Business Capital

Financial Analysis

This is one of the principal methods of interpreting financial statements. Management must know whether the overall financial strategy being applied in the business is successful. They must have the up to date information on the following:

  • Whether the overall profit/financial position is satisfactory.
  • Whether previous investment decisions were justified.
  • Whether the return on investment is adequate.
  • Whether cash collection is sufficient.

It is questions such as these which can be effectively investigated and answered by the use of financial analysis. A business ratio is a method of testing the relationship between various parts of the business. Ratios give mathematical precision to the relationship.

These measures, usually in the form of ratios can be divided into three main groups:

Business Capital Profitability Measures

  • This shows the business owner the amount of profit or loss being earned on invested capital//investments. There are several measures of profit used in analysis.
  • This information is found in the Income Statement and Statement of Financial Position/Balance Sheet. The Gross Margin/ Net Margin figures vary from one industry to another. This is the profit earned as a percentage on sales or investment (ROI). It is important to know the difference between margin and mark-up figures. The former is based on selling prices and the latter on cost prices. The Gross Profit percentage trend will need to be closely scrutinised.

Business Capital Stability Measures

  • This demonstrates the level of risk involved in the sources of capital/capital employed used by the business owner.
  • Gearing refers to the way the company is financed. It is concerned with two types of financing: Debt (borrowings) and Equity (shareholders’ funds/capital).  Gearing can be understood as long term liquidity for the business.
  • A high gearing figure can be considered acceptable as it could be used as equity to finance much greater investment.   However, too much borrowing increases the risk of the company not being able to meet it’s bills as they fall due. 
  • If this happens the company will be put into receivership/ wound up. The higher the level of borrowing, the less able the company is to withstand a downturn in business. Gearing can be measured using these ratios:
  • Long Term Debt/Owners Capital = Debt/Equity Ratio X100%
  • Non Current Liabilities/(Total Equity + Non Current Liabilities) X 100%
  • Profit before Interest and Taxes/ Annual Interest Payments = Times Interest Covered X100%

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