Accounting and Finance Lectures Flashcards
What are the three main methods of reporting financial information?
- SFP - Statement of Financial Position [AKA balance sheet in the UK)
- Income Statement (AKA Profit and loss account (P+L)]
- Statement of Cash Flows
All statements are interlinked and present different information.
What is the accounting equation?
Capital = Assets - Liabilities
Rearranged to:
Assets = Capital + Liabilities.
Capital Transactions?
Capital Transactions affect business in the longer term. Capital Expenditure is expenditure on non-current assets.
Revenue Transactions?
Revenue Transactions affect business in current period. Revenue expenditure is expenditure on items consumes in the period. ItT will have no value at the end of the period to wish it relates.
Terms: Relevance?
Accounting information should make a difference, making it capable of influencing decisions. It should help predict future events or help confirm past events.
Terms: Faithful Representation?
Accounting information should represent what it is supposed to represent. It should be complete, as to represent all the information needed in order to understand what is being portrayed. It should be free from error.
Terms: Comparability?
Standards set in place to make comparison between different companies simpler.
Terms: Verifiability?
Provides insurance to users that the accounting information provided faithfully represents what it is supposed to represent. Different accounting specialists should come to the same conclusion that it provides a faithful portrayal.
Terms: Timeliness?
Accounting information should be produced in time for users to make their decisions. The later the financial information is produced, the less useful it becomes.
Terms: Understandability?
Accounting informant should be set out as clearly and concisely as possible. Also, those at whom the information is aimed should understand it.
How does Financial Accounting compare to Managerial Accounting?
They generally share common objectives, but they differ on emphasis in various respects. Finaical accounts tend to be for general purpose, with a broad overview, subject to regulation, annual or bi-annual, almost always historic and have a great emphasis on objectives wit verifiable evidence.
How is financial accounting having to develop?
Has to respond to:
- Increasing sophistication of customers
- Development of global economy
- Rapid technological changes.
- deregulation of domestic markets.
- Increasing pressure from owners (shareholders) for competitive economic returns.
- Increasing volatility of financial markets.
How are Assets split up and what are the definitions of the two respective divisions?
- Non-Current Assets: AKA Fixed assets. Any assets that are held onto for more than a year.
- Current assets: Held onto for less than a year.
Current Assets?
Assets being held for a short term, with the following criteria:
- Held for sale or consumption during the business’s normal operating cycle.
- Expected to be sold within a year within the current statement of financial position.
- Held principally for trading.
- They are cash. or near cash such as easily marketable, short-term investments.
Current Assets?
Assets being held for a short term, with the following criteria:
- Held for sale or consumption during the business’s normal operating cycle.
- Expected to be sold within a year within the current statement of financial position.
- Held principally for trading.
- They are cash, or near cash such as easily marketable, short-term investments.
Non-current assets?
aka fixed assets. All assets that do not meet the definition of current assets. Only tangible assets shown, PPE and financial investmenrs
Equity?
Claims of the owner(s) against the business. It represents the amounts that owners would revive once all assets were sold and all liabilities were settles at their SFP amounts. Equity = Net assets. Sometimes referred to as owner’s capital. Owners capital will be seen as an external finance, with the businesses accounts being completely separate to the owners. When financial statements are prepared, the funds from the owner will be seen as coming from outside the business and will appear as a claim against the business in its statement of financial position.
Liabilities?
Represent the claims of all individuals and organisations, apart from the owners(s). They arise from past transactions or events such as supplying foods or lending money to the business. A liability will be settles through an outflow of assets (usually cash)
Intangible Assets?
For instance, someone who has been invested in for a long time who is owned by a football club. There only value can be judged from what they were purchased for. Another instance would be relationships and connections made within a community over time. This cannot be valued but certainly holds value. It will be realised upon the sale of the underlying asset.
Business entity concept?
The business has a separate entity from the owners(s).
Types of current assets?
- Inventories.
- Trade Receivables/ Debtors.
- Other Recievables.
- Cash and Cash Equivalents.
Types of Capital?
+ Capital introduced.
+ Profit for the year.
- Drawings.
Different types of equity?
- Ordinary share capital.
- Share premium.
- Retained earnings
- Other reserves
What are the limitations of SFP?
- Historic costs vs current costs. (something may have changed, like economic climate or scandal)
- Just a snapshot at one point in time - Revaluations required due to appreciation of assets over time. (Revaluations are required due to the appreciation of assets over time, such as equipment(down) or buildings (up))
- Doesn’t reflect all assets and liabilities and current markets value fo the entity.
Going concern?
Only prepare accounts if you believe your firm is still going to be in business by the time of the next payment.
Layout for Financial Position?
NCA
+ CA
= Total Assets
Non-current liabilities
+ current liabilities
+ equity
= Equity + liabilities
Historic Cost Convention?
Holds that the value of assets shown on the statement of financial position should be based on their historic cost (their acquisition cost). Current value can be used instead, but can be clarified in two different ways.
Current Value: Two different methods?
- Current replacement cost.
- Current realisable value.
Both result in very different outcomes.
Prudence convention?
Holds that caution should be exercised when making accounting judgements. Often involves recording all losses at once and in full; including both actual and expected losses. Profits are only recognised upon realisation.
Therefore, greater emphasis is placed on losses than profits.
Dual aspect convention?
Assets that each transaction had two aspects, both of which will determine the statement of financial postion. So the purchase of a car will result in an increase in one asset (the car) and reduction of another (cash).
Money Measurement Problem: Goodwill and Brands
How to value goodwill and brands - People are willing to pay above the cost
Human resources valuation - Very hard to value the worth of people, except in the case of footballers.
Monetary stability - In inflation times some forms of accounting can be difficult
Money Measurement Problem: Human Resources
E.g. professional footballers.
Money Measurement Problem: Monetary Stability.
Monies value changes over time.
Uses of the SFP?
- Shows how the business is financed and how funds are deployed.
- Can provide a basis for assessing the value of the business.
- Relationships between assets and claims can be assessed.
= Performance and trends can be compared and assessed.
Duality concept and the two columns used in representing this method, with what each one contains.
Double-entry book-keeping used with Debits and Credits.
Debit (DR): Assets, Expenses and drawings.
Credits (CR): Liabilities, income and capital/equity.
Income Statement (profit and loss account) layout?
Revenue/ Sales/ Turnover = X - Cost of sales = (X) = Gross profit X - Sales and Distribution costs (X) - Admin Expeces (X) = Operating Profit X \+ Financial Income X - Financial Expenses (X) = Profit Before tax X - Income Tax (X) = Profit for the Year X
Asset formula (at the end of the period)?
Assets = Equirt (at start of period) + profit (-loss) for the period + liabilities (at the end of the period)
Gross Profit?
All profit in a period minus the costs of the goods, but without anything else taken off.
Operating profit?
Gross Profit - Overheads, the day-to-day expenses of the business, including wages, salaries, rent, stationery, insurance and so on.
Accruals concept?
All income/ expenditure are recognised in the period in which they occurred, not when cash is received or paid. So timing of cash transfer is irrelevant.
Matching Concept?
Costs are matched to revenues in the period in which those revenues were earned.
Realisation Concept?
Profits should not be recognised until earned.
Prudence Concept?
A cautious, but realistic approach should be taken when preparing accounts. Do not overstate assets or understate liabilities.
Prepayments?
Expense paid for in advance of the accounting period to which it relates. Come statement: \+ prepayment at start of the year \+ prepayments made during the year - prepayments at end of year.
SFP:
Prepayments included as current asset.
Accruals?
An expense owing at the end of a financial year for goods/services received but not yet payed for.
Income Statement:
- Accrual at start of the year
+ payments made during the year
+ accruals at the end of the year
= total expense for year in income statement.
SFP
Accruals included as a current liability.
Depreciation?
Spreading the cost of an asset over its useful life.
Application of accruals concept
Straight line method or reducing balance method.
SFP:
Assets valued at net book value.
Reducing balance method of depreciation?
% of NBV
NBV?
Net book value: Cost - accumulated depreciation.
Disposal of non-current assets?
Sale at end of life. Profit on disposal will lead to a reduction in expenses, a loss will lead to an increase in expences.
Will be on accounting adjustment, not a cash transaction.
Bad Debts?
When customers are unwilling or unable to pay their debts.
Treated as an expense on the income statement.
SFP:
Deducted from trade receivables.
Provision for doubtful debts?
Estimate percentage of customers that will not pay debt in addition to existing bad debts.
Application of prudence concept.
Income statement:
Increase on previous year, added to expenses, fall is subtracted from expences.
SFP:
Total deducted from trade receivables.
What are the three types of inventory valuation methods?
FIFO - First in, First out.
LIFO - Last in First out.
AVCO - Weighted average cost.
Trade Receivables problem?
Wen businesses sell goods or services on credit, revenue will usually be recognised before the customer pays the amounts owing. Recording the dual aspect of a credit sale will involve increasing sales revenue and increasing trade receivables by the amount of revenue from the credit sale.
Bad debt is written off by reducing the trade receivables and increasing expenses, by creating an expense known as bad debt. The matching convention means that bad debt must be written off in the period in which the sale took place.
Lecture 6.
Income statement?
Provides information about business performance (profitability) over an accounting period.
SFP?
Provides information on the business’ financial position (assets, liabilities and capital).
What is the statement of cash flows useful for?
A useful indicator of a company’s liquidity and solvency.
FIFO, LIFO and AVCO?
First in first out, last in first out, weighted average cost.
Accounting conventions influencing the SFP?
- Business entity concept
- Historic Cost
- Prudence
- Duality
- Going Concern
Benefits of Statement of cash flows?
Unlike profit, cash cannot be manipulated
Survival in business depends on ability to generate cash
Payables are more interested in the ability to be paid
A better basis for comparison
Provides users with information on the business ability to maintain a good credit control.
Provide management with useful information on the timing of cash requirements for the business.
Sections in the statement of cash flows?
Cash flows from operating activities:
- all cash flows from trading and operational activities and after tax paid
Cash flows from investing activities
- non-current asset purchase or sale
- finance income (interest and dividends received)
Cash flows from financing activities:
- movements in share capital and borrowings
- finance expenses (interest and dividends PAID)
Cash flows: When using the indirect method for operating activities, what is the procedure?
Start with operating profit and adjust for:
Non-cash (accounting) entries in income statement
Working capital movements (inventories, receivables and payables). The day to day trading
Tax PAID during the year
Cash flows: For investing activities, what is the procedure?
- all payments for purchase of assets and investments
+ proceeds from disposal (sale) of assets and investments
+ all returns on investment (Interest, Dividends received)
Cash flows: For financing activities, what is the procedure?
+ proceeds from issue of loans/debentures/shares
- repayment of loans/debentures
- payments for finance (interest and dividends PAID during the year)
Cash Flows: How do we reconcile the cash balance?
+/- Bank/overdraft balance at start of year
+/- net cash flow (from statement of cash flows)
= Bank/overdraft balance at the end of the year
Week 8
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What are the four types of organisation?
Sole Traders
Partnerships
Limited companies (Ltd)
Public Limited Companies (Plc)
What are the characteristics of limited companies? (9)
Companies Act 2006 Separate legal entity Limited liability Share capital AGM (Annual General Meeting) Voting rights Ownership and management are separated Annual accounts Independent auditors
Differences between Ltd and Plc companies?
Private limited companies (Ltd):
Can’t sell shares to general public
Usually few shareholders
Public limited companies (Plc): Can issue shares to general public Can be traded on stock exchange Can have many shareholders More onerous rules and regulations Public accountability
How are the different businesses financed?
Sole traders and partnerships: Capital introduced (Sole traders and partnerships)
All businesses: Bank finance (overdrafts and loans)
Limited companies:
Debenture loans/bonds
Ordinary share capital
Preference share capital
What are the properties of Debentures/ Loans/ Bond?
Issued to public by Plcs Long-term loans Fixed interest rate Fixed repayment date Usually securitised – fixed or floating Traded on stock exchanges
Share capital?
Issued by all limited companies and Plcs
Permanent source of finance
Profits distributed in the form of dividends
Preference and/or ordinary share capital
Preference vs ordinary shares?
Preference shares: Preferential treatment over ordinary shareholders Fixed dividend Usually cumulative No voting rights
Ordinary shares: Highest risk/potentially higher rewards Fluctuations in dividends, maybe none at all Voting rights Last to be repaid
What are dividends? (deducted from where and when are they paid)
Distribution of profit to shareholders
Deducted from retained earnings
Usually paid in two instalments – interim and final
Reserves - What is distributable and what is not?
Distributable:
Retained earnings
General reserve
Non-distributable: Ordinary share capital Share premium Preference share capital Revaluation reserves
Lecture 8
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Nominal value?
The minimum amount that a share can be sold for.
Ordinary share capital?
The amount raised by shares by the nominal value multiplied by the number of shares.
Share premium?
The amount on top of the nominal value that must be paid per share. So in a plc not listed on the stock exchange, if 20000 shares were sold at £1 and a further 10000 later at £1.50, The ordinary share capital will be £30000 and the share premium will be the extra on top, namely £5000.
Why would shareholders vote to reject a dividend?
They may want to encourage internal investment in the company, or think the owners are trying to extract to much from the business.
What can shareholders vote for?
- Reject/accept the dividend.
2. Choice of directors.
Why do PLCs have to disclose more information?
Theres a greater level of investment so more exposure in the market as. a whole. As such
Why might companies not list on the stock exchange? (4)
- A need to supply more information which can be interpreted in many different ways.
- Potential for more bad publicity and sways due to market sentiment.
- inability to choose who buys the shares, making aims potentially different from share holders and business.
- less control over the business.
Preference share capital?
Sits somewhere between ordinary share capital and debentures (bonds). They take preference over ordinary shares.
Dont have a voting rate and have a fixed rate of dividend (constant perpetuity).
More safe than ordinary shares. more uncommon now and similar to debentures.
What are the three types of financing businesses can use? (3)
- Ordinary shares
- Preference Shares
- Debentures
What happens if a company cannot pay its preference share holders?
A cumulative preference share, the company will rollover the share and pay it next year.
Debentures?
An insecure bond, no collateral. A fixed rate of interest paid back each year and the debentures usually have a finite term. No voting rights, so basically a loan. This cost will be a Finance cost and will reduce tax
Venture capital?
Similar to dragons den. The company will go to venture capitalists and offer them shares for a given percentage of the company.
Preference Dividend vs Debentures
Debentures are tax deductible, so reduce tax bill.
Preference shares cannot be deducted from tax
Lecture 9
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IASB Framework?
The IASB Framework shows how financial statements help in making these assessments.
The financial position of an entity is affected by:
The economic resources it controls,
Its financial structure,
Its liquidity and solvency and
Its capacity to adapt to changes in the environment in which it operates
IASB: What is the financial position of an entity affected by? (4)
The economic resources it controls,
Its financial structure,
Its liquidity and solvency and
Its capacity to adapt to changes in the environment in which it operates
IASB: What is information about financial structure useful for?
- Predicting future borrowing needs and how future profits and cash flows will be distributed among those with an interest in the entity.
- Predicting how successful the entity is likely to be in raising further finance.
IASB: What is information about liquidity and solvency useful for?
- Predicting the ability of the entity to meet its financial commitments as they fall due.
Solvency?
The availability of cash over the longer term to meet financial commitments as they fall due.
Liquidity?
The ability of the entity to raise cash to pay off liabilities as they become due for payment.
Difference between manufactures and retailers with regards to liquidity?
Retailers turn sales into cash very quickly as customers pay cash for goods.
Manufactures sell to their customers on credit and so have to wait for payment.
Retailing cash flow cycle?
- Goods purchased on credit from suppliers
- Goods sold for cash to customers
- Cash used to pay suppliers and other claims upon the entity
Manufacturing cash flow cycle?
- Raw materials purchased on credit from suppliers
- Raw materials turned into finished goods
- Goods sold on credit to customers
- Customers pay what is owed on the due date
- Cash used to pay suppliers and other claims upon the entity
Short term liquidity ratios: Current and quick ratio uses?
Compare current assets with current liabilities to assess the ability of short-term assets to cover short-term liabilities
Current assets generate cash from sales of inventory and from trade receivables paying what they owe
This cash is then used to meet current liabilities as they become due for payment
Current ratio and Positives and negatives?
Current assets / Current liabilities.
Only a snapshot of an entity’s short term liquidity at one day in the year.
Cash circulates constantly as new sales are made, receivables are paid and payables paid.
Ignores the timing of further cash receipts.
A low ratio isn’t necessarily an indicator of short term liquidity problems.
Quick Ratio and Positives and negatives?
(Current Assets - inv)/ Current Liabilities
Ignores inventory as inventory is assumed to be difficult to sell and so not easily convertible into cash
Uses current assets that are either cash or quickly convertible into cash (trade receivables = a contractual right to receive cash for sales already made)
Assumption that inventory will not sell may not be realistic: depends on each entity’s industrial sector and production of goods to order rather than stockpiling production
What are the two ways to asset liquidity?
- Short term Cash flow:
Quick and current ratio.
2. Working Capital Ratios
Working capital ratio, positives and negatives?
Working capital = current assets (inventory, trade receivables and cash) – current liabilities (trade payables).
Working capital ratios look at how quickly inventory is sold, how quickly trade receivables are turned into cash and how quickly trade payables are paid.
Aim to overcome problems posed in liquidity assessment by static current and quick ratios by looking at the speed of cash movement
Assessing Liquidity (2): Inventory Days Ratio, and positives and negatives?
Inventory days = (Inventory / COS) x 365
Measures the average stockholding period
How long an entity holds inventory before it is sold
The lower the inventory days the better
Consider future demand, potential shortages, bulk discounts, insurance and storage when calculating optimum inventory levels
Assessing Liquidity (2): Receivable days, and positives and negatives?
(Trade Receivables/ Credit Sales) x 365
Determines the average credit period taken by credit customers.
Evaluates the efficiency of an entity’s credit control and the speed with which credit sales are turned into cash
Where this ratio increases, take steps to speed up receipts from customers
Assessing Liquidity (2): Payable days, and info?
(Trade payables / COS) x 365
Payables Days:
Determines the average credit period taken by an entity from its suppliers
Measures how quickly an entity is paying for its purchases
Ideally, as trade receivables pay what they owe, the cash is then used to pay trade payables
Assessing Liquidity (2): Cash Conversion cycle?
Cash conversion cycle = inventory days + receivables days – payables days
How quickly inventory is turned into trade receivables
How quickly trade receivables are turned into cash with which to pay trade payables
Assessing Liquidity (2): Long vs short cash flow cycles?
The shorter the cash conversion cycle:
The better working capital is being managed
The more readily cash is available to meet liabilities
Conversely, the longer the cash conversion cycle:
The higher the investment required in working capital
The higher emergency sources of cash will need to be in order to pay liabilities as they fall due
Assessing Liquidity (2): The importance of working capital?
Entities need cash with which to pay suppliers for goods supplied
Suppliers cannot wait for buyers to make products, sell them on credit and then wait for cash from their customers before they pay what is owed
Therefore, many companies rely on short-term finance (overdrafts) from banks from which to make payments to suppliers as firms operate day-to-day or expand
Assessing Liquidity (3): Estimating the Timing of Cash Outflows
Current and quick ratios assume all liabilities are payable on the day after the accounting period end date
This assumption is totally unrealistic as current liabilities are due for payment over the next 12 months
Estimating how much is due on the day after the accounting period end and comparing this estimate to cash available at the year end will present a much more realistic picture of short-term liquidity
Assessing Liquidity (3): Estimating cash flows for one day?
The maximum amounts due for payment on the day after the accounting period end (figures from the statement of financial position):
Current portion of long-term borrowings ÷ 12.
+ Trade payables ÷ trade payables days.
+ Bank overdrafts (repayable on demand).
+ An estimate of other payables due in a day’s time.
= Total current liabilities due one day after the accounting period end date
Assessing Liquidity (3): Cash Surplus/Deficit 1 Day After Accounting Period End Date?
Cash available at the accounting period end date
+ Cash from cash sales for one day (cash sales for year ÷ 365 days)
+ Cash received from trade receivables in one day (trade receivables at period end ÷ trade receivables days)
– Total current liabilities due one day after the accounting period end date as calculated
= Cash available/cash needed after 1 day
How do users assess the entities’ ability to meet liabilities in the short term?
Current and quick ratios
Working capital ratios
Cash conversion cycle
Estimating daily cash inflows and outflows
Long term solvency?
Long-term solvency = an organization’s ability to meet the interest on and repayment of long-term, non-current liabilities as they fall due
Long term solvency ratio, and info?
Gearing=
[(Long + Short term borrowing)/ Equity ] x 100
Gearing is often perceived as a measure of risk
The higher the borrowings, the higher the risk entities will not be able to service their debts:
Through the payment of interest or
By repaying those borrowings when they become due.
Long term solvency ratios: Debt Ratio, and info?
Debt ratio = Total Liabilities / Total Assets
Measures the £s of liabilities per £ of assets
The lower the ratio, the more secure the entity
Long term solvency ratios: Interest cover, and info?
Interest cover = [Profit Before Interest and Tax] / Interest Expense
Assesses how many times interest payable on borrowings can be paid from operating profit
A measure of the affordability of interest on borrowings
The higher the figure the better: a high figure indicates an ability to continue meeting interest payments from profits in the future
Long term solvency: How consistent is demand for an entity’s products or services now and into the future?
The more consistent the demand, the more stable and solvent the entity
Are an entity’s products likely to become obsolete or be replaced by superior products from competitors?
How strong are the entity’s operating cash inflows?
The stronger the operating cash inflows, the more likely an organization will be able to meet its long-term borrowings as they become due
Long term solvency: How many years before repayment of borrowings becomes due?
The higher this number the more time the company has to save up what is owed
Is the interest rate on long-term borrowings fixed or variable?
Fixed interest rates mean an organization will not suffer a sudden fall in profitability or shortage of cash if interest rates suddenly rise
Lecture 10
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What do financial statements allow the user to draw conclusions about?
How profitable an entity is
How strong an entity’s financial position is
How well an entity is performing from a financial point of view
How secure its future cash flows are likely to be
How financially stable it is
Financial Statements: Different analysis categories?
- Profitability
- Efficiency
- Performance
- Short-term liquidity
- Long-term solvency
Why are ratios useful?
Ratios highlight variances across time that are not apparent from the figures in the financial statements
Highlighting these variances enables users to ask questions to find out why the changes have occurred
Calculating ratios provides information about which relationships have changed
Explanations for these changes assist users in understanding a business and how it operates
Why use figures and ratios in evaluation?
Looking at just the ratios ignores the size of the figures
Looking at just the figures ignores the changing relationships between the figures
Profitability Ratios: Gross Profit %, and info?
Gross Profit / Revenue x 100.
The profitability % after deducting the direct costs of production of goods sold or the direct costs of goods bought for resale
Assesses how effectively entities are controlling their production costs/costs of buying in goods for resale
Profitability Ratios: Reasons for the changes in gross profit %?
- Selling prices rising faster/more slowly than direct costs of goods sold
- A changing sales mix from higher to lower margin goods or vice versa
- Rising/falling prices of materials/goods bought in
Increased/decreased productivity of the workforce - Supplier bulk discounts reducing input costs
- Bulk discounts offered to customers reducing revenue
Profitability Ratios: Operating Profit %, and info
( Operating Profit / Revenue ) x 100
Profitability Ratios:
Profitability % on the basis of revenue – all operating costs
But before taking into account the effects of net finance costs and income tax
Evaluate changes in distribution and selling costs and administration expenses and their effect on profitability year on year
Profitability Ratios: PBT %, and info?
( PBT / Revenue) x 100
eliminating the distorting effect of changes in tax rates
The profitability % after deducting all costs incurred and adding all income earned
Profitability Ratios: PAT % and info?
(Profit for year / Revenue ) x 100
Profitability % after adding all income and deducting all expenses and charges for the period under review
Efficiency ratios?
Measure how effectively and productively the resources of the organization are being used in the generation of revenue and profit
Higher profitability as a result of more efficient and productive use of entity resources
What two categories do resources fall under?
Firstly, non-current assets used in the production of goods and generation of sales
Secondly, the employees engaged within the business
Efficiency ratios: NCA Turnover, and info?
Revenue / NCA.
Measures £s of sales per £ of non-current assets
The higher the ratio, the more efficiently and productively the non-current assets are being used to generate sales
Warning: non-current assets at out of date values and leased assets that do not appear in the SoFP non-current assets can distort this ratio
Efficiency ratios: Revenue and Profit Per Employee, and info?
Operating profit or Revenue ÷ number of employees.
Employee performance determines the success or otherwise of organizations
Increasing productivity = greater sales, more profit
If employees are paid a fixed salary, the more they produce/sell for that fixed amount, the more profit their employer will make and vice versa
Efficiency ratios: Sales and Profit Per Unit of Input Resource, and info?
Retail sector: measure sales and profits per square metre or square foot of selling space
Rising sales and profit per square metre/foot of selling space means more has been produced from the same unit of resource
Therefore input resources have been used more efficiently and effectively to generate revenue and profit
More revenue and profit has been squeezed out of each unit of resource
Efficiency ratios: EPS , and info
(Profit after taxation and after preference dividends) ÷ Number of ordinary shares in issue x 100 pence.
A measure of the pence of profit earned during an accounting period by each share
After deducting all prior claims on the profits for the accounting period
Theoretically, the dividend if all profits for the financial period were paid out to shareholders
Why is EPS so important?
EPS is a key figure for the stock market
Where EPS are expected to rise, share prices rise ahead of a profits announcement
Where EPS are expected to fall or stay the same, share prices tend to fall ahead of a profits announcement
Falling EPS suggest reduced dividends
Rising EPS suggest increased
Performance Ratios: P/E Ratio, and info
Price to earnings ratio:
Market value of one ordinary share / EPS.
How many years it will take an investment in a share to repay its owner in earnings
Higher P/E ratios = steady profits as dividends from such shares are more certain
Lower P/E ratios = volatile profits as dividends from such shares are much less certain
An indicator of the market’s confidence in a company: higher P/E = higher confidence
Performance Ratios: DPS, and info?
DPS = Total Ordinary Dividends ÷ Number of Ordinary Shares in Issue.
Rising DPS indicates confidence in a company’s ability to generate rising profits each year
Higher dividends lead to higher share prices
Performance Ratios: Payout Ratio?
DPS/EPS x 100% = the payout ratio, the % of EPS distributed as dividend each year
Performance Ratios: Dividend Yield?
ordinary dividend per share ÷ current market price of one ordinary share.
The DPS as a % of the current market price of one ordinary share
Serves the same purpose as an interest rate on a bank deposit account
Performance Ratios: Dividend Cover?
(Profit after taxation and after preference dividends) ÷ total ordinary dividends.
How many times the current year ordinary dividend could be paid from profit for the year
The higher the dividend cover, the more secure the dividend payout into the future
A measure of profit retention for future investment: the higher the dividend cover, the more profit is being retained within the business
Performance Ratios: ROCE, and info?
Return on capital Employed = (profit before interest and tax / Equity + Long term borrowing) x 100
Compares different profits of different entities with different capital structures
To determine which entities produce the highest returns from their capital structures
To guide investors towards the highest available returns
Problems with ROCE?
Not all assets used to generate profit are presented in entities’ SoFPs
SoFP figures do not represent current values
Share capital and retained earnings are expressed in different value £s to today’s profits
All figures need adjusting for inflation so that capital employed is expressed in terms of today’s money
Total shareholder return is a better indicator of investment returns available from companies
Consistency with regards to ratios?
Ratios must be calculated and presented consistently
To give a fair comparison year on year
Otherwise comparisons are distorted and figures given are misleading
Consistent calculation and presentation gives an accurate picture of an entity’s financial position and performance compared to other years
How can we see how well a company is doing?
Compare company results to: Competitors in the same industry Of similar size In similar locations Over the same accounting period In order to eliminate random variances arising from different activities, size, industry, geographical location and economic factors Comparative data should be consistently prepared to avoid distortions and bias in the figures Industry average Planned Performance data.
