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Unlock This CourseLarge businesses need to keep track of their money - where it comes from, where it goes and whether they're making a profit. Financial analysis is like being a detective, looking at the numbers to understand how well a business is performing. This is crucial for Paper 2 as you'll need to analyse real business data and make recommendations.
Key Definitions:
Imagine you're thinking about investing your pocket money in a company's shares. You'd want to know if they're making money, right? That's exactly what financial analysis tells us - whether a business is healthy, growing, or struggling.
Large businesses must produce three main financial documents each year. Think of them as different ways of looking at the same business - like taking photos from different angles.
This shows how much money the business made or lost over a specific period, usually one year. It's like your bank statement showing money coming in and going out.
Total money earned from selling goods or services. For Tesco, this includes all sales from their stores.
Money spent to run the business - wages, rent, buying stock. These reduce profit.
What's left after subtracting all costs from revenue. This is what shareholders care about most.
This is like a snapshot of everything the business owns and owes at a specific moment in time. It must always balance - hence the name!
Everything the business owns that has value - buildings, equipment, stock, money in the bank. These are split into fixed assets (long-term, like buildings) and current assets (short-term, like stock).
Everything the business owes - loans, money owed to suppliers, wages due to staff. Current liabilities must be paid within a year, long-term liabilities can be paid later.
This tracks the actual movement of cash in and out of the business. A company can be profitable on paper but still run out of cash - that's why this statement is so important.
In 2023, M&S reported revenue of £12.2 billion but profit of only £391 million. This shows that even large businesses have tight profit margins - they need to sell a lot to make relatively small profits. Their cash flow was positive, meaning they had enough money coming in to pay their bills, which is crucial for survival.
Ratios help us compare businesses of different sizes and understand performance trends. They're like converting everything to percentages so we can make fair comparisons.
These tell us how good the business is at making profit from its sales.
Formula: (Gross Profit ÷ Revenue) × 100
This shows what percentage of each sale is profit before paying for overheads like rent and wages. A higher percentage is better.
Formula: (Net Profit ÷ Revenue) × 100
This shows the final profit percentage after all costs. Even 5-10% can be good for large retailers.
These measure whether the business has enough cash and assets that can quickly become cash to pay its short-term debts.
Formula: Current Assets ÷ Current Liabilities
Ideally between 1.5 and 2. If it's below 1, the business might struggle to pay its bills.
These show how well the business uses its resources.
Formula: Revenue ÷ Total Assets
This shows how many pounds of sales the business generates for every pound of assets it owns. Higher is generally better.
Numbers alone don't tell the whole story. You need to look at trends, compare with competitors and consider external factors affecting the business.
Is profit increasing or decreasing over time? Are costs rising faster than revenue?
How does this business compare to its competitors? Industry averages give context.
Economic conditions, seasonal patterns and market changes all affect financial performance.
Between 2014-2018, Tesco's profit margins improved from 1.1% to 2.8%. This wasn't just about selling more - they reduced costs, closed unprofitable stores and focused on efficiency. Their current ratio also improved from 0.6 to 0.8, showing better cash management. This demonstrates how financial analysis helps track business recovery strategies.
In Paper 2, you'll need to suggest what businesses should do based on their financial data. Here's how to approach this systematically.
Possible causes: High costs, low prices, inefficient operations
Recommendations: Reduce costs, increase prices, improve efficiency, focus on higher-margin products
Possible causes: Slow-paying customers, too much stock, high expenses
Recommendations: Improve debt collection, reduce stock levels, negotiate better payment terms with suppliers
When analysing financial data in Paper 2, follow these steps to maximise your marks:
Always calculate ratios to 2 decimal places, show your working and explain what the results mean for stakeholders like shareholders, employees and customers. Don't just describe the numbers - analyse what they tell us about the business's performance and future prospects.