Definitions Flashcards
What are the Liquidity Ratios?
Working Capital Ratio (Current Ratio) x:y Acid Test (Quick Ratio) x:y Debtor Days Creditor Days Stock Days
What are the Profitability Ratios?
Turnover Growth
Gross Profit Margin %
Operating Profit Margin %
Net Profit Margin %
What are the Capital Structure Ratios?
Gearing %
Net Gearing %
What are the Serviceability Ratios?
Interest Cover %
EBTIDA %
What are the Break Even Ratios
Break Even £
Break Even Margin of Safety %
Working Capital Ratio
A companies ability to service short term loans.
Current Assets / Current Liabilities
Acid Test
Excludes stock as these take longer to convert into cash.
(Current Assets - Stock) / Current Liabilities
Debtor / Creditor / Stock days
How quickly debtors turn in cash.
Average length of time creditors are outstanding.
Average length of time stock is held.
(Receivables / turnover)365
(Payables / COGS)365
(Inventory / COGS)*365
Working Capital (In days)
Receivables + Stock - Payables
+ve is out of funds. -ve is in funds.
Gearing
Net Gearing
Proportion of debt the business has.
Compares net borrowings to shareholder capital.
Total Debt / Shareholder Funds
(Total Debt - cash - investments) / Shareholder Funds
Interest Cover
EBTIDA
Ability to meet interest from pre-tax profit.
Ability to fund debt repayment from cash.
Profit before Interest & tax / Interest Paid
(Profit before Tax + Depreciation + Amortisation + Interest Paid) / Debt due in 12 months
Break Even
Break Even Margin of Safety
Level of sales required where the business doesn’t make a profit or loss.
The extent by which sales can fall before the break even point is reached.
Fixed Costs / Gross Profit Margin
((Turnover - Break Even) / Turnover) x 100
What key risks are banks faced with?
Liquidity Credit Market Regulatory Operational Reputational Environmental
Process of risk management
Risk Identification
Risk Analysis & Evaluation
Risk Treatment
Risk Management & Control
Risk Mitigation
Understanding the adverse risks that can impact on the business and taking the appropriate steps to reduce them to an acceptable level.
Risk Acceptance
Without risk there is no reward. If the risk is low enough then it may be accepted as a cost of doing business because of the potential benefits that will accrue.
Risk Retention
The business accepts the risk but only after controls are put in place to make the level of risk acceptable for the business.
Risk Reduction
Taking precautionary measures to reduce the likelihood / severity & consequences of the risk event occurring.
Risk Sharing
The cost of consequences of risk is shared with other parties, for example two or more organisations collaborate to deliver a product or service.
Risk Transfer
A specific risk is taken from a party that does not want to be exposed to it and passed onto another party that is willing to take the risk. E.g. insurance policies.
Risk Avoidance
Avoiding any exposure to the risk whatsoever.
Enterprise-wide Risk Management (ERM)
ERM is a term used to describe the management of risks across the whole of an organisation. It involves identifying particular events or circumstances relevant to the orgs objectives, assessing them in terms of the likelihood of occurrence and magnitude of impact, then determining a response strategy and monitoring progress.
Benefits of ERM
Increased consistency and communication of risks
Enhanced reporting and analysis of risk data
Improved focus, attention and perspective on risk
More efficient and effective activities related to regulatory compliance
More cost-effective management and monitoring of risks
Risk Intelligent Culture
A RI Enterprise is an org with an advanced state of risk management capability balancing value preservation with value creation.
Why do businesses borrow?
Business Expansion
Capital Investment
Seasonality / Cyclicality
New Ventures
Operating Cycle
Raw Mats -> Finished Product -> Distribution -> Invoicing -> Collection of Cash -> Cash in Bank Acc
Capital Investment Cycle
Purchase Equipment -> Operating Cycles -> Cash Generated -> Over time recovers the cash cost of the purchase
Management Buy Out
A MBO involves the sale of a business to its existing management team.
Reasons for MBO over MBI:
There may be limited # of trade purchasers
Potential Buyers may be competitors
Vendor may be keen to ensure continuity
Management might resent being taken over
Mezzanine Finance
Also known as subordinated debt, is a specialist funding that is a hybrid of debt and equity, ranking for repayment after normal debt but before equity. It often used as part of the financing package for MBOs or MBIs.
Deferred Consideration
A vendor defers part or all of the proceeds from the sale of a business and agrees that the purchaser can pay some or all of the consideration at a later date.
Types of Equity Funding
Management Equity
Business Angels
Venture Capitalists
Mezzanine Finance
Types of Debt Funding
Commercial Loans / Mortgages
Invoice Discounting
Asset Finance
Types of Vendor Assisted Funding
Deferred Consideration
Earn-outs
3 Types of Farming
Dairy
Livestock
Crops
Why do farms borrow?
To fund working capital requirements. Farming (depending on the type) is inevitably seasonal and there may be peaks and troughs in the cash conversion cycle.
Risks Farmers face
Production Risk - (uncertainty due to weather)
Price Risk - (price fluctuations linked to weather)
Casualty Risk - (Property losses due to storms etc)
Technological Risk - (Uncertainty from constant development of tech)
Counter-Party Risk - (Risk caused by other parties e.g. landlords)
Legislation Risk - (Actions of Gov’ and legislative bodies)
Personal Risk - (If a farmer becomes incapacitated)
What is the 3 criteria property investors are assessed on?
Capability & Track Record
Asset Quality
Sustainability of Income
Types of Leases for Property
Full Repairing and Insuring Lease - Tenants are fully responsible for paying for all maintenance and insurance costs directly
Internal Repairs Only - Tenants are responsible for all internal repairs without reimbursement. The landlord is responsible for all external repairs.
Valuation of a property considers…
Rents payable under existing leases Open Market Rental Value (OMRV) Landlords' Outgoings Future growth in rents Covenant strength of tenants Length of leases Level of return (yield) required by investors
Capital Value of Property
Total Rent p.a. / Yield
Risk is Property Development
Management of Costs Management of Suppliers Raising Finance Managing Cash Flow Ensuring appropriate demand for finished property
Internal Sources of Finance
Borrowing from friends
Change in Circumstances (Inheritance)
Personal Savings
Personal Debt Facilities
What is a DLA?
Director Loan Account
A nominal account on the company’s SOFP that records all transactions between the company and the director and is a way of keeping track of whether the director owes money to the company or vice versa.
External Sources of Finance
Bonds / Debentures / Loan Stock Revolving Credit Facilities Syndicated Loans Mezzanine Finance Equity Finance
Convertible Bond
Give holders the right to convert the bond into ordinary shares according to a pre-agreed formula at some specified date in the future.
Euro Bond
A Euro bond are only issued by the largest and most creditworthy companies and offer lower costs and interest margins
Syndicated Loan
A syndicated loan is issued by multiple banks due to the size of the loan facility. This shares the risk and reduces the exposure.
Foreign Exchange Risks
Transaction Risk
Translation Risk
Economic Risk
The forward market
The forward market is where currency can be bought and sold at a predetermined rate at a fixed future date.
Forward Currency Pure Option
A forward currency option gives the buyer of the contract the right, but not obligation, to buy or sell a fixed amount of a particular currency at a specific exchange rate, on or before a specific future date.
Fixed Rate Loan
A fixed rate loan is a loan where the repayment of interest and capital does not fluctuate during the term of the fixed rate.
Variable Rate Loan
A variable rate loan is a loan where the repayment of interest and capital fluctuates in line with the base rate.
Cap, Floor and Collar Contracts
A interest rate cap is a contract that gives the business the right to set a maximum level for the interest payable.
An interest rate floor is a contract in which the business pays the bank at the end of each period in which the IR is below an agreed strike price.
A collar is combination of cap and floor.
Forward Rate Agreements (FRAs)
FRAs are used to hedge future interest-rate risk. They’re arrangements whereby one party compensates another should interest rate differ from an agreed rate at some point in the future.
Interest Rate Futures
The buyer agrees to receive interest on a sum of money. The seller agrees to pay the interest on the sum of money on the agreed future date.
Interest Rate Swaps
An interest rate swap involves an intermediary bank matching two borrowers that wish to swap interest payments due on two separate loans. Typically one being a floating rate and the other being a fixed rate.
Dodd Frank Wall St Reform
Signed into law in July 2010 by Obama. It is the US response to the global financial crisis and in particular, the derivates market. It has the following aims:
To promote US financial stability
To bring an end to the threat of financial stability presented by “Too big to fail banks”
To protect US taxpayer from bailouts
To protect consumer from abusive financial service practices
It applies to all business that have US operations or stock listings and over 250bn in assets.
Bribery Act 2010
Brought into force in July 2011, it modernises the law in relation to bribery. Bribery can be defined a giving some financial or other advantage in order to encourage them to perform their function improperly, or as a reward for having done so. There are no specific provisions regarding this however, having a whistleblower policy is seen as good practice.
Foreign Account Tax Compliance Act
Became law in 2010. FATCA is a US law who’s aim is to ensure US individuals and companies pay the right amount of US tax.
Payment Services Directive
The PSD is a European directive implemented in the UK in 2009 in the form of payment services regulation. It introduced an authoritarian and registration regime for payment institutions. It has 5 objectives:
Achieve a single payment market in EU
Provide regulatory framework for single payment market
Create a level playing field and enhance competition
Ensure consistent consumer protection
Create potential for more efficiency of EU payment systems
Second Payment Services Directive
PSD2 came into force in January 2016 and acts as a follow-up to the first PSD. Its key changes are summarised in the following 4 themes: Market efficiency and integration Consumer protection Competition and choice Security
Single Supervisory Mechanism
SSM is a single rulebook for prudential supervision of credit institutions in Europe. It creates a new system of banking comprising the ECB and the national competent authorities of member states. It aims to ensure safety and soundness of the EU banking system.
European Market Infrastructure Regulation
EMIR is regulation that imposes requirements on institutions that deal in derivatives. It came into force in 2012 and is intended to improve transparency and reduce risks associated with this market.
Earn Outs
When there is a difference between the respective valuations the prospective buyer and seller give to a business, an earn out can bridge the gap. Earn outs provide a contractual agreement that they will receive additional compensation based on the businesses future performance.
How to assess a management team
Technical Skills Financial Skills HR Succession Plan Risks Technological Aims Strategic Aims Marketing Skills
What does RIOTARS stand for?
Request Industry - (Porters / PESTEL) Ownership - Ownership structure Trading - Historical performance of the business Ability to Repay Risk / Return Security
Markets in Financial Instruments Directive
MiFID is designed to integrate Europe’s financial markets. Implemented in 2007, it is a directive that regulates firms that provide financial instruments. It is a framework for investment intermediaries and the organised trading of financial instruments. In 2018, MiFID II took effect with the following key changes:
Market structure requirements
Extended transparency requirements
Rules on research and Inducements
Governance requirements
Introduction of a harmonised commodity position limits regime.
What causes overtrading?
Expanding too quickly
Under-capitalisation
Poor utilisation of capital resources
Payment in advance
Obtaining payment for the goods before they’re sent to the customer. Exporters bear no risk using this method.
Letters of Credit
The importer arranges the letter of credit with their bank to unconditionally pay the exporters bank once the paperwork and documents have been accepted.
Open Account Trade
The seller invoices the overseas customer stating when they expect to receive payment.
