The 30 Day MBA by Colin Barrow

capital
1,400
2,000
Gross profit
4,000

2,600
less expenses
3,000
Financed by Owners’ equity

Profit before tax
1,000
Financed by Owners’ equity
2,000
Tax
400
2,000
Profit after tax
600
Reserves
600
2,600
    Filing accounts
    A company’s financial affairs are in the public domain. As well as keeping the government tax authorities such as The Internal Revenue Service (IRS) and HM Revenue and Customs (HMRC) informed, companies have to file their accounts with Companies House ( www.companieshouse.gov.uk ). Accounts should be filed within 10 months of the company’s financial year-end. Small businesses in the UK (turnover below £5.6 ($8.8/€6.3) million) can file abbreviated accounts that include only very limited balance sheet and profit and loss account information and these do not need to be audited. Businesses can be fined up to £1,000 ($1,570/€1,127) for filing accounts late.
    US company accounts can be obtained from The Securities Exchange Commission ( www.sec.gov ). The Investor Relations Society ( www.irs.org.uk > IR Resources > Best Practice Guidelines) makes an award each year to the company producing the best set of report and accounts.
    Financial ratios
    Earlier in this chapter the two important financial statements of profit and loss account and balance sheet were examined. To recap – the trading performance of a company for a period of time is measured in the profit and loss account by deducting running costs from sales income. A balance sheet sets out the financial position of the company at a particular point in time, usually the end of the accounting period. It lists the assets owned by the company at that date matched by an equal list of the sources of finance.
    Reading company accounts, with practice, you can get some insight into a company’s affairs. Comparing the current year’s figure with the previous year’s figure can identify changes in some of the key items, but conclusions drawn from this approach can be misleading. Consider the situation shown in Table 1.11 .
    TABLE 1.11    Factors that affect profit performance
$/£/€

$/£/€
$/£/€
Sales
100,000
Fixed assets

12,500
– Cost of sales
50,000
= Gross profit
50,000
Working capital
– Expenses
33,000
Current assets
23,100
= Operating profit
17,000
– Current liabilities
6,690 = 16,410
– Finance charges
8,090
Total net assets

28,910
= Net profit
8,910
    You can see that the table is nothing more than a simplified profit and loss account on the left and the assets section of the balance sheet on the right. Any change that increases net profit (more sales, lower expenses, less tax etc), but does not increase the amount of assets employed (lower stocks, fewer debtors etc), will increase the return on assets. Conversely, any change that increases capital employed without increasing profits in proportion will reduce the return on assets.
    Now let us suppose that events occur to increase sales by $/£/€25,000 and profits by $/£/€1,000 to $/£/€8,910. Superficially that would look like an improved position. But if we then discover that in order to achieve that extra profit new equipment costing $/£/€5,000 had to be bought and a further $/£/€2,500 had to be tied up in working capital (stock and debtors), the picture might not look so attractive. The return being made on assets employed has dropped from 31 per cent (8,910 / 28,910 × 100) to 27 per cent (9,910 / [28,910 + 5,000 + 2,500] × 100).
    Analysing accounts
    The main analytical approach is to examine the relationship of pairs of figures extracted from the accounts. A pair may be taken from the same statement, or one figure from each of the profit and loss account and balance sheet statements. When brought together, the two figures are called ratios. Miles per gallon, for example, is a useful ratio for drivers checking one aspect of a vehicle’s performance. Some