Proposed Dividend minus Preference Dividend

Transcription

1 Interpretation of accounts Definitions 1 Capital Employed Everyone s money Total of Financed by 2 Equity Funds Owners money Equity Capital + Reserves 3 Fixed Interest Capital Borrowed money Debenture Loan + Preference Capital 4 Equity Capital Number of Ordinary Shares Shares 5 Operating Profit Everyone s profit 6 Interest Debenture interest & - Preference 7 Owners Profit Operating profit less interest = 8 Ordinary Share Proposed minus Preference - The Business Any Business is of a size, which we can show in picture form as a black box. This size is called Capital Employed and the figure is found in the balance sheet. It shows all monies invested in the firm from whatever source, both money belonging to the owners, and any money they have borrowed. As mentioned above the money invested in a business is either provided by the owners or else is provided by investors who lend to the business. The owners we show in blue and the investors in red. The Owners money (for simplicity) we consider to be 1. The Ordinary Share Capital figure & 2. The Reserves, P&L Account figure Both found in the Financed By section of the Balance Sheet. This total money invested by the owners themselves is called Equity Funds The Borrowed monies come from 1. Debenture Loans figure & 2. Preference Share Capital figure. Again both figures found easily in the financed by. This 2 nd point leads to confusion, because Preference Capital is a little bit Owners and a little bit Borrowed at the same time. For the purposes of these questions we treat Preference Capital as pure and simple borrowing. More importantly we treat its dividend as dividend in name but really an interest. These four figures are found in the Finance By section of the Balance Sheet, making the job of finding the size of 1. The business - black box 2. The owners investment - blue box 3. The borrowings - red box fairly easy and straightforward. M. Galligan Page 1 of 9 N:\1m\accountancy\ratios\ratios.doc

2 Division of Profits Sales less Cost of Sales equals Gross Profit. Gross Profit less Operating Expenses equals Operating Profit. Operating Expenses are normal, typical, everyday expenses of a business. Hence Operating Profit is the profit made by a business from normal everyday activities and excludes anything unusual. Operating Profit is going to be shared by both owners and investors and as it applies to everyone connected to the business, it is black. We can show it as a black circle. Operating Profit is going to be shared out into Four pieces in a particular order. First, the Debenture Holders will take their interest. Second, the Preference Shareholders will take their dividend(interest). At this stage what is left belongs to the Owners. Third they will take home a for themselves and finally whatever is left over is being reinvested back into the business. The process looks as follows First we have the Operating Profit ready for distribution between the debenture holders, preference capital investors and owners. First we take out the Debenture Interest. This is easy and straightforward because we are simply given the figure for it in the question. Even if we were not it would still be easy to calculate. Simply, the amount of the loan by the rate of interest. Second we take out the Preference (interest) This is a tiny bit more complicated as the figure is not given to us. However it is easy to calculate. The amount of Preference Capital by the rate of Interest. By this stage we have the half circle of profit left for the blue owners. From this they will decide to take home some of it as an Ordinary and to re-invest the remainder back into the business. Third we take out the Ordinary This involves some sums because the dividend figure given is made up of dividends for both Ordinary and Preference Capital. We have already calculated the Preference dividend bit at the second stage above. Total dividends (given) minus preference dividends/interest (calculated earlier) equals Ordinary dividends. The retained earnings we are left with should be the same as on the question sheet or else we have an error. Mistakes here are not a good thing and we should pause and check our workings. M. Galligan Page 2 of 9 N:\1m\accountancy\ratios\ratios.doc

3 What we are going to need to answer the Question From the Balance Sheet 1 The Size of the Business = Capital Employed 2 The Owners Money = Equity Funds 3 Borrowed Money = Fixed Interest Capital Everyone s money Total of Financed by Owners money Ordinary (Equity) Capital + Reserves Borrowed money Debenture Loan + Preference Capital 4 Ordinary Shares Issued Number of Ordinary Shares Shares 5 Market Value of One Ordinary Share Given in the Question From the Final Accounts 1 Operating Profit Profit for Everyone Debenture holders Preference Shareholders Ordinary Shareholders 2 Interest Debenture interest - 3 Owners Profit Profit just for the Owners = 4 Ordinary Share owners take home - M. Galligan Page 3 of 9 N:\1m\accountancy\ratios\ratios.doc

4 Gearing Gearing and Ownership Structure = % Interest Cover Number of Times Asks the Question How much of the Business is NOT ours? Borrowed Money as a % of the overall Business. Answer > 50% = Highly Geared Smaller = better Highly Geared means there is more Fixed Interest Capital than Equity Capital, (borrowed money than owners money) Should Profits drop the Equity Shareholders will lose out by more than the fall in profits. High geared means lenders have more influence. Asks the Question How many times bigger than the debenture interest is the Operating Profit? Operating Profit divided by Interest. Answer = Profit is X number of times larger than interest. Bigger = better. Means profits easily cover interest with lots left over for owners. Want a figure of 4 or bigger. If it s less than 4, an increase in interest payments can quickly eat up most/all of the profits leaving little or nothing for the owners. Gearing The firm is high/low geared. Gearing is?, was?, has improved/disimproved by? 1. If low/high = not/highly dependent on outside borrowings. 2. If high = shareholders concerned as Decreases their chance of getting a dividend & Increases the risk from outside investors Interest Cover, (IC) Interest Cover is?, was?, has improved/disimproved by? 1. IC is above/below the minimum guideline of 4 This shows the firm has/has little difficulty meeting their interest payments. Both figures together Trend is improving/disimproving. Shareholders happy or not. M. Galligan Page 4 of 9 N:\1m\accountancy\ratios\ratios.doc

5 Profitability Return on Capital Employed = % Return on Equity Funds = % Shows the amount of Operating Profit available for distribution among Everyone. States: A business makes a profit of this size on the back of an investment of this much. We compare to banks, debenture interest and preference dividends/interest. Shows the amount of Owners Profit available for distribution among those same Owners States: A business makes a profit of this size (for the owners) on the back of an investment of this much, (by the owners). We compare to banks, debenture interest and preference dividends/interest. Net Margin = % Sales Shows how much of the Sales are left for Profits. The firm is/not Profitable. RCE is?, was?, has improved/disimproved by? REF is?, was?, has improved/disimproved by? 1. It is/not profitable because it is performing better/worse than Risk free investments Debentures Preference Share Capital If better/not than risk free = a efficient/not use of funds Trend is improving/disimproving. M. Galligan Page 5 of 9 N:\1m\accountancy\ratios\ratios.doc

6 Liquidity Current Ratio CA : CL Min 2 : 1 Acid Test Quick Ratio CA : CL minus stock Min 1 : 1 Shows the Short-Term sources of funds against the short-term outflows of funds. Looks at the near future. Shows the Immediate sources of funds against the short term outflows of funds. Looks at right now. The firm is/not liquid. 1. Can/cannot pay its debts as they fall due. Current Ratio is?, was?, has improved/disimproved by? 1. Has CA cent for every euro it owes. 2. Is above/below the minimum 2:1 ratio. Acid Test is?, was?,has improved/disimproved by? 1. Has CA minus cent for every euro it owes. 2. Is above/below the minimum 1:1 ratio. Trend improving/disimproving. Sector Is in the? sector. o o This is a good/bad sector Because 1 2 Share Value Market Value of Shares is?, was?, has increased/decreased by? Indicates confidence/lack of in the business. How many shares are still available to be issued? How much could this raise? M. Galligan Page 6 of 9 N:\1m\accountancy\ratios\ratios.doc

7 Stock Turnover Cost of Sales Average Stock Activity = Number of Average Stock Times a Year = (opening + closing) / 2 Number of times stock is sold. Dropping figure could mean business slowing down. High figure could mean firm operating with low stock, and risking stock shortages. High figure means a smaller proportion of cash tied up in stock. Debtor's Creditor's average period of credit in months average period of credit in months Debtors X 12 Months Creditors X 12 Months Credit Sales Credit Purchases Time it takes to collect from Debtors. Indicates length of time cash tied up. Time period given to us by Creditors. Should not be significantly longer than that received from Creditors. Security Total Fixed Assets > Debentures The Debentures are secured on the fixed assets. (We are not told this, but they always are). How much of the Total Fixed Assets are Intangible? Are the Tangible Fixed Assets correctly valued? o Have they been depreciated properly, or at all? Is the figure given for the Current Market Value of Investments accurate? We can t answer most of these questions but we should explicitly as the questions. The cost of the Investments was? Their current Market Value is? Investment Policy This shows good/bad management of these Investments. M. Galligan Page 7 of 9 N:\1m\accountancy\ratios\ratios.doc

8 Owners Investment & Policy Everything here only refers to figures for the Owners. Hence All figures here are blue figures. Cover Number of Times Bigger = More of Profit being paid out in s Bigger = Less of Profit is being retained by the Business Earnings Per Share Bigger is better Cent per share Per Share Shares Shares Bigger is better Cent per share Price Earnings Ratio Period to Mkt Years Recoup Mkt Years EPS Market Price DPS Indicates the number of years it would take to recoup the share price based on the current earnings of the company. A High ratio indicates that the company is expected to increase profits in the future. Indicates the number of years it would take to recoup the share price based on the current dividend s of the company. A High ratio indicates that the company is expected to increase profits in the future. Real Return Div Yield * Div Cover Yield DPS % Mkt Shows the Return received by the investor. To be compared with risk free investments such as banks etc M. Galligan Page 8 of 9 N:\1m\accountancy\ratios\ratios.doc

9 Policy Policy only refers to figures for the Owners. Hence All figures here are blue figures. DPS is?, was?,has improved/disimproved by? Cover is?, was?,has improved/disimproved by? 1. If going down = less profits being retained = bigger dividend payout 2. Retaining more = confidence in firm 3. Retaining less = lack of confidence in firm OR shareholders want a payout now. 4. Is enough being retained (saved) to eventually repay debentures? Yield is?, was?,has improved/disimproved by? 1. Performing better/worse than Risk Free Investments Debentures Preference Capital The Real Return ( Yield * Cover) is?, was?,has improved/disimproved by? 1. It is performing better/worse than the Risk Free investments. Recommendation Do or don t buy, but do make a recommendation based on figures. M. Galligan Page 9 of 9 N:\1m\accountancy\ratios\ratios.doc