Accounting Analysis Flashcards
what is accounting defined as?
recording, measuring and reporting of economic events or activities to interest parties or in a usable form
what is the role of financial statements?
enable stakeholders to objectively compare the information against previous periods
who is responsible for the preparation of financial statements?
directors are required to prepare them and make other disclosures through periodic reports
what is the statement of financial position/balance sheet?
provides a snapshot of the companies financial position as of a given date. made up of assets, equity and liabilities. assets and liabilities are on opposite sides of the sheet and must match up
what is the income statement?
summarises income or revenue that is earned and expenses earned over the accounting period- referred to as the profit and loss statement
what is a cash flow statement?
identifies how much cash the company generated over the accounting period and how much cash has been spent. divides the source and use of cash into operating, investing and financing activities
what additional financial disclosures can companies provide?
statement of comprehensive income, statement of changes in equity and notes explaining policies
what are assets?
items owned/controlled by the company- expected to yield economic benefit in a future period
what are liabilities?
money owed by the company to others i.e., to suppliers, taxes and to lenders
what is equity?
amount invested into the business by its owners and earnings made, not paid out in dividends
what is revenue?
sales made by a company, leading to increase in assets or decrease in liabilities
what are expenses?
the costs of doing business
what is GAAP/
generally accepted accounting principles
what is the IFRS Foundation and what is it made up of?
public interest organisation established to develop disclosure standards. standards are developed by two standard-setting boards IASB (international accounting standards board) and ISSB (international sustainability standards board)
why are group financial statements prepared?
when an investment is so significant that the investing company controls the other company. as long as the parent/subsidiary relationship exists, the parent company should prepare and present them as a set of accounts
how are group financial statements presented?
as if the parent and subsidiaries were a single entity?
what is goodwil?
essentially if the cost of investment into the subsidiary from the parent is more than the net assets of the subsidiary, the excess is considered goodwill and will appear as an asset on the consolidated financial statement (as the investment into the subsidiary will provide income in the future- so this asset will yield economic benefit in future periods)
what are non-controlling interests?
when the parent company owns a majority of the shares but not all, there will be other non-controlling interests. reflected by detailing to what extent the net assets and income belong to the non-controlling interests
what are tangible non-current assets?
those that have physical substance such as land or machinery, initially recorded at their cost, to reflect that they will provide a benefit for the business, they are required to be depreciated.
what are intangible non-current assets?
assets that are expected to generate economic benefits over a number of accounting periods but are without physical substance e.g., intellectual property
what are non-current investments?
investible assets such as equity investments or investments in debt in other companies that won’t mature within the next year or be sold
what are current assets?
those that are purchased with the intention of resale or conversion into cash, usually within a 12 month period e.g., stocks, finished goods debtor balances, any short-term investments held
how are current assets typically listed in the statement of financial position?
in ascending order in terms of liquidity
what is depreciation?
applied to tangible, non-currents assets. assets wear out over time and this reflects that- doesn’t apply to freehold land and non-current investments which are not usually depreciated due to having a limited economic life
what is amortisation?
applying the principle of depreciation but to intangible non-current assets such as licenses and patents
what is straight line depreciation and how is it calculated?
spreads out the depreciation amount equally over the economic life of the asset
straight line depreciation+ (cost - disposal value)/useful economic life in years
what is share capital?
nominal value of equity and preference share capital the company has to issue and has called up
what is capital reserves?
revaluation reserves and the share premium account (this arises when the company issues shares at a price above their nominal value)- not distributable to company’s shareholders in the form of dividends, can be converted into bonus issue
what are revenue reserves?
accumulated retained earnings of the company, accumulation of the company’s distributable profits
how is equity calculated?
equity = share capital + reserves
what are non-current liabilites?
company’s borrowing not repayable within the next 12 months
what are provisions/
obligation to make a payment but the exact amount or timing of the expenditure has yet to be established
what are current liabilities?
amount the company owes, fall due for payment within 12 months
what is the income statement?
summarises income earned and expenditure incurred- referred to as profit and loss statement. Bottom line of this shows earning per share.
what are costs of sales?
cost to the company of generating sales made in the financial year- include costs directly associated with producing the goods that are sold, doesn’t include indirect expenses such as cost of distribution
what is gross profit/
total sales minus the cost of the those sales
what is operating profit?
profit on operating activities, gross profit minus operating expenses (e.g., distribution, audit and legal fees) the company has incurred. comes before the consideration of finance costs (interest) and tax payable
what is net income?
income once tax and financing costs have been deduced- reflects all of the revenues earned during the period minus all expenses incurred. profit attributable to the shareholders of the company
what is EPS and how is it calculated?
earnings per share- displays the company’s profit expressed on a per share basis
EPS= net income for the financial year-dividends on preferred shares/ number of ordinary shares in issue
what is capital expenditure/
money spent to buy non-current assets
what is revenue expenditure?
money spent that immediately impacts the income statement e.g., wages to staff, rent paid and professional fees
what is the purpose of the cash flow statement?
summary of all the payments and receipts that have occurred over the course of the year- required by accounting standard IAS-7
what are the key cash flow statement headings and what do they mean?
operating activities: cash that has been generated from trading activities
investing activities: investment income that has been received in the form of cash
financing activities: cash spent during the year on paying dividends to shareholders, borrowing on a long term basis
what is the difference between profit and cash?
profit appears as the excess of revenues over expenses incurred over the period whereas cash is generated when cash received exceeds cash that is paid out. because profit is based on revenue earned not cash paid, the numbers between the two could vary
what is free cash flow and how is it calculated?
no single definition, logically it represents the amount of cash that has been generated that the company can choose what to do with.
calculated by taking the net income from the income statement, adding back charges for depreciation/amortisation and taking away capital expenditure.
what is enterprise cash flow?
free cash flow before considering payments made to any of the providers of finance to the firm i.e., lenders and equity holders
what is equity cash flow?
free cash flow to shareholders, after financing to lenders but before any payments to shareholders
what is the purpose of the strategic report?
directors of the company report on the strategy that the company has adopted including major plans for the future
what is the purpose of the stakeholder view?
looks at the major stakeholders and the way the company is looking after their interests
what is the purpose of the Financial Review?
CFO will outline the companies performance based on a variety of metrics
what is the governance report?
outlines how the company runs the business responsibly and effectively including individual reports from sub-committees of the board
what is director’s renumeration?
how the directors are rewarded
how are ratios used to engage in financial statement analysis?
commonly employed by analysts to assess the prospects of a company and its investment potential
- assists in assessing business performance
- summarises financial information
- identifies trends, strengths and weaknesses
what are the limitations of using ratio analysis?
- not predictive (based on historical data)
- comparison is difficult
- differences in international accounting practices
- significant judgement is needed (can create divergence)
what are profitability ratios?
representation of the percentage of return that the company generates relative to its revenues
what is the operating profit margin?
portrays the percentage of revenues that the company earns after considering costs of sales and other operating costs
what is the net profit margin?
percentage of revenues that the company earns after considering all costs
what is return on capital employed (ROCE)?
best ratio for mearing overall management performance- looks at the amount of profit being generated as a percentage of finance put into the business
what is ROE?
return on shareholders equity- net income generated as a percentage of the equity financing the business
how is ROCE calculated?
(operating profit/capital employed) x100
where operating profit is profit before financing and tax and capital employed is the total for equity on the statement of financial position plus the total for non-current liabilities
how is return on assets calculated?
ROA= (operating profit/total net assets) x 100
where total net assets is is the non-current assets plus the current assets, less the current liabilities
what is the formula for return on shareholders equity?
(net income/shareholders equity) x 100
how are the gross/ operating profit margins calculated?
gross profit margin= (gross profit/revenues) x 100
operating profit margin= (operating profit/revenues) x 100
what is asset turnover and how is it calculated?
annual revenues (turnover) divided by the total assets in the business. reflects the amount of activity generated from the assets
asset turnover (number of times)= revenues/total net assets
what is an alternative way of calculating the ROCE/ROA?
operating profit margin x asset turnover
what is financial gearing?
measure of risk arising from the company’s debt, AKA ‘financial leverage’. determined by examining the amount of a company’s financing that comes from debt and the amount that comes from shareholders funds or equity- debt to equity ratio
what does a higher proportion of debt finance mean?
higher the risk that the company will not be able to meet their financial commitments
how is debt to equity ratio calculated?
debt/equity
how is net debt to equity caluclated?
debt - (cash + short term investments)/ equity
how is interest cover calculated?
used to determine how easily the company will be able to pay interest on outstanding debt.
operating profit/ interest costs
how is the current ratio calculated?
current assets/ current liabilites
what is the quick ratio and how is calculated?
excludes inventory from the calculation of current, gives a tighter measure of the company’s ability to meet a sudden cash call
quick ratio= (current assets - inventory)/ current liabilities
how is EPS calculated?
net profit or loss attributable to ordinary shareholders / average weighted number of ordinary shares
what does EPS reveal?
how much profit that was made during the year is available to be paid out to each share
what is the P/E ratio?
price earnings ratio, how many times profits per share must be paid to buy a share (be worth it) i.e., how expensive/cheap those shares are
how is the EPS calculated once preference shares are equated for?
(Net income for the financial year - dividends on preferred shares) / number of ordinary shares in issue
what could cause share dilution?
- convertible loan stock/convertible preference shares
- options or warrants
calculation and disclosure is IAS 33
how is the P/E ratio calculated?
current market price per share / earnings per share - number of years of earning at the current level to generate the share price
what is the trailing P/E?
trailing twelve months, backwards-looking P/E, can be updated between annual reports
what is the forward P/E?
estimated P/E, based on an estimation of net earning over the next twelve months- derived from the mean (consensus estimate)
what are the uses of the P/E ratio?
can analyse the market’s stock valuation of a company and it’s shares relative to the income the company is actually generating, relative valuation of stocks. can see if the stock or company is over/undervalued
what is EV?
enterprise value- measure of company’s value, alternative to straightforward market cap.
calculated as market cap. + all outstanding debt, non-controlling interests and preferred shares, minus all of the cash and cash equivalents (cost of purchasing an entire business)
how is EBIT calculated?
Earnings before interest and Tax
Revenue - expenses (excluding tax and interest)
what is EBITDA and how is it calculated?
Earnings before interest, tax, depreciation and amortisation. leaves out cash required to fund working capital and the replacement of old equipment.
Revenue - expenses (excluding tax, interest, depreciation and amortisation)
what is the gross dividend yield and how is it calculated?
total dividends paid per share over the last year as a percentage of the share price. high yield might mean the share price is relatively low in comparison with its return
(dividend / current share price) x 100
what is the gross dividend cover and how is it calculated?
used to asses how well a company has covered its dividend payments with the profits generated. also reveals the proportion of profits that were reinvested in the company.
EPS / dividends per share
