Campbells Notes - Company Finance

Question 1

What are a companies main source of finance and why is it important?

Answer 1

a. Share Capital (ordinary and preferences)
b. Debt
c. Retained Profits (profits once dividends allotted)

Companies will need to manage their working capital effectively otherwise they may run short of cash.

Question 2

What are the two share prices of a company?

Answer 2

A share has two prices:
1. Nominal or “at par” price
2. Market Price (2nd hand price – of more interest to shareholders)

Question 3

What is a share premium?

Answer 3

If a share is sold at a price above its nominal value, this is known as a premium. Share premium is a capital reserve of the company Its cannot be touched or used for dividends.

Question 4

What are the key features of an Ordinary share?

Answer 4

Key features of Ordinary shares (sometimes referred to as equity shares) are:

1. No fixed dividend
2. Voting rights
3. Own the reserves of the company

Question 5

In rare circumstances, you can use the Share Premium to do what?

Answer 5

1. Share Issue Expenses
2. Bonus Issue of Shares (sometimes shareholders may accept a bonus issue of shares in lieu of a dividend)

The Share Premium Account is a capital reserve if the company. This cannot be used to pay dividends to the shareholders.

Question 6

What are the key features of preference shares?

Answer 6

Key features of Preference Shares are:
1. Fixed Percentage Dividend (doesn’t increase or decrease however if company has low profit, it doesn’t’ need to be paid)
2. No voting rights
3. Priority of payment (paid before ordinary)

Question 7

What are the key features of cumulative preference shares?

Answer 7

Key features of Cumulative Preference Shares are:
1. The holders receive arrears of dividends if they do not receive their full entitlement in any one period

Question 8

Why do preference shares tend to be unpopular?

Answer 8

Preference Shares tend to be unpopular due to :
1. No voting rights (less control)
2. No participation in high dividends
3. Companies have to set a higher return to compensate

Some people argue whether preference shares should be treated as equity or debt. Although they are called shares, in some ways they have more characteristics or debt as they have fixed return, no voting rights and can be redeemable (get money back after 3 years) similar to a loan.

Question 9

What is debt?

Answer 9

Non-current liability of the company such as a bank loan, mortgage, debenture, or finance lease.

Company needs to be able to pay the interest required on the debt otherwise its likely the company will fold.

Question 10

What is a debenture?

Answer 10

A loan to the company but can be traded on the market.

Debenture holders have no voting rights.

Interest must be paid irrespective of the level of profit.

Finance cost is tax deductible therefore the company can treat the interest as an expenses before tax. This would make the tax bill profit. This is in contrast to dividend payments where there is no tax relief on the dividend payments.

Question 11

What are the primary statements for a company?

Answer 11

1. Statements of Profit and loss and other Comprehensive Income - joint statement showing 5 profit figures
2. Statement of Financial Position – sometimes called the balance sheet
3. Statement of Changes in Equity
4. Notes to the Accounts – Governed by IAS1 if following international stds.
   IAS1 has a rule - only shows dividends paid, not proposed

Question 12

What 5 profit figures are shown on the Statement of Profit and Loss and other comprehensive income?

Answer 12

1. Gross Profit – Profit on trading
2. Profit from Operations – Profit from own business activities
3. Profit before Tax – Before tax and finance costs
4. Profit for Period – Can be used to pay dividends
5. Total recognised income for the period – will include gains and losses (could be re-valuations of property) but these are not distributable as dividends

Question 13

How do you calculate Gross Profit and what IFRS governs the recognition of income?

Answer 13

This is profit on Trading and is calculated as:

Sales Revenue less Costs of Sales = Gross Profit

IFRS 15 provides a five-step model for the recognition of income.

Question 14

How do you calculate Cost of Sales?

Answer 14

Opening Inventory + Purchases – Closing Inventory + Manufacturing Expenses

Question 15

How do you calculate Profit from Operations?

Answer 15

Profit from Operations will be calculated as:

Gross Profit less Operating Expenses

Operating Expenses are normally classified as Distributions Costs, Administration Expenses, Other Costs.

Distribution – Delivery, advertising, and marketing
Admin – office expenses
Other – can’t find a home for

Question 16

How do you calculate Profit before tax?

Answer 16

Finance costs and Tax are deducted.

In many questions, use the tax expense figure provided by the examiner.

Care may need to be taken with finance costs. Watch out for:
1. Unpaid Finance Costs
2. Finance Costs under the terms of a finance lease

Question 17

What would be included in other comprehensive income and what is total recognised income for the period?

Answer 17

Total recognised income for the period – will include gains and losses (could be re-valuations of property) but these are not distributable as dividends

The profit for the Period is distributable to the shareholders as dividends. However, the company may have made other gains which cannot be used to pay dividends but should be recognised in the financial statements.

These gains may be described as “other Comprehensive Income.” For example, a property re-valuation gain.

Question 18

What does the statement of financial position (the balance sheet) show?

Answer 18

Shows the assets and liabilities of the company.

Question 19

What is the definition of an ASSET?

Answer 19

ASSET – A resource controlled by the enterprise as a result of past events from which future economic benefits are expected to flow.

This could be an invention or patent – doesn’t need to be a machine.

Question 20

What is the definition of a liability?

Answer 20

LIABILITY – A present obligation arising from past events, the settlement of which is expected to result in an outflow from the enterprise of resource.

Question 21

What is the definition of equity?

Answer 21

EQUITY – The net assets of an enterprise after all other creditors have been paid off.

Question 22

What can assets and liabilities be categorised as and what would be some examples of such?

Answer 22

Current and Non Current.

The key test, is to determine whether an asset or liability will continue to remain on the books for more than one year. Less than 1 year (current), more (non current).

Examples
Buildings - Non Current Asset
Inventory - Current Asset
Debenture Loans - Non Current Liability
Trade Payables - Current Liability
Bank Loans - NON CURRENT LIABILITY
Trade Receivables - Current Asset
Cash in Hand - Current Asset
Bank Overdraft - Current Liability
Mortgage - Non Current Liability
Finance Lease payable over 5 years - Non Current Liability
Finance Lease payable within one year- Current
Liability
Pre-paid insurance - CURRENT ASSET
Wages in arrears - Current Liability

Question 23

What is the purpose of the Statement of Changes in Equity and why is this needed?

Answer 23

The Statement of Changes in Equity is the moving picture of what happened during the year. Written ‘for the year ending’.

The Statement of Changes in Equity breaks down the equity in a little more detail. It shows items such as:
Share Capital
Premium
Other Reserves
Retained Profit
Total Equity
These are usually showed over 5 / 6 columns.

Its necessary as:
1. Need to known the opening and closing equity of the company
2. Illustrates how movements in Equity may be interrelates by showing changes in equity over the year (eg relationship between dividend and profit)
3. Gives the user of the financial statements a better understanding of the equity section from The Statement of Financial Position