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AC100 > Lecture 8 > Flashcards

Lecture 8 Flashcards

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1
Q

What will I be learning today?

A

How to interpret financial statements.

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2
Q

Which company displays being a growth firmc Aslan PLC or Gilderoy?

What 4 things should you took about when answering this question?

A

The answer is Aslan Plc

1) Cash flow from investing activities
2) Cash flow from operating activites
3) depreciation vs purchase of equipment
4) compare the working capitals ( Trade receivables, Trade payables and inventory.

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3
Q

When looking at Cash flow from investing activities why does Alsns show as a growth firm?

A

For Aslan Plc their cash flow for investing activites is ( 80000) meaning that they are investing in the future, purchasing equipment, whereas Gilderoy Plc has a positive cash flow from investing activities 40000) showing that they are selling equipment, not investing for the future.

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4
Q

When looking at overall cash flow from financing activites, why does Aslan display a growth firm and Gilderoy doesn’t?

A

Gilderoy PLC is returning money back ( paying loans, issuing dividends hence -110,000 cash flow from financing activites) however Aslan have a positive cash flow from investing activites showing that they may have issued shares and repayed a bit of the loan and raising fresh capital.

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5
Q

When looking at depreciation and purchase equipment why does Aslan Plc display a growth firm and Gilderoy doesn’t?

A

Aslan Plc depreciation is 40000 and purchases wass ( 90000), this shows that it is not only replacing used up equipment but purchasing extra equipment for future growth.

In the case of Gilderoy the depreciation was 100000 but purchase of equipment was 0, meaning that even if the equipment is getting used up, it is not replacing the used up equipment.

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6
Q

How does A/R ( ONE OF THE WORKING CAPITALS SHOW THAT ASLAN IS A GROWTH FIRM AND GILDEROY IS NOT?)

A

In the case of Aslan, they have sold a lot, leading to higher receivables, which is seen as a negative cash flow (20000)

Whereass Gilderoy A/R is positive 30000, this tells you yhat their is a decrease in accounts receivable, showing that it is collecting money.

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7
Q

How does the trade payables of ASLAN AND GILDEROY show that Aslan is a growth firm and Gilderoy is a early decline stage firm?

A

In the case of Aslan their T/P is 45000, meaning they are buying more from suppliers and taking more time to repay, so T/P is high.

Whereas in the case of Gilderoy PLC they are collecting cash from customers repaying suppliers, so they are losing money, hence negative accounts payable (160000), showing early decline stage)

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8
Q

How does inventories between Aslan and Gilderoy show that Aslan is a growth firm and Gilderoy is early decline stage firm?

A

In the case of Aslan inventory change is ( 62000) negative meaning inventory has gone up, meaning the company is buying more to sell more.

For Gildeory PLC, inventories change is positive, meaning that they are selling the equipment of what isi remaining, not involved in active trading.

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9
Q

What are 3 financial analysis tools, to intrepret financial statements?

A

Common size financial statements

Trend analysis

Financial ratios

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10
Q

Finish off the sentence, Different user groups ….?

A

Expect different types of returns

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11
Q

What are 2 primary types of user groups of financial statements?

A

Lenders and shareholders, they use financial statements to predict their expected returns and assess the risks asscoiated with those returns.

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12
Q

What are lenders interested when looking at financial statemenets?

A

They are interested in whether the firm will surivive the nect period and repay loan ( short term liqudity and long term solvency)

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13
Q

What are Shareholders interested when looking at financial statemenets?

A

They are concerned with profabitatbility and future share prices.

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14
Q

What is common sizing of financial statements?

A

You restate the financial statements as a proportion of some particular number, it is in a standardised form, year on year, you can compare with.

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15
Q

For an income statement what could be common sizing?

A

income statement in which each line item is expressed as a percentage of the value of revenue or sales.

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16
Q

What are 2 types of common sizing?

A

Veritcal and horizontal

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17
Q

What is vertical common sizing?

A

Expresses all figures in a particular statement in terms of one of the figures in that statement.

The base figure can be for example:

a) Sales or revenues in IS
b) Total assets in BS

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18
Q

How would common sizing look on an I/S statement ( picture)

Revenue(base figure 2240)

COS (1745)

Gross profit (495)

operating expenses(252)

profit before interest and tax (243)

less interest payable (18)

profit before tax (225)

less corporation tax (60)

net profit after tax(165)

A
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19
Q

What is horizontal common sizing?

A

You take a particular year as a base year e.g. how has the firm improved after the financial crisis, so you would take the base year as the year of the financial crisis (2008) and you would express every years figures as a percentage of base year.

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20
Q

Show an example of horizontal common sizing?

A
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21
Q

What is trend analysis and give an example?

A

Trend analysis is based on the idea that what has happened in the past gives traders an idea of what will happen in the future. e.g. can use it to predict future stock prices, based on previous years.

It analysis key ratios over time, and show trends.

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22
Q

Suppose that we have two different businesses: A is a small business and B is a large business Net profit is £10,000 and £80,000 for A and B , respectively. Now, can you determine which company is more profitable ?

A

The answer is No because there is not enough information as B could be a very big company only generating 80,000, so you need to compare output generated with some measure of input.

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23
Q

Now, Suppose that stockholders’ equity is £100,000 and £1000,000 for A and B , respectively

And we know that Net profit is £10,000 and £80,000 for A and B , respectively.

Which company is more profitable?

A

It is company A

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24
Q

What is the numbers 10% and 8% from previous answer an example of?

A

A fianancial ratio ( Financial ratios are created with the use of numerical values taken from financial statements to gain meaningful information about a company. )

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25
Why use financial ratios 2 reasons?
1-To compare the financial health of different businesses (without 2- To highlight the financial strength and weakness of a business, and why do they exist.
26
What is a warning about financial ratio?
They are an inexact science-- results must be interpreted with caution
27
How are ratios compared?
With: Past performance Similar businesses Planned performance.
28
What are fianancial ratios classification ( 5, providing insight on the bussiness)
Profitability Efficiency Liqudity Financial gearing Investment
29
What does the profitability ratio tell you?
tells you how well a company is doing compared to some measure of input. e.g. money from shareholders etc
30
What are the 4 main profiatbility ratios?
Return on Equity Return of capital imployed Operating profit margin Gross profit margin
31
What is the return on equity ratio calculation and target ?
a measure of profitability that calculates how many dollars of profit a company generates with each dollar of shareholders' equity ROE = Profit for the year ( less any preference dividend) / Share capital + reserves ( entire equity section) Target = as high as possible, as you want your company to be as profitable as possible.
32
What does the return of capital employed mean?
the ratio measures how well a company is generating profits from its capital. ROCE = Operating profit ( if you took net profit, you would take into account interest paid towards loans, you don't want that as part of calculation)/ Share capital + reserves + non current liability ( entire equity section + long term liability)
33
What does operating profit mean?
Operating Profit = Operating Revenue - COGS - Operating Expenses - Depreciation and Amortization. A higher operating profit margin means that the company is managing its costs well and earning more in revenue per dollar of sales
34
What is the operating profit margin and target?
Tells you how much sales revenue you are able to convert into operating profit Operating profit margin = Operating profit / sales revenue X 100 You want it to be as high as possible
35
What is the gross profit margin and target?
It shows how much profit a company makes after paying off its Cost of Goods Sold (COGS). Gross profit margin = Gross profit / sales revenue X 100 Target as high as possible
36
What is an important thing to note about Operating profit margin and gross profit margin?
Operating profit margin is very senstivie to changes in gross profit margin.
37
What does it mean that e.g. gross profit margin went from 30% to 35%, whereas operating profit margin went from 10% to 7%
This means that operating expenses increased a lot ( e.g. a huge depreciation expense in that year) , also you sold lots of goods hence gross profit margin went up.
38
What does it mean if Gross profit falls?
Cost of sales as a pereentage of sales revenue has increased.
39
Intrepreting profitability ratios?
TBA?
40
The Gross profit margin of company ABC in 2016 was 70% while in 2017 was 60%. The sales revenue in both years was £100,000. What could be the reason for decline in gross profit margin? A. The company offered more discounts in 2017 B. There was a higher writedown of inventory in 2017 C. Either of the above D. Insufficient information
C. .Either the above
41
What does write down of inventory mean?
A write-down is an accounting term for the reduction in the book value of an asset when its fair market value (FMV) has fallen below the carrying book value, and thus becomes an impaired asset.
42
What is an efficiency ratio?
measures a company's ability to use its assets and manage its liabilities effectively in the current period or in the long-term
43
What are the 5 efficiency ratios?
Average inventories holding period Average settlement period of Trade receivables Average settlement period of Trade payables Net asset turnover ratio Sales revenue per employee
44
What is Average inventories holding period?
This is a measure of how long was the inventory kept in the company Average inventories holding period = Average inventories held/Cost of sales ( because when you sell inventory the historic cost is noted in the cost of sales) X 365 Target: To keep this low, as you want to sell as quickly as possible.
45
When working out average inventories held where do you find the numerator from?
From the statement of financial position, you take the beginning inventory + ending inventory / 2. This is because the balance sheet is a snapshot, so inventories change.
46
What is the average settlement period of Trade receivables?
How long does it take to collect your trade receivables Average settlement period of TR = Average trade receivables (take beginning TR and end/2) / Credit sales revenue ( because you want to get TR when selling on credit, in the exam this will be shown on additional info or if not just usue sales revenue.X 365 Target: you want it to be low as you want to collect from customers quickly, but not too low, as you are pressuring customers to pay instantly.
47
What is Average settlement period for Trade payables ratio and target?
Tells you how long do you take to repay suppliers. Average settlement period for trade payables = Average trade payables ( take average of beg and end) / Credit purchases ( additional info, if not then you may note down the entire purchases as credit purchase) X 365 Target : firms attempt to increase this ratio, but not too high so that their relationship with supply is bad.
48
What does Net asset turnover ratio tell you and whats the formula and target?
Tells you how much of your assets are you converting into sales Net asset turnover ratio = Sales revenue / Share capital + reserves + non - current liabilites. Target : Ratio to be as high as possible, but if it is very high then the firm is overtrading, meaning everytime you sell something you are replacing it, meaning that you haven't planned well in advance to purchase your inventory.
49
What does Sales revenueu per employee tell you and calculation and target?
Measures productivity of workforce Sales revenue per employee = Sales / number of employees Target: as high as possible
50
Intrepreting efficiency ratios
TBA
51
What is the operating cash cycle and target?
It tells you how long does it take the company to have paid cash to supplier and get cash back from customers. Formula = Average inventories holding period + Average settlements period for receivables - Average payment period for payables = Operating cash cycle. Target = you want this to be as low as possible bebcause you want the company to have cash inside operations.
52
Whats the link between efficiency and profitability ratios?
Operating profit margin X Net asset turnover = Return of Capital Employed. Operating profit ( Tells you how much sales revenue you are able to convert into operating profit ) Net asset turnover = how much assets are you converting into sales Return of capital employed = the ratio measures how well a company is generating profits from its capital.
53
What is the link between profitability and efficiency in words?
The relationship between these ratios tells us how can one improve their return on capital employed, either higher operating profit margin or higher net asset turnover sales
54
Following the example explain ROCE in both sainsburys and Nike
As you can see it is easier for Nike to increase prices hence higher operating profit margin, whereas sainsbury cannot do this, they have to increase asset turnover ( increase volume of goods sold) to increase ROCE
55
Whats the answer?
ROCE = Operating profit / Equity + long term liabilitiy 50 / (250 + 350) + ( 200+ 200)/2 = 10% C Whenever there is a B/S always take average.
56
B and C
57
What does Liqudity mean?
This is the ability to cover short term liabilitites, do you have enough cash to repay current liabilties.
58
What does Solvency mean in credit risk analysis?
The ability to generate cash in the long term internally or externally to satisfy capital needs, fuel growth and repay debts.
59
What does liquidity raito answer?
Do you have enough current assets or cash to repay your current liabitlites, as you are worried about the short term.
60
What are the 3 liqudity ratios?
Current ratio Acid test ratio Cash ratio
61
What is current ratio, calculation and target?
Tells you do you have enough assets to pay your current liabilities? Current ratio = Current assets/ Current liabilities Target ( Rule of thumb it should be 2), but this is not necessarily true.
62
Why is the rule of thumb of 2 target not necessairly true for current ratio?
It varies in industry, e,g, manfucaturing business has a relatively higher current ratio than a software business, as they have goods being internally generated, but software business doesn't have current assets being internally generated as a manfucature business, So you should check industries bench marks
63
What is the acid test ratio, calculation and target
Do we have enough current assets excluding inventory to pay current liabilities ( we exclude inventory because this takes longer to convert to cash Acid test ratio = current assets - inventory / current liabilities. Target (1)
64
What is the cash ratio mean, calculation and target?
Do we have enough cash directly from operations to repay current liabilities. Cash ratio = Operating cash flows ( taken from cash flow statement or if not given in exam, take from B/S) / Current liabilities. Target, High
65
In consensus the targets for Liqudity ratios should be what?
High as you want to repay current liabilties as soon as possible
66
A) Yes
67
What is a Gearing ratio and what are the 2 types?
This is when a company chooses to be financed through debts rather than just equity. Gearing ratio/debt to capital ratio Interest cover ratio
68
Why would you want to be financed by debt?
To finance growth To exploit tax advantages ( interest is tax dedcutible)
69
What are dangers of finance gearing?
Risk of bankruptcy Limited flexibility due to restrictions imposed on loan agreements ( e.g. not using the loan in risky projects)
70
What is gearing ratio/ debt to capital ratio mean, calculate?
How much long term debt does the company have compared to overall capital Gearing ratio = non current liabilites / share capital + reserves + long term liabilities ( or equity + non-current liabilities)
71
What does it mean if you say a company has a 20% gearing ratio?
Means the firm is financed 20% by debt
72
What is interest cover ratio mean, calculate and target?
Tells you whether the firm generates enough operating profit to cover interest. Interest cover ratio = Operating profit / Interest payable Target = As high as possible
73
What does it mean if Interest cover ratio is 12?
This means the level of operating profit is 12 times the level of interest.
74
How could you interpret this?
Nike is very healthy, it has enough operating profit to cover interest ( the level of operating profit is 74.28 times the level of interest)
75
Interpreting liqudity and gearing ratios?
TBA
76
What did Thomas cook do to pay dividends and make themselves look good?
They did this 2 years before they went bankrupt, they borrowed money to pay dividends, showing that they are doing great, using it as a signalling mechanism, but they would of been better of using it to pay short term liabilitites. So look out for a rise in gearing ratio ( could be because of this)
77
What is an investment ratio?
You take the angle of the shareholder, this help the shareholders understand the return of their investment.
78
What are 4 types of investment ratios?
Dividend payout ratio Dividend yield ratio Earnings per share Price/ earning ratio
79
What is Dividend payout ratio, caluclation and target?
Shows the proportion of profit are paid out as dividends Dividend payout ratio = Dividends announced for the year / Profit (after tax) less any preference dividend X 100 Target: For shareholders they want this to be high but not too high because you are giving money out and not investing in the business ( e.g. 80% of profit as dividends, meaning you only have 20% for reinvestment)
80
What does a divident payout of 20% mean?
Means 20% of profit is distrubted to shareholders in the form of dividends.
81
What is a dividend yield ratio, calculation and target?
How much cash return you get realtive to its curent market value. Dividend yield ratio = (Dividends per share/ 1 -t )/ Market value per share X 100 (Dividends per share/ 1 -t ) = this will tell you how much cash you will getting net dividend. t = dividend tax credit Target = high
82
What is Earnings per share, calculation and target?
Earnings avaliable to shareholders per share issued EPS = (Profit after taxation - preference share dividend / Number of ordinary shares in issue) X 100 Target : high as possible ( measures of profitability from investor perspective)
83
What does a EPS of £1.20 mean?
Means you are expecting income of £1.20 per share
84
What is Price/ Earning ratio calculation and target?
This measures the market confidence in the future earning power of a business. PE ratio = Market value per share / Earnings per share Target : High as it reflects investors confidence on the international scene
85
What does a P/E ratio of 8 times mean?
This means that the market value of the share is 8 times higher than its current level of earnings.
86
It is C) this is insufficient reason This is not enough information, you must not follow ratios alone, these firms are infact Microscoft and General motorS ( they actually borrowed money to pay dividends and went bankrupt in 2011 hence high dividend per share
87
What is a limitation of ratio analysis in terms of quality of financial statements?
The ratio are only good as the quality of financial statements, so if a firm is not very good at preparing statements, the ratios will not convey a better picture.
88
What is a limiation of ratio analysis in terms of Inflation?
Values change in times of inflation, so companies last year, is different to this years, so if you don't adjust to inflation, you give a wrong picture of whats happening.
89
What is a limitation of ratio analysis in terms of restricted vision?
Ratios only look at certain aspects, you should look at full financial statements.
90
What is a limitation of Ratio analysis in terms of basis of comparison?
Depends on what you are comparing with ( e.g. comparing sainsburys withh nike makes no sense, compare like for like)
91
What is a limitation of ratio analysis in terms of balance sheet ratios?
You take the start and end valuues, but it is not necessarily what happened during the period.
92
C) Gamma
93
A) Alpha

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