Chapter 19 - Financial ratios Flashcards
What is ratio analysis?
the process of comparing and quantifying relationships between financial variables, such as those variables found in the SFP and SPL of a company
Ratios can assist with what?
- measuring the achievement of corporate objectives
- investment appraisal
- working capital management
- capital structure
- business valuations
What does the ROCE give?
a measure of how efficiently a business is using the funds available to it
What is the calculation for the ROCE?
(Operating profit (PBIT) / Capital employed) x 100
What is the calculation for capital employed?
total assets - current liabilities
or
equity + long-term debt
What would reduce capital employed and what would this then do to ROCE?
A reduction in long-term borrowings, consequently increasing the ROCE
What does ROE measure?
the return from an ordinary shareholder perspective rather than a whole company one
What is the calculation for ROE?
(Profit after tax and preference dividends / ordinary share capital and reserves) x 100
ROE uses what?
Profit, which is not directly linked to the objective of maximising shareholder wealth
What is ROE sensitive to?
Gearing levels - increasing as gearing increase
What is included in the reserves?
Share premium
Accumulated profits
revaluation reserves
Profit margin measures what?
how well revenue is converted into profit by the company
What is the calculation for profit margin?
Profit / revenue x100
What is the calculation for the operating profit margin?
Operating profit (PBIT) / Revenue x 100
What is interest cover?
a ratio that is really useful when considering the risk levels faced by investors in the company in relation to its gearing level
What is the calculation for interest cover?
operating profit before interest and tax / debt interest
What does a low interest cover mean?
the greater the risk that profit will become insufficient to cover interest payments
What does the Earnings per share (ESP) calculation measure?
measure of a company’s performance from an ordinary shareholder’s point of view. The amount of profit attributable to each ordinary share
What is the calculation for the EPS?
Profit after interest, tax and preference share dividends / no. of ordinary shares in issue
What does a high EPS signifiy?
means that the company is earning more profits in relation to each of its issued shares
What can influence and EPS?
accounting policies, e.g., changing the depreciation periods of capital assets to longer period will increase annual profits even though the performance of company may not have changed
What is the PE ratio?
gives a basic measure of company performance. Expresses the amount the shareholders are prepares to pay for the share as a multiple of current earnings
What is the calculation for the PE ratio?
Share price / EPS
What does a high PE ratio indicate?
that investors perceive the firm’s earnings to be of high quality - usually a mixture of high growth and/or lower risk expectations
What does the dividend per share (DPS) ratio show?
helps individual ordinary shareholders see how much of the overall dividend payout they are entitled to
What is the DPS calculation?
Total dividend / total number of shares issued
What type of dividends should be included when calculating the DPS?
Ordinary equity shares
What is dividend cover?
measures how many times the company’s earnings could pay the dividend
What is the calculation for dividend cover?
profit available for ordinary shareholders/ dividend for the year
What does a higher dividend cover mean?
higher the better - the ability to maintain dividends if profits drop
What is dividend yield?
a direct measure of the wealth received by the ordinary shareholder
What is the calculation for dividend yield?
DPS / market price per share x100
Is capital growth taken into account for dividend yield?
no
If a dividend yield falls while the dividend levels do not change what does this indicate?
that the market is expecting future growth in the dividend
What is the total shareholder return (TSR)?
Measures the income to the investor by taking account of capital growth and dividend income
What is the calculation for total shareholder return (TSR)?
((DPS + change in share price) / share price at start of period) x 100
What is the dividend per share?
the cash return paid on each equity share. Include ordinary equity dividends only
Share price change shows what?
the capital return (or loss) on the share over the time period under consideration (usually 1 year in exam)
What is interest yield?
measures the interest on debt expressed as a percentage of the market price
What is the calculation for interest yeild?
(interest / market value of debt) x 100
How do we calculate the interest on one loan note?
use the coupon rate % x nominal value of one loan note (usually $100)
