Chapter 4 - Company Performance Flashcards
What accounts do companies listed on the stock market need to draw up?
- annual accounts
- half yearly
- interim reports
what does accrual basis mean?
- transactions are reported
when they occur which is not necessarily when cash is actually received.
what does going concern mean?
- presumed that the company will continue in operation for the foreseeable future.
what are the 3 components of accounts
1) statement of financial position (balance sheet)
2) income statement (profit and loss account)
3) cash flows statement
What is shown on the statement of financial position?
1) assets
2) liabilities
3) shareholder funds
what does income statement show?
- shows the performance of the company over the accounting period
- formerly known as profit and loss account
- summary of revenue transactions over period
what is a cash flow statement?
- identifies how cash has been generated and how it has been spent
- removes accruals
- adjusts for balance sheet items which increase profit but don’t impact cash
- adds back non cash items
what is operating margin?
- profit after paying operating costs of goods sold as well as general and administrative expenses
operating margin formula
operating profit / sales x 100
what is net margin?
- profits after all costs, expenses and tax
net margin formula
net profit after taxation / sales x 100
what is return on equity
- ratio of net income to shareholder’s equity.
- ia measure of the profitability of the shareholders’ investment.
- ROE makes comparisons with other investments, such as bonds and deposits possible,
- ROCE is better for comparing companies
Return on equity formula
net profit after taxation / total equity x 100
what is ROCE
- ROCE determines how much company earned from total of different types of capital it has employed,
- includes equity but also long- or short-term borrowings. So would include funds raised by the issuing of corporate bonds.
- As it includes long-term finance in the, it is a more comprehensive test of profitability than ROE.
- It can be used to compare a wide range of companies, but there are natural variations between sectors.
calculation for ROCE
profit before interest and taxation / capital employed x 100
what is the debt to equity ratio
- One of the most useful measures for shareholders that compares long term debt to equity
Debt to equity ratio
(long term loans + preference shares) / (total equity - preference shares)
what is the interest cover ratio?
- investigate how many times over the interest bill could be paid out of
current profits. - This ratio is very sensitive to changes in interest rates, but having a high ratio can mean that the risks associated with profit changes can be reduced.
Interest cover formula
profit before interest and taxation / gross interest payable
what is the working capital (current ratio)
- ensures enough cash in current assets, to pay off current creditors.
- A healthy ratio between 1.5 and 2, although depends on the business and prevailing economic conditions.
- Too little indicate cash flow problems, too much indicate assets not being used as profitably as they could be.
formula for working capital (current ratio)
current assets / current liabilities
what is the liquidity ratio?
- In a time of crisis, it may not be possible to sell stock quickly to release the cash, so a more cautious view of the company liquidity is the liquidity ratio.
- It is also called the quick or acid test.
- This is because it only includes assets that can quickly and easily be turned into cash by taking off the current stock.
liquidity ratio formula
current assets - stock / current liabilities
what is a z score?
A more in-depth analysis that combines several ratios called a Z-score can more accurately predict collapse
in the short term i.e., over one year, but it is less reliable over longer periods, such as 5 years plus.
what is working capital?
- represents money that circulates through the business automatically, so money being spent on goods and services to enable production to take place, and money being received as customers pay for their purchases.
- The level will vary by industry and may fluctuate with seasons, or business cycles, but useful comparisons can be made with sector averages.
working capital formula
current assets - current liabilities
what is debtor turnover?
- ratio of a business’ net credit sales to accounts receivable during a given period.
- activity ratio that estimates the number of times a business collects its average accounts receivable balance during a period.
- It measures the efficiency of a business in collecting its credit sales.
Debtor turnover formula
sales / debtors
what is debtor collection period in days?
- expressed in days to represent the number of days it takes company to collect its invoices.
- Typical debtor periods will
vary by industry, but the usual benchmark to beat for standard trading is 60 days.
debtor collection period in days formula
debtors / sales x 365
what is stock turnover?
- The stock turnover ratio is used to assess how efficiently a business is managing its inventories.
- In general, a high turnover indicates efficient operations. A low turnover compared to the industry
average and competitors suggests poor management.
stock turnover formula
cost of sales / stock
what is creditor turnover?
- Creditor turnover evaluates how fast a company pays off its creditors or suppliers.
It is a measure of short-term liquidity. - A higher value indicates that the business was able to pay its suppliers quickly, whereas a lower value may mean there are liquidity concerns.
creditor turnover formula
cost of sales / trade creditors
Limitations of ratios
- different accounting procedures can apply, which can make figures unreliable
- if the company has altered share capital through for example share splits these can alter ratios
- often use historical data
- ratios only as good as source of information used
- impact of inflation; interest rates and taxation may be different each year
- often useless on their own
- shouldn’t be used in isolation
Use of EPS ratio
Shows the trend in a company’s profitability
• A widely-used statistic in company performance.
• All companies list their EPS.
• Shows the amount per share, in pence, that the company has earned during the year.
• Widely used to make comparisons from year to yearand with other companies.
• Best looked at as a trend over time.
EPS Formula
profit after tax and preference dividends / number of ordinary shares in issue
Use of dividend yield formula
Shows the true value of a share’s dividend
• The same as the interest yield on bonds, so income (dividend) ÷ price paid.
• Result shown as a percentage.
• Yields fluctuate with share price.
• Unreliable in forecasting future returns.
• A low dividend yield may indicate an overvalued share.
• A high yield may indicate low growth or that it is underrated by the market.
dividend yield formula
dividend per share / current share price x 100
use of dividend cover formula
Shows how many times the dividend could be paid out of available current earnings
• The higher the figure, the better.
• A high figure, e.g. ‘10 x’, shows that profits are being retained rather than shared.
• The higher the dividend cover, the less likely it is that a company will have to reduce dividends if profits fall.
dividend cover formula
earnings per share / dividend per share
Use of P/E ratio
- Used as a comparison between companies in the same sector
- Meaningless on its own; better for ‘comparisons’ between companies or between time periods.
- Measures how highly investors value a company and its ability to grow its income stream.
- Generally, the higher the P/E ratio, the more the shares are in demand, and the more the earnings are expected to grow
What is price earnings to growth ratio used for
Establishes whether a company’s P/E ratio is justified
• A number of less than 1 would indicate that the shares are potentially attractive.
• Future growth would need to be realistic to be of any use.
PEG ratio
P/E ratio / estimate of companies average earnings growth for next 5 years
What is price to book ratio used for
Measures the relationship between the company’s share price and the net book or asset value per share attributable to its ordinary shareholders
• If ratio shows share price is lower than its book value, this can indicate that it is undervalued, or that market perceives that it will remain a stagnant investment.
• If share price is higher than book value, this
suggests investors view it as a company which has above-average growth potential.
price to book formula
share price / NAV
what is gordon’s growth model to calculate share price used for
A simplified model for calculating a share price.
• Assumes constant dividend growth, and dividend payments made at the end of each period.
• Helps place a price on the value of an ordinary share.
• Simplistic, and only suitable for mature
shareholdings with track records.
• Crude and simplistic formula.
• Can give an idea on the current share price against future expected growth.
gordon’s growth model to calculate share price formula
dividend / (return required - dividend growth)
