Chapter 8 - Accounting Analysis (14%) Flashcards
1
Q
What does the statement of financial position provide?
A
A snapshot of the company’s financial position as of a given date, detailing assets, equity, and liabilities.
2
Q
What are the three main sections of a balance sheet?
A
- Assets
- Equity
- Liabilities
3
Q
What does it mean when assets equal equity plus liabilities?
A
It ensures the balance sheet balances, hence the term ‘balance sheet’.
4
Q
What is the income statement?
A
It summarises income earned and expenses incurred by the company over the accounting period.
5
Q
What happens if income exceeds expenses in the income statement?
A
The company has made a profit.
6
Q
What is a cash flow statement?
A
It identifies how much cash the company generated and spent over the accounting period.
7
Q
What activities are categorized in a cash flow statement?
A
- Operating activities
- Investing activities
- Financing activities
8
Q
What is the purpose of a statement of comprehensive income?
A
To provide additional disclosures regarding income and expenses beyond the income statement.
9
Q
What is an audit?
A
An independent assessment of a company’s accounts prepared by the directors.
10
Q
What does an unqualified audit report indicate?
A
The accounts give a true and fair view and comply with regulations.
11
Q
What are the five main components of a financial statement?
A
- Assets
- Liabilities
- Equity
- Revenue
- Expenses
12
Q
Define assets in the context of financial statements.
A
Items owned or controlled by the company expected to yield economic benefit.
13
Q
What are liabilities?
A
Money owed by the company to others, legally binding obligations.
14
Q
What does equity represent?
A
The amount invested in a business by its owners plus retained earnings.
15
Q
What is revenue?
A
Sales made by a company, representing an increase in assets or decrease in liabilities.
16
Q
What are expenses?
A
Costs of doing business, including cash and non-cash expenses.
17
Q
What is GAAP?
A
Generally Accepted Accounting Principles, a combination of accounting regulations.
18
Q
What are International Financial Reporting Standards (IFRS)?
A
Standards issued by the IASB for financial reporting.
19
Q
What is the role of the IASB?
A
To develop high-quality, understandable, enforceable global accounting standards.
20
Q
What is goodwill in group accounts?
A
The excess of the cost of investment over the net assets of a subsidiary.
21
Q
What are non-controlling interests?
A
Ownership stakes in a subsidiary that are not held by the parent company.
22
Q
What is the purpose of the statement of financial position?
A
To provide a snapshot of a company’s financial position at a specific moment.
23
Q
What categorizes non-current assets?
A
- Tangible
- Intangible
24
Q
What are tangible non-current assets?
A
Assets with physical substance, such as land and buildings.
25
What are intangible non-current assets?
Assets without physical substance expected to generate economic benefits.
26
What are current assets?
Assets intended for resale or conversion into cash within a year.
27
Fill in the blank: A company’s tangible non-current assets are often referred to as _______.
plant, property and equipment (PPE)
28
What is depreciation?
The allocation of the cost of tangible non-current assets over their useful lives.
29
What are non-current investments?
Investible assets not expected to be sold or mature within the next year.
30
What is the difference between current and non-current liabilities?
Current liabilities are due within one year, while non-current liabilities are due beyond one year.
31
What is the significance of the balance sheet format?
It ensures that all assets and liabilities are properly categorized and reported.
32
What are current assets?
Current assets include cash, short-term investments, and prepayments.
33
What is a prepayment?
A prepayment is an expense that has been paid in advance, such as rent for future periods.
34
How are current assets typically listed in the statement of financial position?
Current assets are listed in ascending order of liquidity.
35
What is the distinction between current and non-current assets?
Current assets are expected to be liquidated within one year, while non-current assets are held for longer periods.
36
What is depreciation?
Depreciation is the allocation of the cost of tangible non-current assets over their useful economic life.
37
What is amortisation?
Amortisation is the process of expensing intangible non-current assets over their useful economic life.
38
What is the straight-line depreciation method?
The straight-line method spreads the depreciable amount equally over the asset's useful economic life.
39
What is the formula for calculating straight-line depreciation?
Straight-line depreciation = (cost – disposal value) / useful economic life in years.
40
What does net book value (NBV) represent?
NBV is the cost of an asset less accumulated depreciation to date.
41
What is the purpose of revaluing tangible assets?
Revaluation provides a truer and fairer view of the assets employed by the company.
42
What are the three sub-elements of equity?
* Share capital
* Capital reserves
* Revenue reserves
43
What is share capital?
Share capital is the nominal value of equity and preference share capital issued by the company.
44
What are capital reserves?
Capital reserves include revaluation reserves and share premium accounts.
45
What is revenue reserve?
Revenue reserve is the accumulation of retained earnings that have not been distributed as dividends.
46
What are non-controlling interests?
Non-controlling interests arise when a parent company controls a subsidiary but does not own all shares.
47
How is equity calculated?
Equity = share capital + reserves.
48
What defines a liability?
A liability is an obligation to transfer future economic benefits due to past transactions.
49
What are non-current liabilities?
Non-current liabilities are obligations not repayable within the next 12 months.
50
What are current liabilities?
Current liabilities include amounts owed to suppliers, bank overdrafts, and tax payables due within 12 months.
51
What is the purpose of the income statement?
The income statement summarizes a company's income and expenditure over an accounting period.
52
What is another name for the income statement?
The profit and loss statement.
53
What does the bottom line of the income statement represent?
The bottom line shows earnings per share.
54
What is revenue in the context of the income statement?
Revenue is the total sales achieved by the company during the year.
55
What are costs of sales?
Costs of sales are the direct costs associated with generating sales, also known as cost of goods sold (COGS).
56
What is gross profit?
Gross profit is total sales minus the costs of sales.
57
What is operating profit?
Operating profit is gross profit minus other operating expenses incurred.
58
What are finance costs?
Finance costs are the interest incurred on borrowings.
59
What is profit before tax?
Profit before tax is the profit made before considering any tax payable.
60
What is net income?
Net income is the profit for the period after deducting tax and financing costs.
61
What is earnings per share (EPS)?
EPS is the profit after tax earned per ordinary share.
62
How is EPS calculated?
EPS = (Net income - Dividends on preferred shares) / Number of ordinary shares in issue.
63
What are dividends?
Dividends are distributions of profit to shareholders.
64
What are dividends?
Dividends are distributions of profit to shareholders, paid after preference shareholders and at an amount set by the board.
65
How are dividends typically paid by listed companies?
Dividends are usually paid in two or four instalments, either as a single interim dividend or three quarterly dividends followed by a final dividend.
66
Where are dividends shown in financial statements?
Dividends are included in the statement of changes in equity, reconciling the movement in equity from one financial position to another.
67
What is capital expenditure?
Capital expenditure is money spent to buy non-current assets, such as property, plant, and equipment (PPE).
68
What is revenue expenditure?
Revenue expenditure is money spent that immediately impacts the income statement, such as wages, rent, and professional fees.
69
What is the purpose of the statement of cash flows?
The statement of cash flows summarizes all payments and receipts over the year, reflecting the inflow or outflow of cash.
70
Which accounting standard requires a statement of cash flows?
The statement of cash flows is required by accounting standard IAS 7.
71
What are the main headings in a cash flow statement?
The main headings are operating activities, investing activities, and financing activities.
72
What is the difference between profit and cash?
Profit is the excess of revenues over expenses in the income statement, while cash is the actual cash generated or used, detailed in the cash flow statement.
73
What does cash flow indicate for a business?
Cash flow indicates the company's ability to meet its liabilities and continue operations; it is often described as the lifeblood of the company.
74
Fill in the blank: Free cash flow is calculated from the cash flow statement and represents the amount of cash that a company can _______.
choose what to do with.
75
What is enterprise cash flow?
Enterprise cash flow is the free cash flow before considering payments made to any of the providers of finance to the firm.
76
What is equity cash flow?
Equity cash flow is the free cash flow to shareholders, after financing costs to lenders but before dividend payments.
77
What is included in a typical annual report?
A typical annual report includes a strategic report, stakeholder review, financial review, and governance report.
78
What is the strategic report in an annual report?
The strategic report outlines the company's strategy and major plans for the future, providing context for performance.
79
What does the financial review in an annual report include?
The financial review includes performance metrics, accounting ratios, and key risks faced by the business.
80
True or False: Depreciation is a cash expense.
False.
81
What does an increase in accounts receivable indicate?
It indicates less cash has entered the company from customers paying their accounts.
82
What does a decrease in inventory suggest about a company's cash flow?
A decrease in inventory suggests that the company has spent less money to purchase more raw materials, adding to cash.
83
What is the total free cash flow formula?
Total free cash flow = total equity cash flow - dividends paid out.
84
What are some examples of revenue expenditure?
* Wages paid to staff
* Rent paid on property
* Professional fees like audit fees.
85
What is the significance of cash equivalents in a cash flow statement?
Cash equivalents, like Treasury bills, are short-term investments classified as cash.
86
What is the primary focus of the financial review section in an annual report?
Outline the company’s performance based on various metrics and key risks faced by the business.
87
What role does the audit committee play in corporate governance?
Responsible for the appointment, compensation, and oversight of the work of the external auditor.
88
What is goal congruence in the context of directors' remuneration?
Directors have a remuneration scheme that aligns their motivations with those of the stakeholders, particularly shareholders.
89
What does an independent auditor’s report signify?
Gives an opinion on whether the financial statements have been properly prepared and present a true and fair view.
90
What are the three principal financial statements included in an annual report?
* Income statement
* Statement of financial position
* Cash flow statement
91
What is the purpose of ratio analysis?
Assist in assessing business performance, summarise financial information, and identify trends, strengths, and weaknesses.
92
True or False: Ratio analysis can predict future performance.
False
93
What is Return on Capital Employed (ROCE) used to measure?
Overall management performance in relation to the capital paid into the business.
94
What is the formula for ROCE?
ROCE = (Operating profit / Capital employed) x 100
95
How is Return on Assets (ROA) calculated?
ROA = (Operating profit / Total net assets) x 100
96
What does the net profit margin indicate?
The percentage of revenues that the company earns after considering all costs.
97
What is financial gearing a measure of?
Risk arising from the company’s debt.
98
What is the Debt to Equity ratio?
Debt / Equity
99
What does the Interest Cover ratio indicate?
The extent to which profits are being made to cover the interest burden on debt.
100
What is the formula for the Current Ratio?
Current ratio = Current assets / Current liabilities
101
Fill in the blank: The _______ ratio assesses a company's ability to meet its short-term obligations.
Current
102
What is the significance of liquidity ratios?
They assess a company's ability to generate sufficient cash to support day-to-day operations.
103
What does a higher current ratio indicate?
The company should be more readily able to meet its liabilities.
104
What is the formula for calculating Net Debt to Equity?
(Debt - Cash and short-term investments) / Equity
105
What does the operating profit margin represent?
The percentage of revenues that the company earns after considering costs of sales and other operating costs.
106
What can cause share prices to react negatively despite positive financial statements?
If the reported numbers are not as positive as investors expected.
107
What is the asset turnover ratio?
Revenues / Total net assets
108
What does a higher asset turnover ratio indicate?
More effective use of company assets to generate sales.
109
What is the formula for calculating the Gross Profit Margin?
(Gross profit / Revenues) x 100
110
True or False: Dividends on shares must be paid every year.
False
111
What is meant by 'financial leverage'?
The use of debt to acquire additional assets.
112
What key aspect does liquidity assess in a company?
The company's ability to pay its liabilities as they become due.
113
What is the formula for the current ratio?
Current ratio = current assets / current liabilities
## Footnote
A higher current ratio indicates a better ability to meet liabilities.
114
What does a current ratio greater than 1 indicate?
A company has sufficient short-term assets to cover its short-term liabilities
## Footnote
This is a general benchmark for financial health.
115
What is the quick ratio also known as?
Acid test
## Footnote
It excludes inventory from current assets for a stricter liquidity measure.
116
What is the formula for the quick ratio?
Quick ratio = (current assets – inventory) / current liabilities
## Footnote
It assesses a company's ability to meet short-term obligations without relying on inventory.
117
What is the primary purpose of investors' ratios?
To assess whether a company is likely to be a good investment
## Footnote
Ratios help evaluate share price and dividend sustainability.
118
How is Earnings Per Share (EPS) calculated?
EPS = Net profit or loss attributable to ordinary shareholders / Average weighted number of ordinary shares outstanding
## Footnote
EPS reflects profit available per share.
119
What does diluted EPS account for?
Potential future changes in EPS due to convertible securities
## Footnote
It provides a more conservative estimate of earnings per share.
120
What is the formula for calculating the Price Earnings (P/E) ratio?
P/E Ratio = Current market price per share / Earnings per share
## Footnote
It indicates how many years of earnings it would take to pay for a share.
121
What are the two types of P/E ratios analysts often consider?
* Trailing P/E (backward-looking)
* Forward P/E (estimated future earnings)
## Footnote
Trailing P/E uses historical data, while forward P/E relies on forecasts.
122
What does a high P/E ratio generally indicate?
The market expects higher future earnings growth
## Footnote
High P/E ratios are often seen in growth sectors like technology.
123
What is the Enterprise Value (EV) formula?
EV = Market capitalisation + Total debt + Noncontrolling interests + Preferred shares - Cash and cash equivalents
## Footnote
EV represents the total value of a business.
124
What does EBIT stand for?
Earnings Before Interest and Tax
## Footnote
EBIT is an indicator of a company’s operational performance.
125
What does the EV to EBIT ratio indicate?
The relative expensiveness or cheapness of a company
## Footnote
A lower EV to EBIT ratio suggests a potentially undervalued company.
126
What does EBITDA stand for?
Earnings Before Interest, Tax, Depreciation, and Amortisation
## Footnote
EBITDA serves as a proxy for operating cash flow.
127
What is the purpose of comparing EV/EBIT with P/E Ratio?
To evaluate the overall value of a company versus its share price
## Footnote
This comparison helps investors identify potential buying opportunities.
128
What does the Enterprise Value (EV) to EBITDA ratio measure?
It measures the relative expensiveness (or cheapness) of a business.
129
What does EBITDA stand for?
Earnings Before Interest, Tax, Depreciation and Amortisation.
130
How is EBITDA calculated?
EBITDA = Revenue less expenses (excluding tax, interest, depreciation and amortisation).
131
Is EBITDA a GAAP measure?
No, EBITDA is a non-GAAP measure.
132
What is a limitation of using EBITDA as a measure of cash earnings?
It does not account for cash required to fund working capital and replace old equipment.
133
What does the gross dividend yield express?
The total dividends per share paid out over the last year as a percentage of the current share price.
134
How is gross dividend yield calculated?
Gross dividend yield = (Dividend per share / Current share price) x 100.
135
What might a high gross dividend yield indicate?
It may indicate that the share price is relatively low compared to the return it offers.
136
What does a low dividend yield suggest?
It indicates high market confidence in the company’s ability to increase dividends.
137
What is dividend cover used to assess?
How well a company covered its dividend payout with the profits it made.
138
How is dividend cover calculated?
Dividend cover = EPS / Dividends per share.
139
What does a dividend cover of less than one indicate?
It indicates an uncovered dividend, meaning profits were not enough to cover the dividend.
140
If a dividend cover is two times, what does that imply?
Half of the profits are paid out to shareholders and half are retained.
141
What is the alternative name for the financial accounts of a business?
Financial statements.
142
What is a basic description of a statement of financial position?
It provides a snapshot of a company’s assets, liabilities, and equity at a specific point in time.
143
What are non-current assets?
Assets that are not expected to be converted into cash within one year.
144
What are intangible non-current assets?
Non-current assets that do not have physical substance, such as patents and trademarks.
145
What is depreciation generally applied to?
Tangible fixed assets, such as machinery and buildings.
146
What are the two typical types of capital reserves?
* Share premium
* Revaluation surplus
147
How does a non-controlling interest arise?
When a parent company owns less than 100% of a subsidiary.
148
What is the purpose of an income statement?
To summarize a company's revenues and expenses over a specific period.
149
What is another name for the income statement?
Profit and Loss Statement.
150
What is meant by operating profit?
Profit earned from a firm's core business operations.
151
How is the dividend yield calculated?
Dividend yield = (Dividends per share / Current share price) x 100.
