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Intro to accounting > topic 4-6 > Flashcards

topic 4-6 Flashcards

1
Q

What does ‘limited liability’ mean for shareholders in a company?

A

Shareholders are only liable up to the amount they invested in shares; personal assets are protected.

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2
Q

What is the purpose of a company’s Memorandum and Articles of Association?

A

Memorandum defines external objectives; Articles govern internal regulations and shareholder relationships.

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3
Q

How can shareholders remove underperforming directors?

A

A: By voting them out at the AGM and appointing replacements.

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4
Q

Why must companies file annual accounts under the Companies Act 2006?

A

A: To ensure transparency, allow shareholder oversight, and meet legal obligations.

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5
Q

What is the par (nominal) value of a share?

A

The face value assigned to each share by the company, used for accounting but not reflective of market value

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6
Q

Why do companies issue shares at a premium?

A

To reflect growth in value and protect current shareholder equity from dilution.

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7
Q

Where is the premium on issued shares recorded in the accounts?

A

In the Share Premium Account, a non-distributable capital reserve.

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8
Q

What are the rights of preference shareholders in terms of dividends and voting?

A

Fixed dividends paid before ordinary shares; typically no voting rights

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9
Q

In liquidation, how are preference shareholders treated compared to ordinary shareholders?

A

They receive capital repayment before ordinary shareholders.

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10
Q

What is the financial effect of a bonus issue on a company’s equity?

A

Increases share capital and decreases retained earnings; total equity remains the same

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11
Q

Why might a company issue bonus shares?

A

To capitalize retained earnings and signal financial strength without paying cash dividends.

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12
Q

What are pre-emption rights in a rights issue?

A

The right of existing shareholders to be offered new shares before the public.

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13
Q

Why are rights issues usually priced below the market value?

A

To encourage take-up by shareholders and raise capital effectively.

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14
Q

What is the theoretical ex-rights price (TERP)?

A

The adjusted average share price after a rights issue, accounting for new discounted shares.

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15
Q

What is the value of a “right” in a rights issue?

A

The difference between the TERP and the subscription price; can be sold if not exercised.

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16
Q

What’s the primary difference between bank loans and share capital as financing?

A

Loans require repayment with interest; share capital doesn’t but dilutes ownership.

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17
Q

What are the legal restrictions on issuing shares below par value?

A

It is illegal under the Companies Act 2006 to issue shares at a discount to par.

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18
Q

Why is share capital considered long-term finance?

A

It remains in the company as long as it exists and doesn’t require repayment.

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19
Q

From which reserves can dividends legally be paid?

A

Only from distributable reserves, such as retained earnings.

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20
Q

Why are dividends not considered expenses?

A

They are distributions of profit and not part of operating costs.

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21
Q

What prevents a company with retained losses from paying dividends?

A

Dividends cannot be paid when retained earnings are negative; doing so violates the Companies Act.

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22
Q

What is the accounting impact of a share issue at premium (e.g. £1 par, issued at £1.50)?

A

Share capital increases by £1 per share; £0.50 goes to share premium.

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23
Q

What is the dilution effect on share value when issuing new shares?

A

More shares in circulation lower the value per share unless matched by proportional growth in net assets.

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24
Q

In a 1-for-4 bonus issue, how does share capital change?

A

It increases proportionally; e.g., 40M shares become 50M

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25
In a 1-for-4 rights issue at £1.80, how is capital allocated?
£1 per share goes to share capital; excess (e.g., £0.80) to share premium
26
What does a bonus issue imply about a company's retained earnings?
That the company has sufficient retained earnings to convert into share capital.
27
How does a bonus issue affect the share price?
Share price adjusts downward, maintaining the same total value for shareholders
28
What is the purpose of calculating TERP in a rights issue?
To estimate the new average share price and assess the value of rights and dilution impact.
29
What is trend analysis in ratio analysis?
Comparing the same ratios over several periods to identify performance trends.
29
What is the main purpose of ratio analysis?
To evaluate, interpret, and compare financial performance over time using key relationships between figures
30
What does the Gross Profit Margin measure?
The profitability of selling goods/services before considering operating costs.
30
Why is consistency important in ratio analysis?
Inconsistent calculation or presentation distorts comparisons and can lead to misleading conclusions
31
What are potential causes of changes in Gross Profit Margin?
Changes in selling price, cost of goods, sales mix, supplier discounts, or productivity.
32
What does the Operating Profit Margin reveal?
How much profit is generated from core operations before interest and tax.
33
What does Return on Ordinary Shareholders’ Funds (ROSF) indicate?
The percentage return earned for ordinary shareholders on their investment.
34
How is Return on Capital Employed (ROCE) interpreted?
It shows how efficiently long-term capital is used to generate operating profit.
35
Why can ROCE be misleading without adjustments?
Because asset values may be outdated and not adjusted for inflation or unreported leased assets.
36
What can distort the Non-Current Asset Turnover ratio?
Leased assets not on the balance sheet and outdated historical asset values.
37
What does Non-Current Asset Turnover assess?
The revenue generated per £1 of fixed (non-current) assets.
38
How is Revenue per Employee calculated and interpreted?
Revenue ÷ No. of Employees; measures sales productivity per worker.
39
What does Profit per Employee measure?
Operating profit earned per employee; indicates efficiency and productivity of workforce.
40
What does Earnings Per Share (EPS) represent?
The amount of profit attributable to each ordinary share after all prior claims.
41
Why is EPS important to investors?
It affects share prices and signals likely dividend changes.
42
What does a rising EPS typically indicate?
Increased profitability and possibly higher future dividends.
43
What is Dividend Per Share (DPS)?
The cash dividend paid out on each ordinary share.
44
What does the Price-Earnings (P/E) Ratio show?
How many years of current earnings are reflected in the share price.
45
What does a high P/E ratio suggest?
Market confidence in the company’s earnings stability.
46
What does the Dividend Yield tell investors?
The return on investment from dividends as a percentage of share price.
47
How is Dividend Yield calculated?
DPS ÷ Market Price per Share × 100
48
What does Dividend Cover measure?
How many times the company’s profits can cover its current dividend payments.
49
Why is a high dividend cover considered a good sign?
It suggests strong profit retention and dividend security.
50
Why shouldn’t users rely only on ratios or only on figures?
Figures show size, but ratios reveal trends and relationships — both are essential.
51
Why is it important to compare ratios to industry benchmarks?
It provides context and helps assess relative performance
52
What do falling profitability ratios generally indicate?
Worsening control over costs or declining sales efficiency.
53
Why might a company with rising profits be less profitable than before?
Because ratios like net or gross profit margins may have decreased, meaning profit per unit of sales has dropped.
54
What is overtrading and how can it be identified through ratios?
When a business grows faster than its financing allows; signs include strained liquidity, rising payables, and funding gaps despite strong sales.
55
What does the current ratio measure?
A firm's ability to meet short-term obligations using current assets.
56
What is the formula for the current ratio?
Current Ratio = Current Assets/Current Liabilities
57
What are potential limitations of the current ratio?
It may overstate liquidity if inventory is not easily convertible to cash.
58
What does the quick ratio (acid-test) measure?
Short-term liquidity excluding inventory — a stricter measure than the current ratio.
59
What is the formula for the quick ratio?
Quick Ratio = (Current Assets – Inventory)/ Current Liabilities
60
Why is the quick ratio useful?
It provides a more realistic assessment of immediate liquidity.
61
What does inventory days measure?
How many days, on average, inventory is held before being sold.
62
What is the formula for inventory days?
Closing Inventory/Cost of Sales × 365
63
What do receivables days indicate?
How long it takes, on average, to collect payment from customers.
64
What is the formula for receivables days?
Trade Receivables/Credit Sales ×365
65
What do payables days measure?
How long, on average, it takes the company to pay its suppliers.
66
What is the formula for payables days?
Trade Payables/Cost of Sales × 365
67
What is the cash conversion cycle?
The number of days between cash outlay for inventory and receiving cash from customers.
68
What is the formula for CCC?
CCC=Inventory Days+Receivables Days−Payables Days
69
Why is a shorter CCC preferred?
It means cash is tied up for a shorter time, improving liquidity.
70
How does the CCC help users?
It shows how efficiently a company manages working capital.
71
Why is efficient working capital management important?
To ensure operational continuity, avoid cash shortages, and manage payables and receivables effectively.
72
What can poor working capital management lead to?
Liquidity problems and potential business failure, even if the business is profitable.
73
What does the gearing ratio measure?
The proportion of debt compared to equity — a measure of financial risk.
74
What is the formula for gearing?
Long-term + Short-term Borrowings / Equity × 100
75
What does the debt ratio show?
The percentage of a company’s assets financed by debt.
76
What is the formula for the debt ratio?
Total Liabilities / Total Assets ​
77
What does interest cover indicate?
How easily a firm can meet its interest obligations from profits.
78
What is the formula for interest cover?
Profit Before Interest and Tax / Interest Expense
79
Why is a low interest cover ratio a concern?
It indicates that the firm may struggle to meet interest payments, increasing default risk.
80
What does high gearing suggest about financial risk?
The firm is more dependent on debt, increasing financial risk in volatile conditions.
81
Why is long-term solvency important beyond just current profit?
It affects the firm’s ability to survive downturns and secure future funding.
82

Intro to accounting (4 decks)

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