Interpreting Financial Statements (2) Flashcards
what is profit for the year
profit after interest and tax (PaIT)
what is capital employed
non-current assets + (current assets - current liabilities) = non-current assets + net current assets = share capital + reserves + non-current liabilities
what is gearing
the relationship of debt to equity (“leverage”)
how is the company financed (more borrowing or share capital)
what are preference shares
a fixed rate of dividends, do not have to be paid, but better for investor relations if they are
what is the gearing formula
gearing = (borrowings+preference share capital) / capital employed x 100%
what is the interest cover equation
profit before interest and taxation / interest payable times
what is the rank order of payments
1 operational costs
2 banks and other lenders
3 taxes to governments
4 dividends to shareholders
why is gearing important
interest on borrowing must be paid
dividends to shareholders is a management decision based on available current or retained profit
what happens if revenues decrease unexpectedly
the profit before interest and tax will decrease
what is attributed to a high geared company
more debt
more interest
more risk (when debt > equity)
what is attributed to a low geared company
less debt
less interest
less risk
what is interest cover
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
what additional information to the balance sheet and the income statement are needed to calculate investment ratios
interim dividend paid, final dividend paid/proposed, total dividend for the year and current share price
what are investment ratios
they help shareholders and potential shareholders make decisions about their investments
there are six to be discussed
what is the return on shareholder funds (RoSF)
similar to return on capital employed but calculated on shareholder returns and based on profit for the year
what is the return on shareholder funds equation
return on shareholder funds = profits after interest and tax / (ordinary share capital + reserves)
what is dividend cover
measures how safe a dividend payment is, how many times is current profit larger than dividends paid
shareholders would prefer a high dividend cover
what does it mean if dividend cover is consistently low
lots of dividends are paid out and there is little reinvestment
what is the dividend cover equation
dividend cover = profits after interest and tax / ordinary dividend for the year
what is dividend yield
measures return to shareholders on current share value
needs share price
what is dividend per share
total dividends / number of shares
what is the dividend yield equation
dividend yield = dividend per share / market price of share x 100%
what is earnings yield
measures total shareholder return against current share value, considering all shareholder profits and not just the dividends
what is the earnings yield equation
earnings yield = current profit per ordinary share / market price of share x 100%
what is earnings per share (EPS)
how much earnings is made from each share
a fundamental measure of performance, particularly the trend
what is the EPS equation
EPS = current profit for ordinary shareholders / number of ordinary shares (pence)
what is the price to earnings (PE)
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
what is the PE equation
PE = market price of share / EPS (times)
what must be considered about the share price
it is volatile and can be different day to day
should be taken from the balance sheet date
what investment ratio must be reported in financial statements
earnings per share
what is diluted EPS
to be considered if all potentially issuable shares were issued
what does a high PE ratio indicate
high investor confidence
what does improved dividend cover indicate
directors are retaining proportionately more annual earnings for reinvestment
what does a reduction in dividend yield indicate
the dividend per share has not increased at the same rate as the shares market price
what will happen if the earnings yield and earnings per share have increased
there will be a higher return for shareholders
what does a drop in the price to earnings ratio indicate
the earnings have increased more than the share price has increased
the investors assessment of future prospects will reduce
what are the limitations of ratio analysis
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
what does EBITDA stand for
earnings before interest, taxation, depreciation and amortisation
profit for the period + interest, taxation, depreciation and amortisation
what do supporters of EBITDA argue
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
