Financial Ratios (investment)

Question 1

Gearing ratio

Answer 1

Fixed cost capital / total capital

X100

(%)

Fixed cost capital - borrowing - non current liabilities, preference shares, dividends

Total capital - issued ordinary shares capital + resources + reserves + fixed cost capital

Shows % of total capital giving a fixed return

> 50% = highly geared
< 50% = Lot gearing
50% = neutral gearing

Risk :
High gearing means a large proportion of profit is paid in interest. There maybe insufficient profit to pay more interest or dividends

Lenders may question high gearing

Question 2

Debt/equity ratio

Answer 2

An alternative way of expressing the gearing ratio -only ordinary share capital and reserves on the bottom:

Fixed cost capital / ordinary share capital and reserves
X100

(%)

> 100% highly geared
< 100% low gearing

Question 3

Interest cover

Answer 3

Profit before tax and interest (PBIT)/ interest payable

(X times)

The number of times the PBIT covers interest payments

Higher cover gives greater assurance to lenders and shareholders

Question 4

Dividend cover

Answer 4

Profit after tax and preference dividends / ordinary dividend paid and proposed for the year

X times

Indicates how likely it is that the company will be able to pay its current rate of dividend into the future

Higher dividend cover = higher retention of profits

The directors may have a conservative dividend policy and be reinvesting funds in the business

Question 5

Dividend yield

Answer 5

Dividend per ordinary share / market price per ordinary share

X 100 %

This shows the dividend as a percentage of the market price therefore showing investors percentage return

Question 6

Earning per share

Answer 6

One of the most important investment ratios

Profit after tax and preference dividends / number of issued ordinary shares

= pence per share

Always pence

Profit after interest,tax and preference dividends = profit left for the ordinary share holders

Question 7

Price earnings ratio

Answer 7

Market price per share / earnings per share

Always in pence

It shows the number of years earning that investors will pay to purchase the shares

The higher P/E the greater the confidence investors have in the future of the company

P/E ratio shows the stock markets perception of future performance

THE BIGGER THE RATIO THE MORE CONFIDENCE THE MARKET HAS

E.g.

175p/ 25p = 7 times into market price of a share

Question 8

Dividend policy

Answer 8

The directors recommend a dividend- it is then voted on by the ordinary shareholders

I’m recommending a dividend, the directors must consider :

1) whether there are sufficient distribution profits
2) does the company have sufficient cash flow to pay the dividend
3) the balance between dividend and capital growth
4) increased dividends may increase share value