Annual reports and financial statements

LSEPREM7U3Notes LSEPREM7U3VideoTranscript LSEPREM7U2VideoTranscript LSEPREM7U2Notes LSEPREM7U1Notes LSEPREM7U3Activitysubmission11 x

MODULE 7 UNIT 3

Evaluation of financial statements

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Table of contents
1. Introduction 3
2. How investors evaluate a business 3

2.1 Ratio analysis 3
2.2 Vertical and horizontal analysis 4
2.3 Year-to-year change analysis 4

3. Red flags in financial statement analysis 5
4. Creative accounting 6
5. The risk of over- or understating financial results 7
6. Conclusion 8
7. Bibliography 8

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Learning outcomes:

LO5: Identify the limitations of ratio analysis.

LO6: Explain the impact that pressure exerted on management might have on the
accuracy of financial statements.

LO7: Describe how management can mitigate the risk of fraud and misrepresentation in
financial statements.

LO8: Analyse the financial statements of a business to determine its financial performance.

1. Introduction
By now, you should be familiar with the financial ratios that can be used to analyse and
interpret the financial statements of a business. To gain a proper understanding of a
business’s activities, it is necessary to take a more holistic view of the business, rather
than focusing only on financial ratios.

In this set of notes, you will learn what to look out for when analysing a business’s annual
report, and how to identify potential weaknesses or fraudulent activities. This may come in
handy should you ever have to decide whether or not to invest in another business. It will
also provide you with more insight into the expectations a business’s shareholders have,
and how they view financial results.

2. How investors evaluate a business
It is good practice for a potential investor to evaluate the financial position of a business
and compare its performance with that of other potential investments before taking the step
to buy shares. The main objective when analysing financial information is to identify
changes in trends, amounts, and relationships between amounts, and to investigate why
these changes occurred.

It is a good idea to integrate different methods when analysing financial performance, as
one method might not provide enough information to base a decision on. Investors can use
the following methods to analyse the financial performance of a business.

2.1 Ratio analysis
In Module 5, and in Unit 2 of this module, you learnt how an investor can calculate different
financial ratios. When conducting ratio analysis, an investor can compare the current year’s
ratios with the ratios of the previous year, with the ratios of competitors, with industry
averages, or with company standards (such as the gross profit margin that should ideally
be in line with the standard set by the business).

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While ratio analysis is a useful tool to identify a company’s strengths and weaknesses, it
does have some limitations, including the following:

• Every business is unique, which means that comparing the financial ratios of one
business with that of another does not always provide an accurate picture. For
instance, a manufacturing business will probably invest in more assets than a
service business, and this will influence all ratios that include assets as one of the
components.

• Different businesses may use different methods to value their fixed assets, or to
calculate depreciation. This will result in differences in their ratio calculations,
making it difficult to determine which businesses are financially more stable.

• Ratios are useful for identifying potential problems, but do not provide any
background. For example, imagine that the dividend ratio of a business decreased
significantly from one year to the next. If an investor took these numbers at face
value, it would appear as though the business is struggling financially and is
therefore paying out less dividends to shareholders. However, upon further
investigation, it might transpire that shareholders agreed to lower dividend
payments so that the business can use the extra funds to finance an exciting new
opportunity.

(Weetman, 2016)

When basing decisions on the results of ratio analysis, you should consider these
limitations and ensure that you also use other sources of information to inform your
decisions.

2.2 Vertical and horizontal analysis
With this method, information is compared by making use of percentages. This allows the
comparison of businesses that vary in size, as changes in amounts are expressed in
percentages instead of absolute values. Watch the interactive video included in this unit to
learn how to conduct vertical and horizontal analysis.

2.3 Year-to-year change analysis
This method is used to identify trends over a period of time. For example, you can analyse
the growth in revenue and net profit across a few consecutive years. Year-on-year growth
in these two figures is a positive sign, especially if they have grown at the same rate. If the
revenue figure grows at a faster rate than net profit, it might be an indication that the
business is not managing its expenses effectively. If the net profit is growing at a faster
rate than revenue, it might be an indication that the business has taken effective steps to
reduce expenses, but has failed to increase sales – a kind of growth that is not sustainable
over the long term. However, it could also indicate that the business has moved into a
different area (such as delivering services), or started selling new products that earn less
revenue, but are not as costly as other products. Each case should therefore be
investigated based on the unique circumstances present.

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3. Red flags in financial statement analysis
There are certain things you should look out for when evaluating the financial statements
of a business, and when you spot one of these things, you should immediately question
the business’s decisions. The more familiar you become with evaluating financial
statements, the easier it will be to identify these red flags.

Watch Video 1 to learn more about some of the red flags that investors should be able to
recognise to protect their investments.

Video 1: Red flags to look out for when analysing a business. (Source:
https://www.youtube.com/watch?v=lwp6i4Kd4RA)

In addition to the aspects mentioned in Video 1, there are other red flags an investor should
look out for, including the following:

• Revenue has been in decline for three or more consecutive years: This
indicates that the business is failing to increase its sales for a prolonged period of
time, meaning that it may become unsustainable.

• The inventory or accounts receivable figures increase at a higher rate than
sales: This means that the business has less cash on hand, as its money is tied
up in inventory that is not being sold, or in debtors that have to settle outstanding
amounts.

• The number of shares issued increases significantly year on year: This
decreases the value of shares, because, as you will recall, the dividend declared
is divided between the shares. The more shares there are, the smaller the portion
of the dividend each shareholder will get.

• Large amounts appearing under the heading “Other” on the income
statement or statement of financial position: This might be an attempt to hide

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certain transactions. Significant expenses or incomes must be specified and
presented separately in the statements.

There are many other issues in financial statements that may also raise concerns, but the
ones identified are the main things to look out for. If your business is considering investing
in another business, it is important to identify any potential problems, and to investigate
these further before committing to investing.

4. Creative accounting
Creative accounting is when a business records its financial transactions in such a way
that it adheres to accounting standards, but manipulates information to make the business
appear to perform better than it actually is. This is typically done by overstating revenue
and assets, or understating liabilities and expenses.

A business might use this practice to get more shareholders to invest, or to convince a
bank to offer them a loan or a low interest rate on a loan. This practice is also sometimes
a result of the payment of performance-related bonuses, as these may serve as an
incentive for management to inflate results. Other times, it is done to cover up fraudulent
transactions.

Enron is one of the best-known instances of how creative accounting was used to
manipulate shareholders and lenders. Read more about the “fuzzy” rules of accounting
and Enron, and watch Video 2 to see how creative accounting led to Enron’s downfall.

Video 2: The impact of the Enron scandal. (Source:
https://www.youtube.com/watch?v=Mi2O1bH8pvw)

Further reading:

http://www.nytimes.com/2002/01/30/business/enron-s-many-strands-the-accounting-fuzzy-rules-of-accounting-and-enron.html

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If you are interested, have a look at several other famous cases of creative accounting.

Seeing as individuals who commit fraudulent activities often take great care to hide them,
it might be difficult to spot creative accounting practices. However, it is possible to identify
instances of creative accounting by carefully analysing financial statements and
questioning amounts that do not make sense. For example, inventory that increases at a
higher rate than that of sales might indicate that inventory is being overstated in the
financial statements.

5. The risk of over- or understating financial
results
There are various reasons why people might commit fraud when reporting financial
information. The fraud triangle, developed by criminologist Donald Cressey, aims to explain
why fraudulent activities take place, and presents three elements that must be present for
fraud to occur.

Figure 1: The fraud triangle.

These elements are discussed in more detail here:

• Pressure or incentives: As mentioned before, managers might be prone to
misstating financial information if they stand to gain something from doing so, such
as getting a performance bonus. If they are under a lot of pressure from
shareholders or lenders to post positive results, the risk of fraud taking place also
increases.

http://www.businessinsider.com/infographic-the-10-worst-corporate-finance-scandals-2012-11

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• Opportunity: Businesses that rely heavily on estimates when compiling financial
statements are more open to risk, as there is more opportunity to manipulate
figures. A lack of proper accounting procedures also increases the risk of fraud.

• Rationalisation: The attitude that senior management has when it comes to
financial reporting may influence the risk that the business is exposed to. If senior
management does not foster a culture of honesty and trust, managers may feel
justified in their attempts to present financial results in a better light.

Read more about the Tesco fraud trial, and try to identify the elements of the fraud triangle
that were present and may have resulted in the overstatement of financial results.

As a business manager, you must ensure that you balance the need to keep shareholders
happy with the need to report financial information that is accurate and free from bias. As
you discovered in these notes, anyone who takes the time to properly analyse a set of
financial statements will likely be able to spot red flags that might be indicators of fraud.
Fraudulent financial reporting has far-reaching consequences, not only for the individuals
directly involved, but also for the business, as is evident from the Enron scandal discussed
in this module.

A business can mitigate the risk of fraudulent financial reporting by having their annual
reports audited by an independent auditor, and by appointing an audit committee that
oversees the internal auditors and is responsible for establishing processes to identify and
address any risks that might lead to inaccurate financial reports.

6. Conclusion
In these notes, you discovered that, by looking at financial statements in a holistic way,
you can identify trends and red flags that may require further investigation. The risk of
fraudulent presentation of financial information may increase when managers are under
pressure to deliver results, or if the business has a culture of disregarding good financial
practices.

An increased awareness of these risks may prevent you from making investment decisions
that could be detrimental in the long term. It also gives you a better understanding of the
fears and concerns that investors might have about investing in your business – fears and
concerns that you can address by presenting your business’s financial results in a
comprehensive and transparent way.

7. Bibliography
Enron scandal [Video file]. 2013. Available:

https://www.youtube.com/watch?v=Mi2O1bH8pvw [2017, October 18].

Gibson, C.H. 2013. Financial reporting and analysis: using financial accounting
information. 13th ed. Mason, OH: South-Western Cengage Learning.

http://www.independent.co.uk/news/business/news/tesco-fraud-trial-bosses-accused-cooking-the-books-accounting-scandal-chris-bush-carl-rogberg-john-a7974056.html

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Harrison, W.T., Horngren, C.T., Thomas, C.W. & Tietz, W.M. 2017. Financial accounting.
11th ed. Edinburgh Gate: Pearson Education Limited.

MoneyWeek. 2011. Ten signs a company’s in trouble – MoneyWeek investment tutorials
[Video file]. Available: https://www.youtube.com/watch?v=lwp6i4Kd4RA [2017,
October 18].

Pietersz, G. n.d. Creative accounting. Available: https://moneyterms.co.uk/creative-
accounting/ [October 12, 2017].

Weetman, P. 2016. Financial accounting: an introduction. 7th ed. Edinburgh Gate:
Pearson Education Limited.

https://moneyterms.co.uk/creative-accounting/

MODULE 7 UNIT 3

Video Transcript

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Module 7 Unit 3 Video Transcript
KHAMID IRGASHEV: Hello, everyone. Imagine that you would like to make an investment
by buying shares in a business. You want to compare the financial statements of different
businesses to identify the best one to invest in, but you have trouble comparing the
statements to each other. Company A, for example, has 800,000 pounds in outstanding
debt, while Company B has 500,000 pounds in outstanding debt.

It would be easy to assume that Company B is better investment, as the risk of bad debts
is lower; however, Company B might be a smaller business, which would mean that the
500,000 pounds represents much bigger proportion of its operations than the outstanding
debt of a Company A does.

To overcome this problem, you can make use of either horizontal or vertical analysis, which
allows you to compare apples with apples, so to speak.

Horizontal analysis is used to identify trends and changes from one year to another. Look
at the extracts from income statements of two businesses. Are you able to tell, just by
looking at the amounts, which one of the two businesses is experiencing faster growth?

Using horizontal analysis will make it much clear which one of the businesses is
experiencing faster growth. You simply calculate the percentage with which each amount
increased compared to the same amount in the previous year. Let’s look at the example
how this is done.

To calculate the increase in revenue for Company A from Year 1 to Year 2, you will
calculate the difference between Year 1 and Year 2 amounts, and divide it by the Year 1
amount.

So, you would calculate the difference between 85,455 and 78,254, which gives you an
amount of 7,201. You then divide this amount by 78,254, which gives you 0.092. Multiply
this by hundred to get a percentage of 9.2%.

Using the same method for all the other amounts included in the table, your results will
look like this.

It is now much easier to see that the Company B experienced better growth than Company
A in Years 2 and 3, but that the Company A saw better growth than Company B in Year 4.
You can now use this information to decide which company you would rather invest in.

Another method you can use to evaluate the results of two companies is vertical analysis.
When using this method, you express each item in the income statement as a percentage
of a revenue, and each item in the statement of financial position as a percentage of total
assets.

Let’s look at an example of how this vertical analysis is performed on an income statement.
We will once again use the information for Company A and Company B.

Revenue is regarded as the baseline, so that will be indicated as 100% across the board.
You will calculate the percentage of gross profit for Year 1 of Company A by dividing gross

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profit of 34,331 by the revenue amount of 78,254 pounds. This will give you 0.4387. Multiply
this by hundred and you will get a percentage of 43.9%. Following the same process for
all other amounts, results will look as follows.

What does this information tell us? Looking at the results for Year 4, you can see that the
Company B makes higher gross profit than Company A; however, Company A’s net profit
is higher than that of Company B, which suggests that Company B’s expenses are higher.

In this video, you saw that vertical and horizontal analysis are useful tools to compare the
financial statements of different businesses. Looking at absolute values included in
financial statements often doesn’t tell you much, but once you start expressing trends and
relationships as percentages, the real story behind the business results emerge.

Vertical and horizontal analysis are tools that can be used with great effect during the
benchmarking exercises. Benchmarking is the practice of comparing business
performance with other businesses in the same industry.

What do you think management can do with the information obtained during
benchmarking?

If you would like to revisit any of the concepts covered in this video, please select the
appropriate chapter.

MODULE 7 UNIT 2

Video Transcript

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Module 7 Unit 2 Video Transcript
KHAMID IRGASHEV: Hello, everyone. Take a moment to think of any kind of business. All
businesses have to raise capital to pursue its activities, and to maintain and grow its
infrastructure. The capital structure of a business is referred as “gearing”. Gearing is the
proportion of capital that is provided by taking out loans, versus the proportion of capital
provided by the owner or shareholders of a business.

The formula for calculating the company’s gearing ratio is as follows: Long-term liabilities
divided by capital employed multiplied by hundred.

Long-term liabilities include loans that aren’t due within the next year, and mortgages.
Capital employed includes share capital, retained earnings, and long-term liabilities.

Look at the following extract from the statement of financial position of a business. The first
figure you need is long-term liabilities. You will get this from the liabilities sections of the
statement. Be careful not to use the current liabilities figure.

Next, you will need amounts for share capital and retained earnings, which you will find
under the owner’s equity section. Remember to add the amounts for long-term liabilities to
these amounts to get the capital employed figure.

Now that you have the correct amounts, you will calculate the gearing ratio by dividing
110,000 by the sum of 100,000, 50,000, and 110,000 pounds. This will give you an answer
of 0.42, which you will multiply by hundred to get a percentage of 42%.

Businesses are usually regarded as “highly geared” if they have a gearing ratio of more
than 50%. If the gearing ratio is less than 25%, business is regarded as having a “low
gearing”. A ratio between 25 to 50% is considered normal for most well-established
businesses. The gearing of the business in our example is therefore regarded as normal.

The higher the business is geared, more at risk the business will be. This is because the
business has an obligation to repay loans at certain times, while it can decide whether or
not to pay out profits to the shareholders in the form of dividends. Despite this, loans are
usually a more attractive option, as banks often require a lower return on investment than
shareholders do. Interest payments are also usually deductible from the tax, unlike
dividend payments.

So, what is the best gearing ratio for a business to have? It depends on whether business
has enough cash available with which to pay off its debts. A business that has been running
for many years and has a reliable cash flow is able to deal with a higher level of gearing
than a business that has experiences in unpredictable cash flow.

In this video, you saw that the gearing ratio is used to determine whether or not a business
has too much debt relative to the capital invested by its shareholders. Newer business
ventures are usually better off making use of owner’s capital, as it doesn’t have to be repaid
by a certain time. More established businesses can be highly geared, as they usually have
the cash flow available with which to pay off loans.

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You now know that a business has a choice whether to raise capital by getting a loan, or
by issuing shares. Although raising capital by issuing shares has its advantages, what do
you think are some of the disadvantages to the business of raising share capital rather
than taking out a loan?

If you would like to revisit any of the concepts covered in this video, please select the
appropriate chapter.

MODULE 7 UNIT 2

Advanced ratio analysis

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Table of contents
1. Introduction 3
2. Investor ratios 3

2.1 Earnings per share 3
2.2 Dividend per share 4
2.3 Price earnings ratio 5
2.4 Dividend payout ratio 5
2.5 Dividend yield 6
2.6 Example: Calculating investor ratios 6

2.6.1 Earnings per share 6
2.6.2 Dividend per share 7
2.6.3 Price earnings ratio 7
2.6.4 Dividend payout ratio 7
2.6.5 Dividend yield 7

3. Evaluating financial performance using ratio analysis 8
3.1 Profitability ratios 8

3.1.1 Gross profit margin 8
3.1.2 Net profit margin 9
3.1.3 Return on total assets 9
3.1.4 Return on equity 10

3.2 Liquidity ratios 10
3.2.1 Current ratio 10
3.2.2 Quick ratio 11

3.3 Efficiency ratios 11
3.3.1 Inventory turnover 11
3.3.2 Accounts receivable turnover 11
3.3.3 Accounts payable turnover 12

4. Conclusion 12
5. Bibliography 12

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Learning outcome:

LO4: Calculate and interpret advanced financial ratios.

1. Introduction
You were introduced to basic financial ratios in Module 5, and will recall that ratios identify
the relationship between different elements of the financial statements. Ratios provide
information that is not necessarily evident just by looking at financial statements, and they
help users identify underlying problems that must be addressed to improve the
performance of the business, or strengths that the business can build on.

This set of notes introduces more advanced ratios that are useful for current and potential
investors when evaluating their investments. These notes will analyse financial ratios in
more detail, and discuss the actions a business manager can take to improve ratios that
are lower than expected.

2. Investor ratios
Investor ratios show potential or current investors what return they can expect on their
investments. They can use this information to decide whether they should invest (or
continue to invest) in the business, or whether they should move their money to another
investment that will yield better returns. Five investor ratios are explored in this section,
and Section 2.6 includes examples demonstrating how each of these ratios is calculated.

2.1 Earnings per share
Earnings per share (or net income per share) indicates how much of the profit a business
makes in a financial period can be allocated to each share (if all profits were to be paid out
to shareholders). The formula for calculating earnings per share is as follows:

Earnings per share =
Net income − Preferred dividends
Number of ordinary shares issued

Ordinary shares vs preference shares:

A company may raise funds by issuing ordinary shares or preference shares. Shareholders
holding preference shares usually do not have voting rights, but they receive fixed
dividends. Ordinary shareholders have a say in how the business is run, but they only
receive dividends at management’s discretion. If a business did not achieve its
performance targets during a particular year, preference shareholders will still receive
dividends, while management might decide not to pay out any dividends to ordinary
shareholders.

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Dividends paid out to preference shareholders are deducted from net income when
calculating earnings per share, as this calculation focuses on the profit that can be
allocated to ordinary shares.

The earnings per share ratio may be of limited use to investors, as it only indicates how
much money could potentially be paid out per share, instead of showing what is actually
paid out in the form of dividends.

However, it is useful for determining the profitability of an investor’s investment over the
long term. Shareholders cannot simply assume that their return on investment will increase
if the business’s profits increase, as the number of shares issued might also have
increased. For example, if a business declared a profit of £1,000,000 in one year, and
declared a profit of £2,000,000 in the next year, the profit that can be allocated to shares
has seemingly doubled. However, if the number of outstanding shares increased from
20,000 to 50,000 in the same period, the earnings per share will have decreased from £50
to £40.

The earnings per share ratio can be compared to industry averages to determine whether
it is satisfactory. To improve the earnings per share ratio, a business can do the following:

• It can increase net income by increasing sales or decreasing costs.

• It can decrease the number of preference shares in issue by buying them back.
However, this will influence the funds the company has available to finance its
activities.

• It can decrease the number of ordinary shares issued, by buying them back and
making use of loans to fund its activities instead. However, this may have a
negative effect on the current ratio if the loan is payable within the next year (i.e. it
is a current liability). The company will also be obligated to pay interest on the loan
and repay it at a specific time, whereas it can choose whether or not to pay
dividends to ordinary shareholders.

The current ratio:

You will recall from Module 5 that the current ratio is calculated by comparing current
assets to current liabilities. Should a business decrease its share capital and instead take
out a loan, its current liabilities amount will increase if the loan is a current liability (and thus
not long term). This will have a negative effect on the current ratio, as there will now be
more liabilities compared to assets than was previously the case. Even if a long-term loan
does not influence the current ratio directly, the interest payable on the loan will increase
current liabilities and reduce current assets once paid.

2.2 Dividend per share
Earnings per share is the amount that could potentially be paid out for each share, should
the business decide to pay out all profits to shareholders. However, a business usually
only pays out part of its profits to shareholders in the form of dividends. The remaining
profits are kept in the business as retained earnings, ensuring that the business has

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enough money available should a good investment opportunity present itself or any
unforeseen expenses arise.

Dividend per share is calculated using the following formula:

Dividend per share =
Ordinary dividend declared

Number of issued ordinary shares

This amount indicates to shareholders how much money they can expect to receive in cash
for every share they hold. Potential investors may find it useful to track this amount over a
period of time, as it indicates whether or not the company is committed to paying out
dividends to its shareholders. Fluctuations in this ratio might shake investor confidence,
prompting them to seek investments in a different company’s shares that may guarantee
a more reliable income. However, shareholders can earn a return on their investment not
only through dividends paid to them, but also through an increase in value of their shares
over time. The prospect of shares increasing in value over the long term might result in
shareholders being willing to accept lower dividends in the short term.

Once again, dividend per share can be compared against industry averages to determine
whether it is satisfactory. If not, it can be improved by:

• Increasing the dividend declared (either by increasing profit, or by changing the
dividend policy); or

• Decreasing the number of ordinary shares in issue by buying back the shares,
thereby increasing the dividend per share of the remaining shares.

2.3 Price earnings ratio
This ratio compares the earnings per share (explored in Section 2.1) with the market value
of the share.

Price earnings ratio =
Current market price per ordinary share

Earnings per share

A high price earnings ratio usually shows that investors are expecting high growth in the
share value in the future, and are therefore willing to pay more for the shares than what
the earnings per share currently is. The price earnings ratio may also indicate that shares
are overvalued or undervalued in the market. If they are overvalued, an investor might be
better off investing in another company. If they are undervalued, an investor should
consider buying more of the shares, as they are worth more than the asking price.

2.4 Dividend payout ratio
The dividend payout ratio compares the earnings per share with the dividends paid out per
share. It is calculated as follows:

Dividend payout ratio =
Dividend per share
Earnings per share

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This ratio indicates to shareholders how much of the profit that was made (and thus
potentially could have been paid to shareholders) ended up being paid out in the form of
dividends, and how much was kept as retained earnings. While the dividend per share ratio
shows the monetary value that is paid out to a shareholder, the dividend payout ratio
indicates whether or not a company is paying out a reasonable dividend considering the
profit made.

2.5 Dividend yield
As mentioned before, shareholders can earn a return on their investment through dividends
paid or through an increase in the value of their shares. The dividend yield ratio shows the
portion of the return on investment of each share that can be attributed to dividends.

Dividend yield is calculated as follows:

Dividend yield =
Dividend per share

Current market price

× 100

A high dividend yield indicates that the company does not keep a lot of profit as retained
earnings to grow business activities in the future. Instead, it pays out most of its profit to
shareholders in the form of dividends. An investor who is more interested in receiving high
dividends in the short term (rather than waiting for shares to increase in value over the long
term) might prefer a high dividend yield. An investor who is interested in shares increasing
in value over the long term might prefer for the company to keep more profit as retained
earnings.

2.6 Example: Calculating investor ratios
French Flair recorded a net profit of £1,000,000 in their income statement for the current
financial year. They have 20,000 ordinary shares in issue, and declared a dividend of
£600,000 for the financial year (£200,000 of which is payable to preference shareholders).
Shares in French Flair are currently trading at £100 per share.

Calculate the different investor ratios.

2.6.1 Earnings per share

Earnings per share =
Net income − Preferred dividends
Number of ordinary shares issued

=
£1,000,000 − £200,000

20,000

= £40 per share

If all profits earned during the year were paid out to the shareholders, they would receive
an amount of £40 per share.

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2.6.2 Dividend per share

Dividend per share =
Ordinary dividend declared
Number of issued ordinary shares

=
£600,000 − £200,000

20,000

= £20 per share

A holder of ordinary shares will receive an amount of £20 for every share held.

2.6.3 Price earnings ratio

Price earnings ratio =
Current market price per ordinary share
Earnings per share

=
£100
£40

= 2.5

The current market price per share is 2.5 times that of the profitability of the share. This
could either indicate that the shares are overvalued in the market, or that the market
expects the earnings per share to grow in the future. Read more about using the price
earnings ratio to evaluate shares.

2.6.4 Dividend payout ratio

Dividend payout ratio =
Dividend per share
Earnings per share

=
£20
£40

= 0.5

This indicates that for every £2 of profit earned per share, £1 (or 50%) was paid out to
shareholders in the form of dividends.

2.6.5 Dividend yield

Dividend yield =
Dividend per share
Current market price
× 100

=
20

100
× 100

= 20%

This means that 20% of the market value of each share is attributable to dividends. The
other 80% is attributable to the increase in value of the share over time.

https://www.thebalance.com/using-price-to-earnings-356427

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3. Evaluating financial performance using ratio
analysis
Investors and the managers of a business can use ratio analysis to determine whether the
business is in a healthy financial state, and whether it will be able to achieve its strategic
objectives.

Ratio analysis is often used in benchmarking, which is the process of comparing a
business’s performance with that of another similar business in the industry. Alternatively,
trend analysis is used to compare the same business’s performance from one year to the
next, with the goal of identifying certain trends. Any significant changes may indicate
underlying problems, or strengths that the business should aim to build on.

This section gives you the opportunity to analyse all the financial ratios you learnt about in
Module 5, identifying what these ratios mean for your business, and which steps you can
take to improve them. It also provides more insight into the matters you should consider
before deciding to invest in another business.

3.1 Profitability ratios
Profitability ratios show how well a business is using its resources to generate a profit.
Each ratio is analysed in more detail in the following sections.

3.1.1 Gross profit margin
The gross profit margin indicates a business’s ability to cover its operating expenses, and
is calculated as follows:

Gross profit
Sales

× 100

Refer to Module 5 to revise calculating the gross profit margin. The higher the gross profit
margin, the better a business’s chances of covering all its operating expenses with the
amount of money it earns through sales. Gross profit margins vary significantly between
businesses, and from one industry to the next, so there is not a standard gross margin that
a business should aim to achieve. A business should set target margins based on what it
needs to meet its strategic goals, and then measure its performance to determine whether
it achieved the margin it planned for.

If a business’s gross profit margin is not met, it could improve by:

• Changing its sales mix by selling more products with high gross profit margins; or

• Reducing production costs by improving its manufacturing processes or
negotiating better prices with suppliers.

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3.1.2 Net profit margin
Net profit margin shows the percentage of sales that remains after all expenses have been
deducted. These expenses may include rent, salaries, and insurance, as well as tax and
interest. Net profit margin is calculated as follows:

Net profit after tax
Sales

× 100

Refer to Module 5 to revise calculating the net profit margin. Once again, there is a not an
industry standard that a business should aim to achieve, but the higher this percentage is,
the better. A high percentage indicates to the market that the business is profitable and is
managing its expenses efficiently.

To increase the net profit margin, a business can do the following:

• It can change its sales mix by selling more products with a high net profit margin.

• It can reduce its overall expenses (and not just production expenses as was the
case with gross profit margin). You will often hear that businesses are trying to
reduce their “overheads”, which are the expenses incurred that do not relate
directly to sales. Salaries, rent, staff benefits, and utilities are examples of
expenses that can be reduced to increase net profit margin.

3.1.3 Return on total assets
Return on total assets measures how well a business is using its assets to generate profits,
and is calculated as follows:

Net profit after tax
Total assets

Refer to Module 5 to revise calculating return on total assets. The greater the return on
total assets, the better. To determine whether the return on assets ratio is acceptable, it is
usually compared to the industry average (as different industries will require different levels
of investment in assets). It can also be compared to the rate the business could have
earned elsewhere by investing the money currently tied up in assets.

If the ratio is lower than the industry average or what the business could have earned on
another investment, the following steps can be taken to improve it:

• Increasing net profit by increasing sales or reducing production and general
expenses

• Investing less in inventory if forecasts show that sales will decline

• Selling assets that are no longer being used, or have become obsolete

• Outsourcing activities if it would be cheaper than investing in the assets needed to
complete those activities in-house

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3.1.4 Return on equity
Return on equity shows how much profit an investor makes on every pound invested, and
is calculated as follows:

Net profit after tax
Total equity

× 100

Refer to Module 5 to revise calculating return on equity. Once again, this ratio can be
compared to the industry average, or to the rate shareholders could have earned by
investing their money elsewhere. The following actions can be taken to improve an
unsatisfactory return on equity ratio:

• The business can increase net profit by increasing sales or reducing production
and general expenses.

• The business can buy back some of the issued shares, and instead make use of
loans to finance business activities. This will reduce the number of shareholders
and thus increase the profit made by the remaining shareholders of the business.

3.2 Liquidity ratios
The two liquidity ratios you learned about in Module 5 are the current ratio and the quick
ratio.

3.2.1 Current ratio
The current ratio shows whether a business would be able to pay its short-term creditors
using the assets that it expects to convert into cash in the short term. It is calculated as
follows:

Current assets
Current liabilities

A current ratio of 2:1 is usually the industry standard, so anything lower than that must be
improved.

To improve the current ratio, you should either increase current assets or decrease current
liabilities, by taking the following steps (among others):

• You can improve the cash flow of the business by, for example, offering debtors a
discount if they settle their debts early.

• Take out more long-term loans instead of relying on short-term debt. You may
however end up paying more interest on a long-term loan, making this a costly
option.

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3.2.2 Quick ratio
The quick ratio measures whether or not a business would be able to pay its short-term
debt without having to sell its inventory. It is calculated as follows:

Current assets − Inventory
Current liabilities

A quick ratio of 1 or more is usually the industry standard. The same steps that can be
taken to improve the current ratio can be applied to improve the quick ratio, but the quick
ratio can also be improved by decreasing the amount of inventory held (which can be
achieved by improving sales).

3.3 Efficiency ratios
As you will recall from Module 5, efficiency ratios measure the efficiency with which assets
are converted into cash.

3.3.1 Inventory turnover
Inventory turnover shows whether the business is managing its inventory effectively, by
indicating how many times it has converted inventory into sales during a specific period. It
is calculated as follows:

Cost of sales
Average inventory

Inventory turnover varies between businesses, so there is no industry standard the
business should aim to achieve. However, a high inventory turnover indicates that a
business is controlling its inventory well, and is not buying too much stock. It also indicates
that the business’s sales function is efficient, and that it can sell most of the inventory
bought.

A business can improve its inventory turnover ratio be keeping less inventory in stock.
However, sales requirements must be considered, as the business is at risk of running out
of stock if it keeps inventory levels too low.

3.3.2 Accounts receivable turnover
Accounts receivable turnover measures how many times a business can turn its accounts
receivable into cash during a specific period. It is calculated as follows:

Credit sales
Average accounts receivable

The higher this ratio, the better, as it shows that the business is effective at collecting
outstanding amounts from debtors. It also decreases the risk of the business having to
write off bad debts.

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A business can improve its accounts receivable turnover by taking the following steps:

• Providing debtors with incentives (such as discounts) to settle their debts on time

• Decreasing the number of days debtors are granted to pay their debts, by
changing the business’s credit terms (though this could result in debtors deciding
to buy from another business that offers more favourable terms)

• Improving internal processes to ensure that outstanding debts are followed up

3.3.3 Accounts payable turnover
Accounts payable turnover is a measure that shows how quickly a business pays off its
suppliers. It is calculated as follows:

Credit purchases
Average accounts payable

The lower this ratio is, the better, as it illustrates that the business can make maximum use
of cash on hand before paying it over to other parties.

A business can improve its accounts payable turnover by negotiating better terms with
suppliers.

4. Conclusion
In this set of notes, you discovered how investors can analyse the information included in
the financial statements of a business to determine if they should continue with their
investment. As a business manager, you could use these ratios to assist you in evaluating
potential investment opportunities, or help you identify areas that the shareholders of your
business concentrate on when planning their investments. The business can take certain
steps to improve investor ratios, which may result in more investors buying shares in the
business, as the business will be regarded as a good investment that delivers high returns.

You also explored in greater detail the financial ratios introduced in Module 5, discovered
when these ratios are deemed unsatisfactory, and looked at the things a business can do
to improve these ratios. Watch the video included in this unit to learn how to calculate and
interpret the gearing ratio, which indicates how much long-term debt a business has
relative to the amount of capital it has raised by issuing shares.

5. Bibliography
Atrill, P. & McLaney, E. 2017. Accounting and finance for non-specialists. 10th ed.

Edinburgh Gate: Pearson Education Ltd.

Weetman, P. 2016. Financial accounting: An introduction. 7th ed. Edinburgh Gate:
Pearson Education Ltd.

3. Evaluating financial performance using ratio analysis
3.1 Profitability ratios
3.1.1 Gross profit margin
3.1.2 Net profit margin
3.1.3 Return on total assets
3.1.4 Return on equity
3.2 Liquidity ratios
3.2.1 Current ratio
3.2.2 Quick ratio
3.3 Efficiency ratios
3.3.1 Inventory turnover
3.3.2 Accounts receivable turnover
3.3.3 Accounts payable turnover

4. Conclusion
5. Bibliography

MODULE 7 UNIT 1

Financial reporting

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Table of contents
1. Introduction 3
2. The role and importance of financial reporting 3
3. Structure and components of an annual report 4

3.1 Financial statements 4
3.2 Notes to the financial statements 5
3.3 Directors’ report 5
3.4 Audit report 5

4. Corporate governance, corporate social responsibility, and ethics 6
4.1 Corporate governance 6
4.2 Corporate social responsibility 7

5. Qualitative characteristics of financial information for decision-making 8
5.1 Fundamental qualitative characteristics 8
5.2 Enhancing qualitative characteristics 8

6. Financial reporting standards 9
6.1 The regulatory framework 9
6.2 International Accounting Standards (IAS) 10

7. Conclusion 10
8. Bibliography 10

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Learning outcomes:

LO1: Recognise the importance of financial reporting, the regulatory framework, and
standard setting.

LO2: Discuss the qualitative characteristics of financial information for decision-making.

LO3: Apply your knowledge of annual financial reports to a real-life example.

1. Introduction
In Module 5, you learnt how to compile an income statement and statement of financial
position for a business, and discovered which components are included in the statement
of cash flows. In this set of notes, you will learn more about the standards that should be
followed to ensure that the financial statements are consistent and can be used by different
parties around the globe.

The information contained in the financial statements is of great importance to all the
business stakeholders. However, it is not the only information about a business that is
useful when making decisions. To this end, listed companies publish annual reports, which
contain more comprehensive information for decision-makers than financial statements
present in isolation. A real company’s annual report will be used to guide you through these
notes, giving you the opportunity to familiarise yourself with the components you might
come across in your own business’s annual report.

2. The role and importance of financial reporting
The aim of financial reporting is to:

Provide information about the financial position, performance and changes
in financial position of an enterprise that is useful to a wide range of users
in making economic decisions.

(IFRS Foundation, 2010)

You learnt more about these users and their specific requirements in Module 5. The
information included in financial statements is useful for the following reasons (among
others):

• Management can use it to plan, and to compare the business’s performance with
that of similar businesses in the industry.

• It helps the business raise capital, either through loans or shareholder investment.

• It provides stakeholders, such as employees and investors, with an overview of the
performance of the business and the ways its resources are allocated.

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• Information included in financial statements is used by auditors to form an opinion
on the business’s compliance to statutory requirements.

However, while financial statements provide information on how a business used its
resources, they do not provide background information explaining why certain decisions
were made.

Stakeholders might be interested in knowing about the key events that influenced decisions
during the year, or the strategic goals of the business for the financial period and if those
goals were met. Since senior management should be held accountable, it is expected of
them to explain the steps they took to increase shareholder wealth while at the same time
being socially responsible and adhering to best practices.

As a result, listed companies must issue a comprehensive annual report, which includes
not only their financial statements, but also other information that may be of interest to
different stakeholders. The annual report delivers a holistic overview of the activities of a
business, providing information that will give different users the detailed view they need to
make informed decisions. It also provides stakeholders with the assurance that the
company is adhering to the principles of good corporate governance and acting in the best
interest of society.

Case study – M&S:

The annual report of M&S (one of the biggest retailers in the UK) will be used as a reference
throughout this module, serving as a practical example of the concepts discussed.

3. Structure and components of an annual report
The more comprehensive and transparent an annual report is, the more likely the company
is to attract new investors and gain a good reputation in the market. Listed companies may
include in their annual report any information that they believe users will need to make
good decisions. However, there are some components that must be included in all annual
reports. This section explores and discusses each of these components.

3.1 Financial statements
Financial statements illustrate how the company used its resources to achieve its strategic
goals. It indicates how much profit the business made, how many assets and liabilities the
business has, and whether the business has enough cash at its disposal to meet its
obligations. The following financial statements are included in an annual report:

• Income statement (or statement of comprehensive income)

• Statement of financial position (or balance sheet)

• Statement of cash flows

https://corporate.marksandspencer.com/documents/reports-results-and-publications/annual-report-2017

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• Statement of changes in equity

If a company consists of a parent company with subsidiaries (businesses in which the
parent company has a controlling share), consolidated financial statements are also
presented. Consolidated financial statements are the combined statements for a group of
companies.

Case study – Consolidated financial statements:

Refer to Pages 92 to 95 in M&S’s annual report to view its consolidated financial
statements.

3.2 Notes to the financial statements
The financial statements also include notes, which provide more information to users about
the amounts included on the face of the statements. For example, only a final amount is
included under assets in the statement of financial position. The note provides more
information on the procurement and disposal of assets, and the depreciation of assets
recorded during the financial period.

The notes also provide information on the accounting policies used (such as the methods
used to calculate depreciation, for instance).

Case study – Notes to the financial statements:

Refer to Pages 96 to 127 in M&S’s annual report to view the notes to the consolidated
financial statements.

3.3 Directors’ report
The directors’ report provides a high-level overview of the state of the business and what
it has achieved during the financial period. It also provides more information regarding the
matters the board of directors were responsible for, and discloses the remuneration that
was paid to directors as well as possible conflicts of interest directors might have
experienced.

Case study – Directors’ report:

Refer to Pages 34 to 83 in M&S’s annual report to view its directors’ report.

3.4 Audit report
The audit report is compiled by external, independent auditors. This report provides
assurance that the financial statements have been compiled in line with international
accounting standards, and that they are a fair representation of the financial state of the
company. An auditor can deliver one of the following opinions:

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• An unqualified opinion: The auditor believes the financial statements are a fair
representation of the financial state of the company.

• A qualified opinion: The auditor was either not provided with enough information
to form an opinion about specific amounts, or there are material misstatements
relating to specific amounts in the financial statements.

• Adverse opinion: There are various material misstatements in the financial
statements, which leads the auditor to believe that they are not a true reflection of
the financial state of the company.

• Disclaimer of opinion: The auditor was unable to obtain enough evidence to form
an opinion about the financial statements.

Case study – Audit report:

Refer to Pages 84 to 91 in M&S’s annual report to view its audit report.

4. Corporate governance, corporate social
responsibility, and ethics
An annual report usually includes dedicated sections focused on corporate governance
and corporate social responsibility. These sections provide evidence of the ethical conduct
of the business.

4.1 Corporate governance
Corporate governance refers to how a business is managed and controlled. Listed
companies are owned by shareholders who are usually not involved in the day-to-day
running of the business. The board of directors and senior management team therefore
act as the shareholders’ agents, making decisions on their behalf.

The assumption is that the board and managers will act in the best interest of the
shareholders, and protect their investment. However, over the years, several corporate
scandals were exposed, during which it transpired that managers acted in an unethical
way and not in the best interest of the shareholders or society. Many countries have
subsequently implemented corporate governance codes, which listed companies are
expected to adhere to. These codes address issues such as risk management,
remuneration, and the composition of the board of directors.

The Global Network of Director Institutes issued a paper that summarises the guiding
principles of good governance. The codes applicable in different countries are based on
these basic principles. The principles are applicable to all businesses, but how these
principles are implemented in practice depends on the nature and size of a business.

https://corporate.marksandspencer.com/documents/reports-results-and-publications/annual-report-2017

http://gndi.weebly.com/uploads/1/4/2/1/14216812/2015_may_6_guiding_principles_of_good_governance

https://corporate.marksandspencer.com/documents/reports-results-and-publications/annual-report-2017

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Case study – Corporate governance:

Refer to Pages 34 to 53 in M&S’s annual report to view their take on corporate governance.

4.2 Corporate social responsibility
Corporate social responsibility means that a business acts responsibly and fairly when
dealing with its employees, the community it forms part of, and the environment. For
example, it is expected of a manufacturing enterprise to disclose how it deals with any
damage it does to the environment during the production process. Watch Video 1 to learn
more about the long-term impact that corporate social responsibility may have on the profit
of a business.

Video 1: Alex Edmans discusses the long-term impact of corporate social responsibility. (Source:

The “triple bottom line”:

In Module 5, you learnt that the net profit of a business is also referred to as the “bottom
line”. For a long time, this was regarded as the most important indicator of a business’s
performance. However, the amount of profit a business makes does not indicate how the
business has contributed to society, or whether its management team is acting in the best
interest of its shareholders.

Therefore, it has become standard practice for businesses to report on their economic,
social, and environmental achievements, which is referred to as the “triple bottom line”.
This term suggests that it is just as important for a business to contribute to society and
protect the environment as it is to earn profit.

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5. Qualitative characteristics of financial
information for decision-making
Financial information should display certain characteristics to make it useful for individuals
making business decisions.

5.1 Fundamental qualitative characteristics
The two most important characteristics that financial information must display are
relevance and faithful representation.

Information is relevant if it is “capable of making a difference in the decisions made by
users” (IFRS Foundation, 2010). The amount of profit earned, for example, is relevant to
potential investors, as it is an indication of whether buying shares in the business is a good
investment. Information is represented faithfully if it is complete and does not contain any
errors.

According to the IFRS Foundation (2010) “information must be both relevant and faithfully
represented if is to be useful”. Relevant information that is incorrect may result in a user
making a wrong decision. For example, if the statements include reference to an asset sold
(which is a relevant piece of information), but the profit made during the transaction is
calculated incorrectly, it will not be of use to individuals using the statements. Similarly,
information that is correct but irrelevant is also of little use when making decisions.

5.2 Enhancing qualitative characteristics
In addition to relevance and faithful representation, there are other characteristics that will
also enhance the usefulness of financial information.

• Comparability: Information is useful when it can be compared to information from
previous periods or other businesses. For example, including the last two years’
figures in the current financial statements allows users to identify trends and
establish whether performance has improved from previous years.

• Verifiability: Information is verifiable if different, knowledgeable parties can reach
consensus that the information is faithfully represented. For example, two different
auditors should be able to reach the same conclusion about the financial
statements of a business.

• Timeliness: Information is timely when it is made available to users at a time when
it can influence their decisions. The annual report should be released within a
reasonable amount of time after the end of the financial year so that users can
base their planning and decisions on the information included.

• Understandability: Information is understandable if it is clear and concise.
However, the assumption is made that the users of financial statements have some
business background and knowledge, and will take time to analyse the information

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correctly. Complex information should therefore not be excluded from the
statements just to make it more understandable.

Compiling financial statements using certain standards is one way of ensuring that the
information included in the statements is useful for decision makers.

6. Financial reporting standards
Most countries have standards that accountants must follow when compiling financial
statements. This ensures that financial statements meet the requirements of the end users,
and that consistency is achieved across different industries. Financial reporting standards
differ from country to country.

However, globalisation and the interaction between businesses situated in different
countries created a need for global accounting standards to be used when compiling
financial statements. If businesses in different countries and in different industries use their
own formats and methods to compile financial statements, it might become near impossible
to compare results. Many countries now require, or at least encourage, listed companies
to adhere to these global standards when compiling their financial statements.

6.1 The regulatory framework
The International Accounting Standards Board (IASB) issued a framework to use when
compiling financial statements to ensure that the information contained in these statements
is reliable and relevant. This framework includes the following sections:

• Objectives of financial reporting

• Underlying assumptions made when financial reports are compiled (such as the
going concern assumption, which means that a business reports its financial
position with the assumption that it will continue to do business and operate as
usual in future)

• Qualitative characteristics of financial information

• Elements of financial statements

• Recognition of elements of financial statements

• Measurement of elements of financial statements

(IFRS Foundation, 2010)

You can read a summary of the Conceptual Framework for Financial Reporting, which
highlights the most important concepts included in the framework.

http://www.ifrs.org/use-around-the-world/why-global-accounting-standards/

https://www.iasplus.com/en/standards/other/framework

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6.2 International Accounting Standards (IAS)
The Conceptual Framework for Financial Reporting provides high-level guidance to
accountants compiling financial statements. The IASB also issues standards that address
specific matters, such as when and how to record revenue, and how to present
consolidated financial statements.

These standards are referred to as International Accounting Standards (IAS) if issued
before or during 2001, or International Financial Reporting Standards (IFRS) if issued after
2001. If there is no standard to address a problem a company is experiencing when
compiling financial statements, the Conceptual Framework is used as guidance. Visit the
IFRS Foundation’s website to read more about the standard-setting process and view a
list of all the global accounting standards that have been issued thus far.

As a business manager, it is not usually expected of you to have an in-depth understanding
of accounting standards, as this typically falls in the domain of accountants and auditors.
However, it is useful to be aware of these standards should it come up when you are
involved in finance-related discussions.

7. Conclusion
The annual report is a comprehensive document that serves as a source of information for
various parties that have an interest in a listed company, including employees, creditors,
and investors. An annual report must include an overview of the financial year’s business
activities and the steps directors took to increase shareholder wealth. It should also include
comprehensive financial statements that are compiled in line with the International
Accounting Standards and audited by an external, independent auditor.

It has become common practice to include sections relating to corporate governance,
corporate social responsibility, and environmental responsibility in the annual report. This
provides stakeholders with information about the steps the company has taken to balance
its pursuit of profit with the well-being of the community and environment it operates in.

In Unit 2, you will discover how the information included in the annual report (and
specifically the financial statements) can be analysed to identify the strengths and
weaknesses of a business, and which steps can be taken to improve the business’s
performance if it becomes necessary.

8. Bibliography
Auditor-General of South Africa. n.d. Audit terminology. Available:

https://www.agsa.co.za/Auditinformation/Auditterminology.aspx [2017, October
17].

Edmans, A. 2015. The social responsibility of business [Video file]. Available:
https://www.youtube.com/watch?v=Z5KZhm19EO0&t=431s [2017, October 17].

http://www.ifrs.org/about-us/how-we-set-standards/

http://www.ifrs.org/issued-standards/list-of-standards/

https://www.agsa.co.za/Auditinformation/Auditterminology.aspx

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EduPristine. 2015. Financial reporting. [Blog, 2 December]. Available:
http://www.edupristine.com/blog/financial-reporting [2017, October 17].

IFRS Foundation. 2010. The conceptual framework for financial reporting 2010. Available:
https://dart.deloitte.com/resource/1/7036afd8-3f7e-11e6-95db-2d5b01548a21
[2017, October 17].

Maynard, J. 2017. Financial accounting, reporting & analysis. 2nd ed. Oxford: Oxford
University Press.

Melville, A. 2017. International financial reporting: A practical guide. 6th ed. Edinburgh
Gate: Pearson Education Limited.

The Economist Newspaper Limited. 2009. Triple bottom line. Available:
http://www.economist.com/node/14301663 [2017, October 2017].

Financial Reporting

https://dart.deloitte.com/resource/1/7036afd8-3f7e-11e6-95db-2d5b01548a21

http://www.economist.com/node/14301663

lse.ac.uk

MODULE 7 UNIT 3

Activity submission

Learning outcomes:

LO5: Identify the limitations of ratio analysis.

LO6: Explain the impact that pressure exerted on management might have on the accuracy of financial statements.

LO7: Describe how management can mitigate the risk of fraud and misrepresentation in financial statements.

LO8: Analyse the financial statements of a business to determine its financial performance.

Name:

1. Instructions and guidelines (Read carefully)

Instructions

1. Insert your name and surname in the space provided above, as well as in the file name. Save the file as: First name Surname M7 U3 Activity Submission – e.g. Lilly Smith M7 U3 Activity Submission. NB: Please ensure that you use the name that appears in your student profile on the Online Campus.

2. Write all your answers in this document. There is an instruction that says, “Start writing here” under each question. Please type your answer there.

3. Submit your assignment in Microsoft Word only. No other file types will be accepted.

4. Do not delete the plagiarism declaration or the assignment instructions and guidelines. They must remain in your assignment when you submit.

PLEASE NOTE: Plagiarism cases will be investigated in line with the Terms and Conditions for Students.

IMPORTANT NOTICE: Please ensure that you have checked your course calendar for the due date for this assignment.

Guidelines

1. There are 4 pages and 4 questions in this assignment.

2. Make sure that you have carefully read and fully understood the questions before answering them. Answer the questions fully but concisely and as directly as possible. Follow all specific instructions for individual questions (e.g. “list”, “in point form”).

3. Answer all questions in your own words. Do not copy any text from the notes, readings, or other sources. The assignment must be your own work only.

Plagiarism declaration:

1. I know that plagiarism is wrong. Plagiarism is to use another’s work and pretend that it is one’s own or to fail to cite references when necessary.

2. This assignment is my own work.

3. I have not allowed, and will not allow, anyone to copy my work with the intention of passing it off as his or her own work.

4. I acknowledge that copying someone else’s assignment (or part of it) is wrong, and declare that my assignments are my own work.

2. Mark allocation

Each question receives a mark allocation. However, you will only receive a final percentage mark and will not be given individual marks for each question. The mark allocation is there to show you the weighting and length of each question.

Question 1 4

Question 2 2

Question 3 2

Question 4 12

TOTAL 20

Please note: Unlike most other assignments, this assignment will not be marked using a rubric, given the nature of the answers required.

3. Questions

Reminder:

You are not required to conduct independent research for this submission. However, if you wish to make use of additional sources outside of the course material, you will need to reference these sources correctly. Please consult the Course Handbook in the Orientation Module for guidance on referencing requirements.

In-text citations and reference lists are not included in the word count of your submission.

Question 1

Identify and explain two of the possible limitations of ratio analysis. (Max. 60 words)

Start writing here:

Question 2

Describe how pressure exerted on senior management by shareholders and other parties may impact the accuracy of financial statements. (Max. 50 words)

Start writing here:

Question 3

Suggest one action management can take to mitigate the risk of fraud occurring when financial statements are being compiled. (Max. 50 words)

Start writing here:

Question 4

View the

annual report and financial statements of M&S for 2017

Do you think M&S is performing well as a business? Provide three examples or arguments from the annual report to justify your answer. You may use any information found in the report to support your answer. (Max. 100 words)

Start writing here:

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