Interpreting Financial Statements (2)

Question 1

what is profit for the year

Answer 1

profit after interest and tax (PaIT)

Question 2

what is capital employed

Answer 2

non-current assets + (current assets - current liabilities) = non-current assets + net current assets = share capital + reserves + non-current liabilities

Question 3

what is gearing

Answer 3

the relationship of debt to equity (“leverage”)
how is the company financed (more borrowing or share capital)

Question 4

what are preference shares

Answer 4

a fixed rate of dividends, do not have to be paid, but better for investor relations if they are

Question 5

what is the gearing formula

Answer 5

gearing = (borrowings+preference share capital) / capital employed x 100%

Question 6

what is the interest cover equation

Answer 6

profit before interest and taxation / interest payable times

Question 7

what is the rank order of payments

Answer 7

1 operational costs
2 banks and other lenders
3 taxes to governments
4 dividends to shareholders

Question 8

why is gearing important

Answer 8

interest on borrowing must be paid
dividends to shareholders is a management decision based on available current or retained profit

Question 9

what happens if revenues decrease unexpectedly

Answer 9

the profit before interest and tax will decrease

Question 10

what is attributed to a high geared company

Answer 10

more debt
more interest
more risk (when debt > equity)

Question 11

what is attributed to a low geared company

Answer 11

less debt
less interest
less risk

Question 12

what is interest cover

Answer 12

how much profit is available to pay for interest payment
the higher the better, especially for shareholders because after tax there are still profits for dividends and investment

Question 13

what additional information to the balance sheet and the income statement are needed to calculate investment ratios

Answer 13

interim dividend paid, final dividend paid/proposed, total dividend for the year and current share price

Question 14

what are investment ratios

Answer 14

they help shareholders and potential shareholders make decisions about their investments
there are six to be discussed

Question 15

what is the return on shareholder funds (RoSF)

Answer 15

similar to return on capital employed but calculated on shareholder returns and based on profit for the year

Question 16

what is the return on shareholder funds equation

Answer 16

return on shareholder funds = profits after interest and tax / (ordinary share capital + reserves)

Question 17

what is dividend cover

Answer 17

measures how safe a dividend payment is, how many times is current profit larger than dividends paid
shareholders would prefer a high dividend cover

Question 18

what does it mean if dividend cover is consistently low

Answer 18

lots of dividends are paid out and there is little reinvestment

Question 19

what is the dividend cover equation

Answer 19

dividend cover = profits after interest and tax / ordinary dividend for the year

Question 20

what is dividend yield

Answer 20

measures return to shareholders on current share value
needs share price

Question 21

what is dividend per share

Answer 21

total dividends / number of shares

Question 22

what is the dividend yield equation

Answer 22

dividend yield = dividend per share / market price of share x 100%

Question 23

what is earnings yield

Answer 23

measures total shareholder return against current share value, considering all shareholder profits and not just the dividends

Question 24

what is the earnings yield equation

Answer 24

earnings yield = current profit per ordinary share / market price of share x 100%

Question 25

what is earnings per share (EPS)

Answer 25

how much earnings is made from each share
a fundamental measure of performance, particularly the trend

Question 26

what is the EPS equation

Answer 26

EPS = current profit for ordinary shareholders / number of ordinary shares (pence)

Question 27

what is the price to earnings (PE)

Answer 27

measures the market price of a share to earnings
how many times the EPS an investor may be willing to pay to buy a share

Question 28

what is the PE equation

Answer 28

PE = market price of share / EPS (times)

Question 29

what must be considered about the share price

Answer 29

it is volatile and can be different day to day
should be taken from the balance sheet date

Question 30

what investment ratio must be reported in financial statements

Answer 30

earnings per share

Question 31

what is diluted EPS

Answer 31

to be considered if all potentially issuable shares were issued

Question 32

what does a high PE ratio indicate

Answer 32

high investor confidence

Question 33

what does improved dividend cover indicate

Answer 33

directors are retaining proportionately more annual earnings for reinvestment

Question 34

what does a reduction in dividend yield indicate

Answer 34

the dividend per share has not increased at the same rate as the shares market price

Question 35

what will happen if the earnings yield and earnings per share have increased

Answer 35

there will be a higher return for shareholders

Question 36

what does a drop in the price to earnings ratio indicate

Answer 36

the earnings have increased more than the share price has increased
the investors assessment of future prospects will reduce

Question 37

what are the limitations of ratio analysis

Answer 37

accounting data is inherently subjective
different year end dates have external factors influencing numbers
ratios can be interpreted differently
multiple years of data should be considered to see meaningful trends
financial statements always look to the past not the future
ratios can be calculated differently
ratios highlight changes but not the why behind them

Question 38

what does EBITDA stand for

Answer 38

earnings before interest, taxation, depreciation and amortisation
profit for the period + interest, taxation, depreciation and amortisation

Question 39

what do supporters of EBITDA argue

Answer 39

it is a more valid comparison of performance between companies
it is not affected by finance or subjective depreciation
it is a good approximation for operating cash flow