Chapter 19 - Financial ratios

Question 1

What is ratio analysis?

Answer 1

the process of comparing and quantifying relationships between financial variables, such as those variables found in the SFP and SPL of a company

Question 2

Ratios can assist with what?

Answer 2

• measuring the achievement of corporate objectives
• investment appraisal
• working capital management
• capital structure
• business valuations

Question 3

What does the ROCE give?

Answer 3

a measure of how efficiently a business is using the funds available to it

Question 4

What is the calculation for the ROCE?

Answer 4

(Operating profit (PBIT) / Capital employed) x 100

Question 5

What is the calculation for capital employed?

Answer 5

total assets - current liabilities
or
equity + long-term debt

Question 6

What would reduce capital employed and what would this then do to ROCE?

Answer 6

A reduction in long-term borrowings, consequently increasing the ROCE

Question 7

What does ROE measure?

Answer 7

the return from an ordinary shareholder perspective rather than a whole company one

Question 8

What is the calculation for ROE?

Answer 8

(Profit after tax and preference dividends / ordinary share capital and reserves) x 100

Question 9

ROE uses what?

Answer 9

Profit, which is not directly linked to the objective of maximising shareholder wealth

Question 10

What is ROE sensitive to?

Answer 10

Gearing levels - increasing as gearing increase

Question 11

What is included in the reserves?

Answer 11

Share premium
Accumulated profits
revaluation reserves

Question 12

Profit margin measures what?

Answer 12

how well revenue is converted into profit by the company

Question 13

What is the calculation for profit margin?

Answer 13

Profit / revenue x100

Question 14

What is the calculation for the operating profit margin?

Answer 14

Operating profit (PBIT) / Revenue x 100

Question 15

What is interest cover?

Answer 15

a ratio that is really useful when considering the risk levels faced by investors in the company in relation to its gearing level

Question 16

What is the calculation for interest cover?

Answer 16

operating profit before interest and tax / debt interest

Question 17

What does a low interest cover mean?

Answer 17

the greater the risk that profit will become insufficient to cover interest payments

Question 18

What does the Earnings per share (ESP) calculation measure?

Answer 18

measure of a company’s performance from an ordinary shareholder’s point of view. The amount of profit attributable to each ordinary share

Question 19

What is the calculation for the EPS?

Answer 19

Profit after interest, tax and preference share dividends / no. of ordinary shares in issue

Question 20

What does a high EPS signifiy?

Answer 20

means that the company is earning more profits in relation to each of its issued shares

Question 21

What can influence and EPS?

Answer 21

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

Question 22

What is the PE ratio?

Answer 22

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

Question 23

What is the calculation for the PE ratio?

Answer 23

Share price / EPS

Question 24

What does a high PE ratio indicate?

Answer 24

that investors perceive the firm’s earnings to be of high quality - usually a mixture of high growth and/or lower risk expectations

Question 25

What does the dividend per share (DPS) ratio show?

Answer 25

helps individual ordinary shareholders see how much of the overall dividend payout they are entitled to

Question 26

What is the DPS calculation?

Answer 26

Total dividend / total number of shares issued

Question 27

What type of dividends should be included when calculating the DPS?

Answer 27

Ordinary equity shares

Question 28

What is dividend cover?

Answer 28

measures how many times the company’s earnings could pay the dividend

Question 29

What is the calculation for dividend cover?

Answer 29

profit available for ordinary shareholders/ dividend for the year

Question 30

What does a higher dividend cover mean?

Answer 30

higher the better - the ability to maintain dividends if profits drop

Question 31

What is dividend yield?

Answer 31

a direct measure of the wealth received by the ordinary shareholder

Question 32

What is the calculation for dividend yield?

Answer 32

DPS / market price per share x100

Question 33

Is capital growth taken into account for dividend yield?

Answer 33

no

Question 34

If a dividend yield falls while the dividend levels do not change what does this indicate?

Answer 34

that the market is expecting future growth in the dividend

Question 35

What is the total shareholder return (TSR)?

Answer 35

Measures the income to the investor by taking account of capital growth and dividend income

Question 36

What is the calculation for total shareholder return (TSR)?

Answer 36

((DPS + change in share price) / share price at start of period) x 100

Question 37

What is the dividend per share?

Answer 37

the cash return paid on each equity share. Include ordinary equity dividends only

Question 38

Share price change shows what?

Answer 38

the capital return (or loss) on the share over the time period under consideration (usually 1 year in exam)

Question 39

What is interest yield?

Answer 39

measures the interest on debt expressed as a percentage of the market price

Question 40

What is the calculation for interest yeild?

Answer 40

(interest / market value of debt) x 100

Question 41

How do we calculate the interest on one loan note?

Answer 41

use the coupon rate % x nominal value of one loan note (usually $100)