
Profitability: gross profit margin, mark-up, profit margin, return on capital employed (ROCE), expenses to revenue and operating expenses to revenue.
Liquidity: current ratio and acid test ratio, written as x : 1.
Efficiency: non-current asset turnover, trade receivables and trade payables turnover in days, inventory turnover in days and the rate of inventory turnover in times.
Only the formulae in the syllabus appendix are credited. Use year-end figures unless the question asks for averages; inventory turnover uses average inventory.
Interpretation means saying whether the ratio is better or worse, giving a likely cause from the data, and suggesting a realistic improvement.
Accounting information has limitations: historic cost, non-financial factors left out, different policies between businesses, and a single date that may not be typical.

1. Users of Accounting Information

Syllabus 1.6.1 · AS Level · Papers 1 & 2

Who reads the statements, and what for

The statements are published once, but each group of users looks for something different. In an exam answer, name the user, say what that user wants to know, and point to the statement or ratio that tells them.

User	What they want to know	Where they look
Owners (sole trader, partners, shareholders)	Is the business profitable? Is my capital earning a good return? How much can I take out?	Profit for the year, ROCE, profit margin, drawings or dividends
Managers	Which areas are performing well or badly? Are costs under control? Is cash sufficient for plans?	Detailed statements, expenses to revenue, efficiency ratios, budgets
Employees	Is my job secure? Can the business afford a pay rise or a bonus?	Profit trend, liquidity, going concern
Investors (potential shareholders)	Will the business grow and pay a dividend? Is it a better use of my money than another business?	Profit trend, ROCE, dividends, comparison with other businesses
Lenders (banks, debenture holders)	Can the business pay interest and repay the loan? What security is there?	Liquidity ratios, profit from operations, existing borrowing, non-current assets
Suppliers	Will we be paid, and on time? Should we offer more credit?	Current and acid test ratios, trade payables days
Customers	Will the business keep trading, so that supplies, guarantees and spare parts continue?	Profit trend, liquidity, going concern
Government	How much tax is due? Is the business following the law? Employment and statistics	Profit for the year, revenue, payroll
Public and environmental bodies	Does the business behave responsibly towards the community and the environment? Is it likely to expand or close sites locally?

Communicating

Practice Question 1

two

Practice Question 2

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Also in the full note

How well does the business turn sales and capital into profit?
Can the business pay its debts as they fall due?
How hard are the assets and working capital working?
From the ratio to a recommendation
Why ratios never tell the whole story

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Analysis and communication of accounting information

Analysis and Communication of Accounting Information

Who reads the statements, and what for

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