ILM 8605-421 Interpreting Financial Statements to Assess Organisational Performance Using Financial Ratios Assignment Help UK

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Assignment Task 1: Understand the purpose of financial statements and the financial expectations of organisational stakeholders

AC 1.1 Explain, using figures extracted from a set of financial statements, the purpose of each of the financial statements produced by the organisation

1. Income Statement

Objective: It shows the profit or loss of the organisation for a particular period by a list of revenues and expenses.

Example: Revenues $ 500,000, Expenses $ 300,000, Net Income $ 200,000

2. Balance Sheet

Objective: A balance sheet presents an idea of the financial position of the company at a specific date by a list of assets, liabilities, and equity.

Example: Assets $ 800,000, Liabilities $ 300,000, Equity $ 500,000

3. Cash Flow Statement

Purpose: Cash flows from inflows and outflows, exhibiting liquidity as well as cash management.

Example: Operating cash flow is +$150,000, investing is -$50,000, financing is -$30,000, bringing about a net increase of $70,000.

4. Statement of Changes in Equity

Purpose: Reveals change in equity over a time period, which comprises profits and dividends.

Example: Opening equity is $450,000, net income $200,000, dividends -$50,000, closing equity at $500,000

Each statement provides crucial information concerning the performance, position, and cash flow of an organisation.

AC 1.2  Identify the organisation’s stakeholders and users of accounts and explain their various expectations in terms of the financial performance of the organisation 

Stakeholders and users of accounts of an organisation are organisation shareholders, management, employees, customers, suppliers, creditors, and regulatory bodies. Stakeholders have some expectations about the financial performance of the organisation. Shareholders are expecting extremely high profitability and growth with positive returns on their investments. Management is concerned with operational efficiency. 

They expect financial data to reflect true performance and areas for improvement. Employees will be looking for financial stability since this would mean a job, wages, and benefits. The customers will look for financial stability in the organisation to get quality products and continue servicing. Suppliers and creditors would look for organisations to be financially stable to ensure they get their payments on time. 

Also, the regulatory bodies would like organisations to portray transparently compliant and regular financial reporting in maintaining the trust of the public and upholding the standards of the industry. Both parties rely on financial performance indicators to determine whether the organisation is sustainable and, hence, in its correct direction.

Assignment Task 2: Understand how to use and interpret financial ratios to assess a range of performance areas relevant to organisational stakeholders

AC 2.1 Calculate a set of financial ratios across a range of performance areas using actual figures extracted from the organisation’s financial statements 

Different types of financial ratios can be calculated using the information of the organisation extracted from its financial statements to analyze the financial position of an organisation. Profitability ratios like gross profit margin and net profit margin evaluate the profitability of the company based on revenue. The liquidity ratios would cover the company’s short-term obligations as it would continue to reveal the company’s ability to meet the short-term obligations through the current ratio and quick ratio. 

Efficiency ratios, such as asset turnover, portray how well the assets can generate revenue based on their usage. This measure of stability and dependence on debt also includes debt-to-equity. All of these ratios together provide an overview of the performance of the organisation based on key financial dimensions.

AC 2.2  Interpret the set of financial ratios to provide an assessment of the organisation’s financial performance in a way that is relevant to each of its stakeholders 

Financial ratios enable the interpretation of an organisation’s performance from the point of view of a stakeholder, such as:

• Liquidity Ratios (e.g. Current Ratio) :

Investors/Creditors: Whether the company is able to meet short-term obligations

Management: Whether cash flow is capable of ascertaining stability in operations.

• Profitability Ratios (e.g. Net Profit Margin, ROA) :

Shareholders: Return on investment (ROE).

Employees: Good profits mean job security.

Management: In making strategic planning decisions.

• Efficiency Ratios (e.g. Asset Turnover) :

Management: To assess the usage of assets and thus attain improved efficiency.

Suppliers/Investors: Demand and how well the company is doing.

• Leverage Ratios (such as Debt-to-Equity Ratio)

Creditors: Measure their risk of debt

Investors: Compare their financial risk against potential growth.

Management: Ensure that there is balance in capital structure.

• Market Ratios (such as P/E Ratio)

Shareholders/Investors: Determine whether the current value and value of growth are attained

Management: Decide on investor confidence

With each ratio, the stakeholders gain an overview of this assessment of financial health and ability to decide on it.

AC 2.3  Explain the limitations of the set of financial ratios as a truly accurate assessment of organisational performance

Limitations of Financial Ratios in Assessing Organisational Performance

• Historical Data: Ratios are based on past data, which may not reflect current or future performance.
• Contextual Factors: They may not consider industry differences or market conditions, leading to inaccurate comparisons.
• Lack of Qualitative Insights: Ratios ignore factors like customer satisfaction, employee morale, or brand strength.
• One-dimensional: Ratios focus only on financial aspects, missing broader performance indicators.
• Potential Manipulation: Companies can manipulate financials, skewing ratio results.
• Time Lag: Ratios rely on past data and may not capture recent changes or trends.
• Over-Simplification: They often oversimplify complex business conditions.
• Inconsistent Standards: Different accounting practices can distort comparisons between companies.
• External Factors: Economic or regulatory changes may not be reflected in ratios.