Understanding The Key Concepts Of Business Finance And Economics Essay.

Internal and External Factors Affecting Business Performance

Purpose and overview of report

This paper is a culmination of five different questions and elements which will be addressed with the help of appropriate theories, formulas and concepts in order to showcase the understanding of the author concerning the involvement of key concepts. The paper is intended to be presented as a report addressing the key aspects pertaining to the module of Business Finance and Economics all of which help attain the five learning outcomes that have been discussed in the assignment brief.

If a business intends to be successful and viable in any competitive marketplace, it needs to assess and identify the factors that can play a role in affecting the performance, either in a positive or a negative way (Vartiak 2016). These factors may either be internal or external to an organisation. The internal business factors refer to such variables or elements which are within the control of the business irrespective of being tangible or intangible. These are also referred to as micro economic factors. Once these factors are figured out, these are either grouped as strengths or weaknesses of the business. On the contrary, the external factors also referred to as macro-economic factors are such elements that are outside an organisation and its business environment wherein the company cannot exercise any direct control over such factors.

There are several internal factors that may bring about changes or may affect the performance of the business. Some of these factors have been discussed as follows:

1. Management and Employees: Any company’s human resources form one of the most important aspects of the internal business environment comprising of employees and senior management. Hiring of skilled human resources can help in becoming one of the most competitive sources of internal strengths that can provide a competitive advantage for any business which can radically bring about changes in performance.
2. Work and Company Culture: The internal culture of any organisation comprises of its ethics, core values and priorities. An organisation that has a motivating work culture which emphasizes teamwork and collaboration is most likely to contribute to a positive business performance while a culture of internal competition and corporate politics is most likely to adversely affect the performance of the business as a result of demotivated employees.
3. Resources and Cash Flows: Cash flows are one of the most important resources of an organisation that can help ensure that the business is operating in an efficient manner. Even the most profitable businesses operating in a sound economy may fall in trouble if exposed to weak operating cash flows. As a result, cash flow management is quite important and an organisation must ensure that their resources are deployed efficiently (Maylor, Blackmon and Huemann 2016).

Likewise, there are several external factors that may also bring about performance impacts to businesses. These are discussed as follows:

1. External Economy: The economic forces can bring about a significant impact on the performance of any business. An economy with a high unemployment level will result in reducing the spending power of consumers which can hurt sales. Likewise, a situation of volatility caused in the economy due to contingencies such as the Covid-19 pandemic is a prime example of how industries on a mass scale can get affected. An inflationary economy can result in higher prices which will eventually result in increasing prices to compensate for the increase in costs. Hence, understanding the economy is important for understanding the opportunities and threats (Gitman, Juchau and Flanagan 2015).
2. Political Factors: Political factors may also be another external source which may affect the performance of a business in either a positive or negative way. For instance, political support and government policies can go a significant way in uplifting the business performance while any government intervention may also result in adversely affecting the performance of the business.
3. Technological Factors: Rapid advancement in technology with upcoming sophisticated automation can help businesses in attaining a competitive advantage. These tend to decrease costs in the lower run but may require significant upfront capital investments which most may not be able to afford (Martin, Keown and Titman 2020).

Meaning of Accounting:

Accounting is often referred to as the ‘language’ of any business and is concerned with recording, summarising, analysing, interpreting and communicating the financial results and performance of an entity for a particular financial period (Collier 2015).

Scope of Accounting:

Accounting as a discipline comprises of two main procedural aspects which are generating of financial information and using the financial information. Financial information at first are generated by recording (journal), classifying (ledger), summarising (trial balance and financial statements), analysis & interpretation (financial statement analysis) and communicating (distribution of financial statements to end users). Financial information are then used by the users of financial information for making informed and effective decisions (McLaney and Atrill 2020).

Branches of Accounting:

There are several forms of accounting which may not be same as some tend to focus upon costs, while others tend to focus more upon taxes and audits. There are several branches of accounting as it is a broad discipline. These are outlined as follows:

1. Financial Accounting.
2. Cost & Management Accounting.
3. Managerial Accounting.
4. Tax Accounting.
5. Accounting Information System.
6. Forensic Accounting.
7. Fiduciary Accounting.

Accounting Regulations:

In order to promote comparability and help management exercise control, the GAAP (Generally Accepted Accounting Principles) help in serving as the main accounting regulation and guidelines in the United States. However, the international countries other than the United States have started adhering to a common set of guidelines known as the IFRS (International Financial Reporting Standards). Hence, the IFRS and the US GAAP are the two predominant accounting set of regulations that regulates accounting as a professional discipline worldwide (Salas and Campos 2016).

Different Forms of Accounting

Objectives of Accounting:

The main set of objectives that concerns accounting have been discussed as follows:

1. One of the most basic objectives of accounting is to maintain systematic records of all transactions which is also referred to as book keeping. These records are later on used for classification and summarisation for preparing and presenting the financial statements in order to allow interpretation and analysis.
2. Accounting helps in ascertaining the financial results of a business for a particular financial period. These results of the business operations are mostly depicted from the income statement. In case of any adversities or negative aspects, the management may resort to taking remedial actions.
3. Businesses are not just interested in the financial results but are also interested in the financial position of the business as at a particular period. Accounting therefore allows understanding the financial health of the business which is one way of understanding the ability of the company in meeting their short term debts and long term debts (Winfield 2021).
4. Accounting is known as the language of business for a reason. This is because it communicates the results and performance to the users of information with the help of the financial statements. It therefore aims to meet the informational needs of stakeholders which can assist with rational decision making (Dhamija 2015).

The three major financial statements which are prepared and presented by a business entity are the income statement, the balance sheet and the cash flow statement. These are discussed and differentiated as follows:

The income statement which still goes by the name of statement of profit and loss showcases the financial results in the course of operations for a given financial period. As the name rightfully implies, this financial statement showcases the profitability position of the business which is its ability to generate income for covering the expenses. This financial statement will present the different sources of income (operating revenue and other income) as well as expenses (cost of sales, operating expenses and financial expenses) to determine the ultimate bottom line profits for a particular period. Some of the main results which the statement presents are the gross profit, operating profit, pre tax profit and the after tax net profits. The statement is a presented in a vertical format and is based on the matching concept wherein all expenses incurred for a particular period are matched against the revenue which is earned during the same period (O'Hare 2016).

The balance sheet is also referred to as the statement of financial position for it reflects upon the financial position or the financial health of the business as at a particular year end date. This financial statement forms the basis for the accounting equation which states that assets is equivalent to the sum of liabilities and the owner’s interests in the business. Conclusively, there are three main elements of the balance sheet which are assets, liabilities and equity. Assets are the resources which are owned and operated by a company and is expected to generate economic benefits for the entity. Liabilities are all the obligations and debts which are owed by the entity to others. The equity of the business can simply be understood as the net worth of the business. The assets and liabilities of any business are classified into current (short term) and non-current (long term) respectively. Further, the equity section of the balance sheet comprises of the owner’s capital and the retained earnings of the business over the years (Weetman 2019).

While financial statements are prepared on the basis of accrual accounting, the cash flow statement is prepared using the cash basis of accounting. The financial statement helps to calculate the closing balance of cash and cash equivalents for a particular financial period and is prepared using either the direct method or the indirect method. While ascertaining the profitability of any business is important, understanding and monitoring of cash flows are equally important. This financial statement provides for a summary of different sources of cash flowing in and flowing out of the business by appropriately categorizing these activities into operating activities, investing activities and financing activities the sum of which helps determine the net increase/decrease in cash flows for a particular financial period (Warren, Jonick and Schneider 2020).

Preparation and Differentiation of Financial Statements

Calculation of Ratios:

 (Source: Calculated by Author)

1. Operating Profit Margin: This is a measure of the profitability performance of an entity in the ordinary course of operations. The metric evaluates the margin of sales which is left behind after meeting the direct expenses and the operating expenses that have been incurred by the company (Jackson 2021). When it comes to XYZ Plc, the operating profit margin ratio can be observed to have declined from 9.60% in 2019 to 1.27% in 2020 which is despite an increase in revenue and a decline in operating expenses. This is because of an increase in the cost of sales. This is elaborated in the next ratio.
2. Gross Profit Margin: It is one of the most common measures of profitability position in any entity. The metric gauges the cost efficiency of making the product or rendering the service and measures the ability of the company to generate sales for covering the total direct costs incurred (Williams and Dobelman 2017). The metric has visibly declined from 26% in 2019 to 13.64% in 2020. This is despite a surge in total sales. The line item cost of sales is the reason for which the metric has deteriorated. The total direct costs have increased in absolute and relative terms resulting in a decline in profitability.
3. Current Ratio: This metric is one of the most common indicators of liquidity position of the business or the short term solvency. This metric gauges the availability of current assets which are the available short term resources vested with an entity to cover and meet the current liabilities or the short term obligations of the business. The metric has deteriorated from 3.13 times in 2019 to 2.34 times in 2020 which is because of an increase in current liabilities such as trade payables and bank overdrafts. However, it is worth mentioning that the current ratio is still above 1 which means that XYZ Plc still has enough current assets to cover its current liabilities.
4. Acid Test Ratio: It is conservative measure of liquidity as it places reliance only upon quick assets for meeting current liabilities (Fridson and Alvarez 2022). As a result, inventories are not included in total current assets for meeting the near term obligations. The quick ratio of the company has also deteriorated from 1.29 times in 2019 to 0.95 times in 2020. This is because of an increase in closing inventory which results in a decline in quick current assets. Furthermore, the quick ratio in 2020 is below 1 which means that the company does not have sufficient quick assets for meeting its total current liabilities.
5. EPS: The metric stands for earnings per share and is market ratio which indicates the total available profits per share outstanding for a company. In simpler words the metric reflects upon the total earnings which a company has been able to generate relative to the total number of shares in a company therefore implying the profitability per stock (Robinson 2020). The metric has declined from £0.21 in 2019 to £0.02 in 2020 therefore indicating a less growth potential for the company. A decline in this ratio is because of a decline in the net income of the company.

Definition of Management Accounting:

Management accounting is best understood as the provision of accounting information to the internal users within the organisation which can help them with making better decisions in an effort to improve upon the effectiveness and efficiency of the existing business operations (Blocher et al. 2019). In a nutshell, this branch of accounting is concerned with presenting the analysis of business activities to the internal management for decision making purposes (Drury 2018).

Planning is best explained as the formulation of short or long term action plans for attaining a particular set of objectives. Budgets in this context are formal financial plans which helps ascertain how resources are meant to be acquired and deployed. Management accounting is interwoven in planning as it helps in providing managers the reports that help estimate the impacts of alternative course of actions for attaining desired goals (Datar and Rajan 2018).

Control is defined as the process that monitors, measures, evaluates and corrects the actual results which are attained for ensuring the achievement of the set goals and objectives. Control is established with the help of feedback. It is with appropriate feedback that management may continue a particular operation or take remedial steps to rectify variances. Management accounting helps exercise control by providing reports such as variance reports or control reports which serves as the basis to take necessary corrective action thus following the management of exception principle. It also allows for better resource allocations for avoiding wastage (Eldenburg et al. 2020).

The process of decision making helps an organisation to choose among competing alternatives which are brought together through management accounting information. Decision making forms an inherent function among planning and control. A management cannot plan or exercise control without indulging in decision making. The information can help managers in structuring decision problems formally placing alternatives and consequences for better evaluation. Information is not just restricted to financial information as tools such as the balanced scorecard can help with non-financial information as well for decision making.

Conclusion

Based on the above report it can be concluded upon that that there are several different branches of accounting for accounting is a broad discipline. Financial Accounting and Management Accounting can be considered as one of the most important and distinguishing branches which are intended for different users of accounting information. An entity has to be mindful of the internal as well as external factors which can affect business performance. Lastly, accounting ratios are quite effective when it comes to analysing the financial performance of an entity.

References

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