84 ACCOUNTING FOR MANAGERS
4 The financial statements: Profit and Loss account, Balance Sheet and Cash Flow
statement. The consolidated figures should beused, as these are the total figures
for the group of companies that comprise the whole business.
5 Notes to the accounts, which provide detailed figures and explanations to the
accounts. These often run to many pages.
6 A five-year summary of key financial information (a Stock ExchangeYellow Book
requirement).
The Accounting Standards Board recommends that listed companies include an
operating and financial reviewthat provides ‘a framework for the directors to discuss
and analyse the business’s performance and the factors underlying its results
and financial position, in order to assist users to assess for themselves the future
potential of the business’ (quoted in Blake, 1997). The operating and financial
review would replace much of the information contained in the chairman’s or
directors’ reports (item 2 above).
The Profit and Loss account, Balance Sheet and Cash Flow statement can be
studied using ratios.Ratiosare typically two numbers, with one being expressed
as a percentage of the other.Ratio analysiscan be used to help interprettrends
in performance year on year and bybenchmarkingto industry averages or to the
performance of individual competitors. Ratio analysis can be used to interpret
performance against five criteria:
žthe rate of profitability;
žliquidity, i.e. cash flow;
žgearing, i.e. the proportion of borrowings to shareholders’ investment;
žhow efficiently assets are utilized; and
žthe returns to shareholders.
Ratio analysis
There are different definitions that can be used for each ratio. However, it is
important that whatever ratios are used, they are meaningful to the business and
applied consistently. The most common ratios follow. The calculations refer to
the example Profit and Loss account and Balance Sheet provided in Tables 6.1,
6.2 and 6.3 in Chapter 6. Ratios are nearly always expressed as a percentage (by
multiplying the answer by 100).
Profitability...........................................
Return on (shareholders’) investment (ROI)
net profit after tax
shareholders’ funds