Chapter 1 - Financial statement analysis and ratios (fin.)

Question 1

stakeholders who benefit from financial statements

Answer 1

INTERNAL STAKEHOLDERS
owners, directors and managers - req fin statements to make bis decisions which affect continued ops
part of managers annual pres to shareholders

employees - need reports to make collective bargaining agreements with managements/unions/etc
can also use to make decisions e.g. promotions

EXTERNAL STAKEHOLDERS
- prospective investors - use statement to help make investment decisions
- analysts - to provide systematic analusis of performance and ratios, enhancing basis for investment decisions
- fin. institutions - use them to decide whether/terms of working cap/loans to finance expansion
-gov entities - to assess correct level of taxation to be paid by comp
-media - analysis, profiles on key staff etc

Question 2

accounting standards

Answer 2

format of statements governed by law and underprinned by various acc standards

GAAP - generally accepted acc principles
- rules bases - rules and criteria
- guidelines to ensure uniformity and comparability of statements within a country
- US based

IFRS - international financial reporting standards
- set of international standards adopted by >140 jurisdictions
- principles based - good reporting and guidance

Question 3

core accounting principles (11)

Answer 3

DAMGAMPEMC

1. Dual Aspect concept
2. Accounting entity concept
3. Money Measurement concept
4. Going concern concept
5. Accruals concept
6. Matching principle
7. Prudence concept
8. Economic entity concept
9. Materiality concept
10. True and fair concept
11. Consistency and comparability concept

Question 4

1. dual aspect concept

Answer 4

fundamental convention - necessitates recognition of all aspects of a transaction
underlying basis for double entry acc system
replaced single entry (where only sales rev recognized not other side relating to receipt of cash)

aspects of transaction recognised under 2 main types
debit - portion that accounts for increase in assets/expenses and decrease in liabilities/equity/income
credit - portion that accounts for decrease in assets/expenses and increase in income/liabilities/equity

increase in assets must be offset bu increase in claims (liabilities or capital)

Question 5

3. money measurement concept

Answer 5

every recorded transaction is measures in monetary terms
- if not poss then not considered a material event and not recorded in comps accounting recs
- included instread in notes

Question 6

2. accounting entity concept

Answer 6

financial records prepared for distinct entity regarded as separate from individuals that own bis
- personal expenses of owners dont appear in income statement
-personal and bis assets/liabilities must be kept separate under this concept

bis entity distinct from owners

Question 7

4. going concern concept

Answer 7

assumption that bis will be in existence for forseeable future (UK = >12 months from date of statement authorisation)
legal req
assets recorded at lower of cost or book val

where comp is not a going concern - break up basis used and assets calc at net realisable val

auditors will need to issue opinion if they doubt validity of going concern statement

Question 8

5. Accruals concept

Answer 8

Incomes and expenses must be recognised when accrued regardless of when cash is paid
- so can be accounted for in one trading period even if cash is paid in another

income must be reported in period it is earned - not recieved
prepaid income must not be shown in period it is received, but in subsequent periods when service/obligation is performed

expenses record in period they are incurred not period they are paid
prepaid expenses not recorded in eriod paid but when services performed

Exception = CF statement whose main purpose is to present CF effects of transactions during period so accounts for movement of cash

ensures revenues and expenses are matched in acc period - similar to matching principle

Question 9

6. Matching principle/accruals based accounting

Answer 9

closely related to accruals concept (income/expenses recognized when accrued not when cash paid)

revs and related expenses must be matched and reported @ same time

expenses must be charged to income statement in acc period in which rev to which expenses relate in earned
- accrued expenses on income statement when incurred
- pre paid expenses deferred
- depreciation matches against economic benefit from asset over several acc periods

before this = expenses charged to income statement when paid meaning accrued expenses weren’t recognized and prepaid expenses were

matching - presents more balanced view of financial performance of comp - specifically due to depreciation

Question 10

7. Prudence

Answer 10

accounting should exhibit prudence and conservatism
- prevents eq being overvalued through overstatement of assets and income
- prevents liabilities from being understated

should not recognise an asset at value higher than could be recovered from its sale or use

inherent risk that assets are likely to be overstated and liabilities likely to be understated as company benefits through higher share price and cheaper sources of financing

Question 11

8. consistency and comparability concept

Answer 11

comp must use same acc method or principle throughout accounting period - allowing comparability

• should continue to use same assumptions such as depreciation yoy in same way
  -if assumptions are altered - must explain

statements within industry must also be consistent

Question 12

9. Materiality concept

Answer 12

companies may ignore acc standards if net impact of doing so would have small impact on financial statements
- such that someone reading statement wouldnt be mislead

varies based on comp size
100k charged now or in 9 months (matching principle) immaterial to apple but material to Tala

Question 13

11. Economic entity concept

Answer 13

transactions of the comp must be kept separate from owners and other entities

Question 14

10. True and fair concept

Answer 14

Directors must only approve accounts that are true and fair view of assets, liabilities, financial position and profit and loss
- no statutory definition of true and fair

New regulator from 2019 - ARGA replaced FRC - accountable to parliament - can make direct changes to accounts rather than via courts
- directly regulates biggest audit firms

Question 15

Construction of comp accounts

Answer 15

balance sheet - statement of fin. position

P&L - income statement

CF statement

Question 16

statement of fin position/balance sheet composition

Answer 16

snapshot of financial position @ particular moment

split into 2 halves which must balance (assets-liabilities) = equity

Question 17

Assets

Answer 17

CURRENT ASSETS
- cash
- trade receivables
-inventories/stocks
-prepayments

NON CURRENT ASSETS
-tangible
-intangible
-investment in financial assets

Question 18

current vs non current assets

Answer 18

current = those that can be liquidated within a year
non current = longer term

Question 19

CURRENT ASSETS

Answer 19

those purchased with intention of resale/cash conversion within 12 months

cash - cash balances at bank
trade receivables - amount owed by customers following sale on credit (recorded on income statement already - accruals concept) - aka debtors
inventories/stocks - finished goods or work in progress
prepayments - company prepaying an expense

Question 20

NON CURRENT ASSETS

Answer 20

LT investments with useful life of >year

tangible non current - physical substance e.g land, buildings, plant and machinery
usually recognized initially @ acquisition cost and depreciation over time

intangible non current - non monetary without physical substance, e.g. brands, goodwill, trademarks, copyrights

Purchased goodwill = Price paid for company - Fair value of identifiable net assets

strict reqs for definition of intangible asset so some commercial brands not included as they dont meet accounting definition

Question 21

NON CURRENT ASSETS

Answer 21

LT investments with useful life of >year

tangible non current - physical substance e.g land, buildings, plant and machinery
usually recognized initially @ acquisition cost and depreciation over time

intangible non current - non monetary without physical substance, e.g. brands, goodwill, trademarks, copyrights

Purchased goodwill = Price paid for company - Fair value of identifiable net assets

strict reqs for definition of intangible asset so some commercial brands not included as they dont meet accounting definition]

investment in financial assets - LT investments in fin. instruments e.g shares, bonds etx
recorded @ fair value

Question 22

LIABILITIES

• provision
  -contingent liability

Answer 22

effectively money owed to someone else. current = to be paid within a year, non current = to pe paid after a year

CURRENT
-overdrafts
-trade payables
- tax payable
-provisions
-accruals

NON- CURRENT
-loans
-bonds
-finance leases

provision - liability of uncertain timing/amount
contingent liability - possible liability depending on occurrence of another uncertain future event, or present obligation whose payment is unlikely/whole amount hard to measure

Question 23

CURRENT LIABILITES

Answer 23

• overdrafts - ST debt with bank
• trade payables - ST debt when comp has bought something on credit
  -tax payable
  -provisions - liability of uncertain timing or amount.
  -accruals - expenses incurred but not yet paid

Question 24

NON CURRENT LIABILITIES

Answer 24

borrowing not repayable in next 12 months
-LT bank loans
-bonds
-finance leases

Question 25

EQUITY

Answer 25

= shareholder's funds, owners' equity or capital SHARE CAPITAL - NV of ord and pref shares (may differ from authorized share capital as not all may be called up) CAPITAL RESERVES - cash on hand for future expenses or to offset losses -share prem account - £ in here when shares issued above NV. not distributable as divi. can be converted into bonus issue REVALUATION RESERVES - arises from upward revaluation of non current assets REV RESERVES/RETAINED EARNINGS - accumulation of profits of lifetime of comp - can be used for divi NON CONTROLLING INTEREST - arise when parent comp controls subsidiary but doesnt own all share capital -eq attributable to remaining shareholders is here

Question 26

EQUITY

Answer 26

= shareholder's funds, owners' equity or capital SHARE CAPITAL - NV of ord and pref shares (may differ from authorized share capital as not all may be called up) CAPITAL RESERVES - cash on hand for future expenses or to offset losses -share prem account - £ in here when shares issued above NV. not distributable as divi. can be converted into bonus issue REVALUATION RESERVES - arises from upward revaluation of non current assets REV RESERVES/RETAINED EARNINGS - accumulation of profits of lifetime of comp - can be used for divi NON CONTROLLING INTEREST - arise when parent comp controls subsidiary but doesnt own all share capital -eq attributable to remaining shareholders is here

Question 27

depreciation

Answer 27

method to allocate cost of tangible non current asset over its useful life annual depreciation charge main in income statement to spread cost of asset over useful life - helping to match cost with rev it produces doesnt apply to freehold land or non current assets - since they dont have limited economic life - they are periodically revalued annual depreciation charge calc by 1st subtracting estimated disposal val from cost = depreciable amount, then writing off over assets useful life. 2 methods

Question 28

straight line depreciation

Answer 28

spreads depreciable amount over useful economic life equally/linearly annual depreciation charge is a nonc ash entry on income statement to reflect estimated cost of resource sin period on balance sheet = asset recorded at NBV net book val = cost - accumulated depreciation

Question 29

reducing balancing depreciation method

Answer 29

an accelerated depreciation method - s depreciation calc @ fixed % of net book val - so higher depreciation costs in earlier years may be more realistic as assets more effective when they are new annual depreciation = depreciation rate x book val @ beginning of eyar depreciate rate = %depreciation /year * 2

Question 30

amortization

Answer 30

process of gradually writing off initial cost of an asset/loan - income statement/bal sheet not cash position loan = spreading out loan payments over time asset = spreading cost of intangible asset over its useful life (depreciation = for tangible) writing down allowance -cap allowance can be claimed when you buy assets to use in a bis - some/all of val can be deducted from pre tax profits -e.g. patents, IP,copyright purpose - tax relief for reduction in val of qualifying assets, allowing cost to be written off against taxable income of bis availablee to; sole traders, self employed, or partnerships, comp and orgs liable to corp tax

Question 31

what is income statement/ PL statement

Answer 31

sumarises income earned and expenditure incurred over acc period function: to report profit/loss

Question 32

order of income statement

Answer 32

Question 33

IS: revenue

Answer 33

Revenu @ top of income statement everything comp has sold, whether payment received or no aka turnover, sales

Question 34

IS: cost of sales

Answer 34

2nd line rev - COGS = gross profit includes raw mats, wages of staff making prods etc costs to comp of generating the revenue

Question 35

IS: gross profit

Answer 35

rev - COGS = gross profit total sales - cost of the sales reflects income prior to overhead expenses

Question 36

Operating profit

Answer 36

= gross profit - op expenses - depreciation and amortisation aka operating income aka PBIT/EBIT op expenses - distro costs, admin expenses, marketing, rent etc

Question 37

EBITDA

Answer 37

EBITDA = earnings before interest, tax, depreciation and amortisation = rev - expenses (Excluding those above) eliminates effect of financing and acc decisions = net profit + tax + interest + dep and amort

Question 38

Interest payable/interest receivable

Answer 38

operating profit/EBIT/PBIT -interest payable +interest receivable Profit before tax

Question 39

Interest payable/interest receivable

Answer 39

operating profit/EBIT/PBIT -interest payable +interest receivable Profit before tax payable - interest incurred from borrowings, loans, bonds, overdrafts receivable - interest income earned from surplus funds deposited

Question 40

Net profit

Answer 40

bottom of income statement all profit less all expenditures = profit attributed to shareholders technically as all could be distributed as divi numerator of EPS calc (EPS = net profit/no. of ord shares)

Question 41

capital vs revenue expenditure

Answer 41

capital expenditure - money spent buying non current assets e.g. plant, property etc. reflected on balance sheet revenue expenditure - $ spent that impacts income statement e.g. wages, rent, audit fees

Question 42

CF statement

Answer 42

summary of payments and receipts that have occurred throughout year - representing total inflow/outflow of cash IAS7 = reqs CF statement to be broken down into 3 headings OPERATING ACTIVITIES - cash generated and consumed by main rev producing activities (trading activities) of comp - usually excluding interest expenses INVESTING ACTIVITIES - cash inflows/outflows from the disposal/purchase of LT assets FINANCING ACTIVITIES -cash spent paying divi/interst -cash raised from issuing shares or bowwing on LT minus cash spent repaying debt/buying back shares short term, high qual + highly liquid investments are classified as cash equivalents e.g. T bills

Question 43

CF statement composition

Answer 43

OP ACTIVITIES NET INCOME - start with this and reconcile to reflect net cash + depreciation/amortisation +depreciation/amortisation (not cash) + loss from sales fixed assets (not cash)/ - gains + decrease in trade receivables/ - increase + decrease in inventory/ + increase + accounts payable / - accounts receivable + increase in accrued expenses/ - decrease INVESTING ACTIVITIES + decrease in fixed assets, securities investments, non tangible current assets (sales) - increase in fixed assets, securities investments, tangible non current assets (purchases) FINANCING ACTIVITIES + increase in borrowing, increase in capital stock, increased interest received - divi or interest payments, redeeming loans Total FCF = total enterprise CF post reconciliation - divi - tax

Question 44

Profitability ratios (8)

Answer 44

Gross profit margin (gross profit/rev) Operating profit margin (op profit/rev) Net profit margin Return on capital employed (EBIT/CE) Asset turnover (rev/assets) Return on equity (net prof/equity) Operational gearing ratio ((Revenue-Variable Cost)/Profit before tax) Equity multiplier generally - higher = better = comp better at converting sales to profit

Question 45

gross profit margin (profitability)

Answer 45

both from income statement gross profit = rev - COGS - compare to last year comment on trend (where have rev/COGS moved?) - higher = can spend higher proportion of income on other op expenses GOOD : relationship between turnover and direct cost of providing product/service BAD: may portray bis in too pos a light - ignores operating expenses which are v real

Question 46

operating profit margin (profitability)

Answer 46

operating profit margin % = operating profit / rev (x100) rev = top of income statement op profit = rev - cogs - operating costs -compare to last year and say what that means - varies widely between sectors (supermarkets v low, jewellers v high) - effected by competition, economic climate, industry etc -higher = better, yoy increase = sales up more than costs GOOD: provides relationship between turnover and all costs of providing service including op costs GOOD: appropriate for making comparisons because differences in way bis is financed wont influence measure BAD: discrepancies can arise between comps for various reasons e.g. method of depreciation used - so hard to make comparisons

Question 47

net profit margin (profitability ratio)

Answer 47

net profit margin (%) = net profit / revenues (x100) net income = bottom of income statement (all expenses removed) revs = top - compare to last year GOOD: all costs accounted for, so measures how successful a comp is at making profit on each sale GOOD: provides final pic of comps overall health BAD: can be influenced by one off items e.g. sale of an asset BAD: doesnt provide insight into whether management is managing production costs

Question 48

return on equity (ROE) profitability ratio

Answer 48

ROE (%) = net income / equity (x100) net profit = bottom of income statement equity = assets - liabilities = share capital + share premium + retained earnings measures rate of profit earned for shareholders higher = better conversion of equity finance to profits must be compared to comp previous and industry - varies by industry, lifecycle of bis GOOD: shows how well comp benefits shareholders beyond earnings GOOD: shows return on investments BAD: doesnt show risk associated with high level of return - e.g. may use lots of debt to generate high net profit and this isnt reflected BAD: easily manipulated - inflating income by overvaluing assets or deflating equity (increasing liabilities or with buybacks) BAD: v low with new comps and capital requirement high in early days

Question 49

Equity multiplier - profitability ratio

Answer 49

eq multiplier = total assets / shareholders funds fin. leverage ratio - evaluates companies use of debt to purchase assets - higher debt = lower shareholder funds and higher eq multiplier - comps wiht horrible sales and margins can take on excessive debt to artificially increase ROE - eq multipier allows you to see what portion of return on eq is result of debt

Question 50

DuPont analysis

Answer 50

breaks ROE into 3 distinct elements after analysing drivers of ROE operating efficiency - measured by net profit margin (less pre fdivi) - as net profits increase (reducing costs or increasing prices) ROE will increase asset use efficiency - measured by total asset turnover (rev/total assets) - industry specific - as asset turnover increases ROE increases financial leverage - measured by equity multiplier (assets/ shareholder funds) - if ROE increases with increases eq multiplier - could indicate overleverage and higher risk ROE = net profit margin x total asset turnover x equity multiplier

Question 51

extended DuPont analysis

Answer 51

ROE (%) = (Operating profit margin x Tax retention rate - Interest expense rate) x Equity multiplier x Total asset turnover removed effect of tax and interest

Question 52

Asset turnover

Answer 52

asset turnover = revenue / capital employed = x: 1 ratio capital employed = assets - current liabilities OR = non current liabilities + equity measures efficient use of assets to produce sales - helps measure productivity of company's assets high = better but too high could indicate overtrading (insufficient assets to sustain level of sales rev) comps with low profit margins tend to higher assets turnover retail tends to be higher (2-3) utilities with large asset base will be lower compare to prev years as ever ROCE = OPM x asset turnover v diff quality bis can achieve same ROCE (e.g. high asset turnover x low margin = low asset turnover x high margin)

Question 53

operational gearing ratio profitability

Answer 53

operational gearing ratio = (revenues - variable costs) / Profit before tax if comp has greater level of fixed = greater variation in profit as a result of revenue changes effect of op gearing ratio can be calced by taking increase/decrease in normal output and x by geearing ratio

Question 54

Breakeven point

Answer 54

denominator = contribution per unit because it contributes to meeting fixed costs contribution margin = margin profit per unit sale computed using contribution income statements which separate fixed and variable costs

Question 55

ROCE profitability

Answer 55

ROCE = operating profit / capital employed capital employed = assets - current liabilities OR = non current liabilities + equity often regarded as one of best measures for judging management of comp in its utilization of available cap resources compare ROCE to target figs useful for cap intensive comps as it analyses debt and liabilities as well as probability - gives clear pic of financials cant be considered in isolation - must compare to last year and across sector unlike ROE - doesnt capture risk associated with generation of return older comps generally have higher ROCEs than newer - due to depreciation which can be misleading

Question 56

Liquidity ratios

Answer 56

current ratio (CA/CL) acid test ratio (CA-Inv/CL) Altman Z score

Question 57

Current ratio (x)

Answer 57

Liquidity aka working cap ratio current ratio = current assets / current liabilities - ideally 1.5-2 - purpose is to determine if the cover that current assets provide to cover liabilities that fall due within a year ISSUES -overdrafts may actually be long term but are a current liability -doesnt take timing of CF into account -inventory may not be easily liquidated (recession, distressed prices)

Question 58

5 TYPES OF ACCOUNTING RATIO

Answer 58

profitability - asses trading/operating performance: profits needed to provide investors with returns liquidity -evaluates trading risk of the company operational efficiency gearing -assesses ability of bis to meet lLT debts and risks to those financing comp investor - asses returns to those financing the comp

Question 59

current ratio modified form

Answer 59

to address critisim that current ratio is static = net sales to working capital working cap turnover ratio = net annual sales/ avg amount of working cap working cap = current assets - current liabilities

Question 60

Quick/acid test liquidity

Answer 60

quick ratio = (current assets - inventory) / current liabilities <1 may be cause for concern depending on industry akak (Cash + marketable secs + trade receivables) / current liabilities still doesnt take CF timing into account if quick ratio is much lower than working cap - current assets are highly dependent on inventory - retail stores big e.g. of this = sensitivity to recession

Question 61

Altman Z score liquidity

Answer 61

determine prob of comp going into liquidation - analyses sales and gearing and distills to single score only as good as sata that goes into it cannot asses comp with little or no earnings (new) highly sensitive to write offs in accounts which may falsely indictae bankruptcy A - tests corporate distress B - reflects extent of gearing C - assesses ability to squeeze profits from assets D - how much must MV fall by for liabilities to exceed assets E- how efficiently assets used to generate sales

Question 62

working capital/cash cycle

Answer 62

working cap = current assets - liabilities = funding avail for conducting day to day bis aka operational efficiency ratios efficiency can be increased by - minimising inventory elvels - ensuring debtors pay quickly, delaying payments to creditors comps should maintain at least an equal balance between coleection period and payment period for receivables and payables considers velocity of CF within working cap cycle payables payment period (Payables/COGS) receivables payment period (Receivables/Revenue) inventory holding days (COGS/INV)

Question 63

receivables collection period op efficiency

Answer 63

receivables collection period = 365 x trade receivables / revenue asses how quickly comp can realise cals of receivables indicates proportion of year's sales which are unpaid (@ bal sheet date) may be distorted by large comps either v quick or slow to pay static - can be distorted espec by seasonal sales

Question 64

payables payment period op efficiency

Answer 64

payables payment period = 365 * trade payables/ COGS want this to be even balance with receivables collection period could upset creditors if too high

Question 65

inventory holding days

Answer 65

365 * inventory / COGS indicates how quickly a comp is selling its inventory high turnover bis will have low inventory day generally prefer shorter as there are costs to hold inventory compare to industry - low suggests strong sales or ineffective buying static so bad for seasonal bis inventory management - likely demand -possibility of supply shortages - likelihoo dof price rises - amount of storage - perishability - prospect of obsolescence

Question 66

financial gearing ratios (4)

Answer 66

debt to equity (Interest bearing debt + pref shares) / (Equity S/H Funds – pref) net debt to equity (Interest bearing debt + pref shares - cash) / (Equity S/H Funds – pref) interest cover (operating profit + int received + other receivables)/ int paid) asset cover (Total Assets – Current Liabs)/ Loans payable high levels of gearing can indicate greater levels of financial risk

Question 67

debt to equity gearing

Answer 67

debt includes liabilities with an interest bearing component (bot ST and LT) trade payables, deferred income and divi payables generally excluded sometimes pref shares included in equity overdrafts included? case by case - ST anomaly or LT financing generally >100% indicates comp would struggle to pay LT debt if loans called in bis like utilities with steady earnings can tolerate a higher level than vol sectors e..g banking/tech - utility bis tend to be monopolies

Question 68

net debt to equity gearing

Answer 68

alt to debt to eq taking into account assets tha can be used to offset debt (cash and ST investments from bal sheet )

Question 69

interest cover gearing

Answer 69

measures ability to pay ineterst out of op profits and other incomer receivables higher = less risky appropriate level varies sector to sector key for lenders

Question 70

asset/loan cover gearing

Answer 70

asset cover = (total assets - current liabilities) / loans payable assesses security/likelihood of loan repayment should be calc for each priority of loan bal sheet assets recorded @ book value which is often higher than liquidation/selling value - which could inflate ratio

Question 71

investor ratios

Answer 71

EPS (earnigns attributable to ord SH / weighted avg no. of shares) diluted EPS earnings yield (EPS / share price) divi cover (EPS / divi per share) divi yield (divi per share/ share price)

Question 72

investor ratios

Answer 72

EPS (earnigns attributable to ord SH / weighted avg no. of shares) diluted EPS earnings yield (EPS / share price) divi cover (EPS / divi per share) divi yield (divi per share/ share price)

Question 73

EPS investor

Answer 73

EPS = net profit (loss) attributable to SH / avg weighted no. of shares for period - indicates companies scope for increasing divi - assess how expensive of cheap a comp is

Question 74

restated vs diluted EPS

Answer 74

EPS will change is no. of outstanding shares changes

Question 75

Diluted EPS

Answer 75

must publish diluted EPS on income statement to warn of potential future changes in EPS for hypothetical events (the exercise of rights which have already been granted and would require issue of further shares) - convertible loan stocks in issue - warrants in issue - employee share options issued but not exercised

Question 76

Bonus/scrip/capitalization issue

Answer 76

effectively a free issue of shares paid for with retained earnings/share prem account converts retained earnings to share capital retained earnings down share cap up no change to total shareholder funds or net assets NV of share remains the same share price adjusts to reflect new shares in issue, as does EPS and divi per share bonus factor = no.of shares after issue/no. of shares before issue restated EPS = EPS/bonus factor UK, most Europe, China, India- 5:2 = 5 new shares for every 2 you own US: 5:2 = every 2 shares held will be converted to 5 if fractional share - rounded down and offset w/ cash payment

Question 77

share split/reverse split

Answer 77

UK comp act - NV of share must be 100p comp can increase no. of shares by decreasing NV - stock split - increases marketability, decreases trading price reverse split: increase NV, increases trading price per share ratios effected no financial impact on comp other than admin as no CF involved fractional shares typically sold off

Question 78

rights issue

Answer 78

shares offered to existing holders @ disocunted price to raise finance - fund takeover - acquire assets -repay debt causes signif change to comp CF requires publication of prospectus essentially an issue of shares @ full price combined w/ bonus issue bonus element backdated to original issue date and prev years EPS adjusted bonus fraction = cum rights price / TERP restated EPS = EPS/ bonus factor 5:2 always means 5 new shares issued for 2 existing increase is share capital and share premium acc

Question 79

tail swallowing rights issue

Answer 79

aka cashless take up - selling some rights and buying remainder such that no cash expenditre is required no. of rights to sell = rights price/TERP x rights entitlement entitlement = total no. of shares investor is allotted

Question 80

nil paid right

Answer 80

= TERP - rights price

Question 81

share buybacks

Answer 81

occurs when comp purchases own shares and either cancels or holds in treasure for reissue at later date - open market -proportional offer (set % from each investor purchased) -universal tender (fixed no. acquired @ particular price) using proceeds of fresh issue or from distributable profits way of keeping comp nimble to prevent having to cut divi @ times of stress (Shell 2020) - if comp increases divi after good year this is expected to be maintained - buybacks allow return of wealth with les stress - discount management -preventing controlling stakes -common is US as mroe tax efficient than divi payments - scrutinised as priortitises interests of external shareholders vs workforce, environment etc - if funded via debt this increases probability of default on other debt and respresnts direct transfer of val from creditors to shareholders increases price, relative ownership stake and per share metrics

Question 82

diluted EPS convertibles (pref shares and loan stock)

Answer 82

diluted EPS = (net profit - pref divi) / (weighted avg no. of ord shares + dilutive shares) 1. calc interest saved on conversion 2. deduct corp tax from that saving 3. add interest saving to profit 4. calc additional no. of shares 5. enter into formula over time - according to prospectus - no. of shares resulting from convertible decreases over time as share price rises assume all shares would be converted to give max possible dilution warning to shareholders in some cases the decrease in interest cost may offset the dilution effect of conversion on EPS

Question 83

diluted EPS warrants and options

Answer 83

diluted eps figure on income statement - assumes exercise of all outstanding warrants and options warns of potential future changes options are generally not dilutive as trade in existing shares on market - only include dilutive options if present in calc new total no. of shares = avg no. of basic shares outstanding + no. of new shares issued on ex - no. of shares issued @ fair val (due to proceeds on exercise) then do EPS calc with this fig (net profit - pref divi)/ fig fair val = avg market price over period

Question 84

earnings yield and PE ratio investor ratios

Answer 84

PE = share price/EPS = 1/earnings yield earnings yield = EPS/ share price x100 EPS = (net inc - pref divi)/weighted avg no. of shares earnings yield expresses EPS as % of market price indication of value (can compare ftse100 with 10yr gilt) if lower for ftse then shares likely to be overval difference between 2 = equity risk prem high earnings yield may reflect anticipation of poor earnings/other weaknesses low may reflect high growth prospects P/E should be compared in similar sector or to prev year - not in isolation! high = overvalued potentially

Question 85

divi yield investor

Answer 85

divi yield = divi per share / market price per share x100 no relation between divi yield and perception of comp in market place not guaranteed - Shell cut quarterly divi by 66% in 2020 Janus Henderson research - 220$ bili global divi cut in 2020 European banks instructed to pause divi to maintain cap by regulators High - could be high divi or low share price (latter would give high PE, comp risky so more yield) could be comp with strong CF defensive sector comps often by high divis reliably

Question 86

divi cover investor

Answer 86

divi cover = EPS/ net divi per share OR divi cover = net earnings attributable to SH/ total ord divi net earnings attrib.. = net income - pref divi >2 = safe <1 cause for concern as having to fund out of reserves not current earnings <1.5 not sustainable

Question 87

limitations of ratio analysis

Answer 87

limitations - uses historic data so not predictive -different industries have different characteristics and within a secotr comps may be at different stages -profitability ratios dont account for future econ events, management changes etc liquidity - no account taken of maco environments -accounting policies may differ (e.g depreciation of non current assets) - distortions - e.g. use of year end balance to analyse full year transactions window dressing - putting figures in best light @ time of statments - postponing payments to suppliers to improve cash balance - finding ways to book revenue earlier -repaying debt temporarily near end of period - applies to sate govs too e.g Brazil before 2015 election -

Question 88

window dressing methods

Answer 88

circular transactions - sale and repurchase to give inflated turnover with no commercial authenticity - improves profitability ratios - should be disclosed under IAS 24 bed and breakfast transactions - circular transaction that occurs over end of acc period - illegal if disclosures not made in accordance with acc standards postpoing of payments to improve cash balance booking rev earlier repaying debt near end of period financed by sale of inventory false or misleading statements

Question 89

trend analysis - horizontal analysis

Answer 89

assesses bal sheet/income statement over time - observing trends and any changes in them - can see if numbers are unusually high or low apply base % of 100 to first year to make this easier - e.g. allows you to compare rate of divi growth with rate of rev growth can be missused by analysts to report skewed findings - can change no of periods (should disclose) - or should good MoM figures when YoY is bad

Question 90

common size/vertical analysis

Answer 90

each line on bal sheet is shown as % of one tiem (usually total assets