week 23

Question 1

what is solvency

Answer 1

the ability to cover liabilities when they fall due
potential problem if current assets < current liabilities

Question 2

what is liquidity

Answer 2

refers to the ease of turning an asset into cash (without loss)
cash is most liquid

Question 3

what is the working capital/current ratio

Answer 3

current assets / current liabilities
indicates ability to pay current liabilities from current assets

Question 4

what is a good working capital/current ratio

Answer 4

between 1.5 and 2, very industry dependant

Question 5

what is the limitation of working capital/current ratio

Answer 5

some assets are more liquid than others

Question 6

what is the quick ratio (acid test)

Answer 6

(current assets - inventories) / current liabilities
more stringent test of liquidity because inventory is less liquid

Question 7

what is a good ratio for the quick ratio

Answer 7

at least 1, depends on industry and size

Question 8

how do you predict insolvency

Answer 8

current and quick ratios are crude measures of liquidity, most users of financial statements are interested in liquidity as an indicator of whether the company can pay all its debts or will go into liquidation in the near future

Question 9

when does overtrading occur

Answer 9

when a business is operating at a level beyond its financial capacity

Question 10

why does overtrading occur

Answer 10

young, expanding business
manager miscalculation
unavailability of financing

Question 11

what are symptoms of overtrading

Answer 11

persistent use of bank overdraft facility
working capital ratios and liquidity ratios
significant increases in payment payables periods and settlement periods for receivables
long inventory holding period
low current and quick ratios

Question 12

what are the impacts of overtrading

Answer 12

liquidity problems
supply problems
planning problems
business failure
business must ensure sufficient financing. for long term success

Question 13

how do you calculate dividend yield

Answer 13

annual equity dividend / current market value of equity shares x 100

Question 14

what is dividend yield

Answer 14

seeks to assess equity shareholders annual cash return on investment
often between 2-5%
dividend yield is very important to some shareholders but not others
may be compared with other investments

Question 15

how do you calculate dividend cover

Answer 15

profit for the year / annual equity dividend

Question 16

what is dividend cover

Answer 16

shows the number of times dividend is covered by current profits
indicates how likely it is that company will be able to maintain dividends if profits fall
measure of risk

Question 17

how do you calculate earnings per share

Answer 17

profit for the year / number of equity shares in issue

Question 18

what is earnings per share

Answer 18

key measure of profitability and ability to pay dividends
profit - represents profit avaliable for distribution to equity shareholders
weighted average number of shares to take account of the period which shares are in issue

Question 19

what is basic EPS

Answer 19

takes account of all equity shares in issue

Question 20

what is diluted EPS

Answer 20

takes account of shares that may result if thee are financial statements which might be converted into shares in the future because this conversion would dilute the EPS

Question 21

how do you calculate return on equity

Answer 21

profit for the year / (equity - minority interest) x 100

Question 22

what is return on equity

Answer 22

comprehensive indicator of performance - how well managers use funds invested by shareholders
ROE should exceed cost of equity capital for the firm to be regarded as a success

Question 23

what is minority interest

Answer 23

refers to ownership aside from the parent
reported on balance sheet - reflects claim on assets belonging to other non controlling shareholders

Question 24

how do you calculate price-earnings ratio

Answer 24

current market price of each equity share/earnings per share

Question 25

what is price-earnings ratio

Answer 25

compares amount invested in one share with earnings per share represents the number of years of current earnings that investors are prepared to buy often is in the range between 10 and 25, variation across industries

Question 26

what does low P/e ratio mean

Answer 26

riskier firm firm is expected to stagnate

Question 27

what does high P/e ratio mean

Answer 27

firm is expected to grow

Question 28

why is there variation in P/e ratio

Answer 28

due to level of stock market and industry of firm

Question 29

how do you calculate market book ratio

Answer 29

market capitalisation of shares (market value) / book value of shares (capital and reserves)

Question 30

what is market to book ratio

Answer 30

relationship between stock market value of shareholder equity and accounting value of shareholder equity can indicate whether a company is under or over valued or whether market expectations of the company are high or low

Question 31

how do you calculate interest cover

Answer 31

operating profit (before tax and interest) / interest expense

Question 32

what is interest cover

Answer 32

an indicator of how much cushion there is before interest is paid

Question 33

what is gearing or leverage

Answer 33

the relationship between fixed interest capital and the amount of equity capital

Question 34

why should shareholders care about gearing

Answer 34

concerned about risk, gearing is an indicator of financial risk high leverage = high risk

Question 35

how do you calculate equity

Answer 35

share capital + share premium account + reserves + retained profits

Question 36

how do you calculate debt

Answer 36

preference shares + loans + bonds + other non-current borrowings

Question 37

are preference shares debt or equity

Answer 37

typically debt because interest must be paid before any dividends to ordinary shareholders

Question 38

what is debt-equity ratio

Answer 38

debt capital / equity capital x 100

Question 39

what is the gearing ratio

Answer 39

debt capital / (debt capital + equity capital) x 100

Question 40

why is high gearing potentially negative

Answer 40

increases profit available for distribution as dividends and it is deductible for tax purposes more debt, more financial risk and more volatility attributable to shareholders

Question 41

what is financial risk

Answer 41

relates to company’s exposure to fixed interest

Question 42

what is operating risk

Answer 42

relates to particular industry in which the firm is operating