Accounting Topic 3 (Financial Statement Analysis) Flashcards
financial analysis tools
- financial ratio analysis
- graphics
financial ratios
- comparable across companies & see trends
- ratios are interrelated
-> inefficient = poor profitability = low value = cant sell equity = low leverage = high costs/risky funding - express 1 number in relation to another
- standardise financial data in terms of mathematical relationships expressed as %, times or days
analysis of past performance
- aspects of performance = success competing in the industry
- How well perform (own history and competitors)
- Causes of performance
- Does the performance reflect the company’s strategy?
ratios are not always relevant:
- irrelevant for certain companies
- redundant
- Industry specific = as important as general financial rations
-Different users = focuses differ (creditors, investors)
-Creditors - focus on solvency ratios (leverage and coverage)
-Investors (market ratios, P/E, P/B) combined with financial
-Sources categorise some ratios differently and include different ratios - Accounting standards = different reported = limit comparability
liquidity
whether company can pay off interest
whether the company has repaid part of the debt/ability to repay
- investors are concerned with if bankruptcy - debt holders are paid first
4 performance ratios of a company
PROFITABILITY
- Asset turnover
- ROE
- profit margin
- ROCe
5 position ratios of a company
LIQUIDITY
1. Quick ratio
- inventory holding
- receivables collection period
- payables payment period
- current ratio
3 Position ratios of company
GEARING
1. Interest cover
- Gearing
- Debt to equity
Debt vs Equity
· Cost of debt < cost of equity
- Most debt is secured against assets
- Creditors are not really going to lose money
- Equity more expensive = if Bankrupt not getting anything till all liabilities are paid
- Higher expected returns effectively from shareholders
- Too much debt is risky for shareholders as
· Shareholders dividends are paid after interest
· Investors take the largest portion of the risk
Repayment of equity capital comes after principal repayments of debt on winding up of the company
Capital employed
debt + equity
(2 main ways of funding a company)
investors and return
- investors concerned with total return on their investment
return is made up of 2 elements
- dividends
- capital growth - change in mkt value
(gains through share price going up)
3 elements of investor ratios
- market value - amount paid for share
- earnings - total available to pay out to SHs
- dividend - what is paid out to SHs
4 investor ratios
RETURN ON INVESTMENT
1. dividend cover
2. dividend payout ratio
3. EPS
4. PE ratio
EPS
○ Earnings/Number of shares
- Share price movements
- Heavily regulated calculation from accounting standards
- Basic EPS
- Diluted EPS
Number of shares are going up
Basic EPS
number of shares that the company has, they have issued some of them are traded on stock exchange, some not traded on stock exchange
Diluted EPS
debt can be converted into equity if debt holder exercises this option = change number of shares or dilute the number of shares, all convertible instruments from debt to equity exercised their option
cash flow ratios
- cost generated from operations (how much money coming from runnignthe business. customers from investing activities, buying and selling assets
- financing activities (cash flows from funding the company)
- provide info that help analyse better the company’s past performance (trend and cross sectional) & develop expectations about company’s future prospects
5 cash flow performance ratios
6 cash flow coverage ratios
free cash flow to the firm
Cash flow available to the company’s suppliers of capital (debt and equity).
- After all operating expenses (including taxes) & investments (fixed and working capital) have been paid.
free cash flow to equity
Cash flow available to the company’s common stockholders.
- generated enough cash from operations after organic growth and after debt holders have been paid
-operating expenses (including taxes) have been paid.
-borrowing costs (principal and interest) have been paid.
-operating investments have been made for fixed capital and working capital.
fixed capital expenditure
desirable that operating cash flows are sufficient to cover capital expenditures
CFO
- CFO represents cash flow from operating activities under U.S. GAAP or under IFRS where the company has included interest paid in operating activities.
- Under IFRS, if interest paid was included in financing activities, then CFO does not have to be adjusted for Int(1 – Tax rate).
Under IFRS, if the company has placed interest and dividends received in investing activities, these should be added back to CFO to determine FCFF. In addition, if dividends paid were subtracted in the operating section, these should be added back in to compute FCFF.
advantages and disadvantages of using cash flow as a measure of company performance
advantages and disadvantages of using EPS as a measure of company performance
limitations of ratios
-Companies = not very similar & many industries
- Accounting numbers are subject to creativity
- starting point = identify further questions to ask about the present position and future directions of the operations and the financing of a company.
- They do not provide answers in themselves.
Value of ratios
- facilitate comparisons
- prior expectations & external observations
- previous figures and comp figures
- industry averages
graphics
- geographical segments - most major market for revenue or profit
- benefit = more info = informed decision
con = handing out info to competitors
