内容说明成果msc fa1lecture

1、1Lecture 7The Analysis of Company Accounting Information Financial Accounting 12ObjectivesBy the end of this lecture you should be able to -Apply techniques to elicit useful information from company accounting informationExplain and evaluate measures of a companys performance ratio analysisCriticall

2、y apply ratio analysis, bearing in mind its strengths and limitations3Why do we need ratios?1. Comparisons between entities which of the following companies is the most profitable?Co. ACo. B000000Profit 200 1,000Net assets 500 10,000Return 40% 10%4 2. Comparisons over time has there been an increase

3、 or decrease in profitability from one year to the next?CurrentPrevious year year 000 000Profit 1,000 900Net assets 10,000 8,000Return 10% 11.25%In both cases a comparison of the absolute profits would give a misleading evaluation5The Functions of Ratio AnalysisThe main function of ratio analysis is

4、 to enable users of published financial statements to evaluate the financial performance and financial position of the reporting entity for the purpose of making economic decisions (buy/sell/hold decision for example). This usually takes the form of:1. Comparisons with other entities (interfirm); an

5、d/or2.Comparisons over time (time series analysis).Warning!Before you calculate ratios:Understand the industry, the economy, the management, the governance, the products, the competitors, the value drivers (see next slide), major risks (see later slide) etc.Look for trends in the dataLook for keep p

6、erformance indicators (KPIs) including non financial data e.g. Sales per square metreCalculate percentage changes7Value DriversBusiness TypeValue DriverExampleMerchantProduct / price differentialsM&S plcServiceExploit assets, e.g. knowledgeKPMGManufacturingTransform bought-in goods and servicesRolls

7、 Royce plcExtractiveExploit natural resources BPBankingDifferentials in price of moneyHSBC8Measuring RiskFinancial risk: the risk that a firm will have insufficient funds to pay interest or repay capital on its borrowing and hence default against its lenders.Business risk: the risk of failure in the

8、 product or supply markets and hence a failure of its return-generating power; business risk also includes risk brought about by technological change.Regulatory risk: the risk that a firms products market or critical supply markets may be subjected to adverse regulation which diminishes its ability

9、to earn revenue. The recognition in the 1980s that asbestos was a principal cause of lung disease led to a ban on its use as a building material; principal asbestos manufacturers were forced out of business.Market risk: the risk of variability in the firms share price and in the price of its other t

10、raded financial securities.9The Classification of RatiosMeasures of an entitys financial performanceMeasures of liquidity and control of working capitalMeasures of solvencyMeasures of return on investment and risk101. Measures of a Companys PerformanceReturn on capital employed (ROCE)Gross Profit ma

11、rginNet Profit MarginAsset turnover ratio11Return on Capital EmployedProfit before tax and interest (PBIT) x 100Net capital employed (NCE)Where net capital employed = shareholders interests + non-current liabilities = total assets current liabilities.Relates returns to historical investment Profit b

12、efore interest and tax (PBIT) is related to capital employedCapital employed can either be seen as net assets (i.e. total assets less current liabilities) or as debt plus equityit is a measure of the operating efficiency of the organisation in terms of the of PBIT generated per of asset 12Gross Prof

13、it MarginGross Profit x 100TurnoverThis shows what percentage of sales revenue is gross profit. Different industries have different gross profit margins. For example, supermarkets have low margins (but high volumes) whereas jewellers have high margins due to low volumes. Ratio can also be expressed

14、as a mark up (sales/cost of sales). For example, if you buy something for 1 and sell it for 1.50 the margin is 33% and the mark-up is 50%.13Net Profit MarginProfit before tax and interest (PBIT) x 100TurnoverThis shows what percentage of sales revenue is net profit.Not a very useful ratio as expense

15、s tend to be fixed in the short-term better to analyse gross margins and look at percentage changes in expenses. 14Asset Turnover RatioTurnover Net Capital employedThis shows the amount of sales revenue generated per of capital employed. It is a measure of the level of activity and productivity.Labo

16、ur intensive industries usually have a high asset turnover ratio, whereas capital intensive industries normally have a low asset turnover ratio. Interfirm comparisons should therefore be limited to companies in the same industry.Changes in the asset turnover ratio over time may be due to producing a

17、t under capacity, labour inefficiency, overstocking, etc.15ROCE PyramidROCENet Profit MarginAsset TurnoverGross Profit MarginROCE=Net profit margin*Asset TurnoverPBIT = PBIT * TurnoverNCE TurnoverNCE16Student ActivityDavros plc started in business on 1.1.X3 with 240m equity. It has the following res

18、ults:All profits are paid out as dividends. Calculate ROCE, Asset turnover, gross margin and net margin. Ignore tax.20X4m20X3mTurnover300200Cost of Sales(150)(120)Gross Profit15080Expenses(30)(20)Net Profit1206017Answer20X420X3ROCE50%25%Asset turnover1.250.83Gross Profit margin50%40%Net Profit margi

19、n40%30%The business is performing well. Turnover has increased by 50% to 300m and margins are up, possibly due to economies of scale. 2. Analysing LiquidityYou need to analyse the cash flow statement! Look at how the firm generates cash through operations (good) through selling assets or by raising

20、finance. New firms will be burning cash and you can work out how long they have before refinancing is required.Two main ratiosCurrent RatioLiquid Ratio19Liquidity RatiosCurrent RatioCurrent assetsCurrent liabilitiesThis is a measure of the extent to which current liabilities are covered by current a

21、ssets.2. Acid Test RatioCurrent assets inventoriesCurrent liabilitiesThis ratio excludes inventories because these are not as liquid as other current assets. As a generalisation, the liquidity ratio should be at least one although this depends on the type of industry (e.g. food retailers may have a

22、ratio of less than one because they turn over their inventory rapidly).Measures of the Control of Working CapitalReceivables and Payables days provide an indicator of the time being funded (receivables) or sourced (payables) and are frequently used as internal efficiency measures, e.g. receivables d

23、ays indicates the average time taken, in days, to receive payment from credit customers. Inventory Days indicates how long stock is heldWorking Capital cycle (sometimes called cash conversion cycle) is receivables days plus inventory days less payables days. This gives an indication of how long cash

24、 is tied up in working capital i.e. how long it takes to buy inventory, sell it and receive the cash.InventoryReceivablesCashPayables21Trade Receivables DaysTrade receivables x 365Turnover/sales revenueChanges in the proportion of cash to credit sales revenue can distort the ratio over time.Where th

25、e period of credit is high compared with other businesses (or the average for the industry), and/or increasing over time, this is taken as indicating inadequate credit control procedures. However, firms can boost revenue by extending the credit period.22Trade Payables DaysTrade payables x 365Purchas

26、es (or Cost of sales)Where the period of credit is high compared with other businesses (or the average for the industry), and/or increasing over time, this indicates that the company is delaying paying its credit suppliers. It may adversely affect a companys credit rating, suppliers may refuse to su

27、pply further goods on credit, and it could suggest financial weakness. However, trade credit is a major source of short-term financing.23Inventory TurnoverCost of salesInventory of finished goodsThis shows the number of times that a business turns over/sells its average/ normal level of inventory du

28、ring the accounting year.Where the inventory turnover ratio is low compared with other businesses (or the average for the industry), and/or decreasing over time, this is taken as indicating a lack of adequate inventory control. However, the firm does not want stock outs either.24Inventory DaysInvent

29、ory of finished goods X 365Cost of SalesThis is the same as inventory turnover but expressed as the number of says inventory is held before it is sold.Expressing it like this allows us to work out the working capital cycle:Working capital cycle = Receivables days + Inventory days less Payables daysM

30、ost firms have more inventories and receivables than payables and so the working capital cycle is positive. However, large supermarkets that receive cash from customers can have negative working capital cycles!25Unusual working capital Sainsburys 2013 m2012 mInventories987936Receivables306286Payable

31、s2,7262,740Cash in hand517739Revenue23,30322,294Cost of sales22,02621,0832013 2012Inventory days1616Receivables days55Payables days4547Working capital cycle-24-26Conclusion Sainsburys have around 1bn of free finance263. Analysing SolvencyGearing, or leverage as it is called in the USA, refers to the

32、 relationship between the amount of fixed interest/debt capital and the amount of equity share capital.The debt capital includes loan stock, debentures, preference shares, bank loans, mortgages and any other long term borrowing.High gearing is where debt equityLow gearing is where debt equityA firm

33、should match its long-term finance to its long-term assets27Measures of Gearing1. Leverage or Debt/equity ratio:Debt capital (x 100)Equity capital2. Gearing ratio:Debt capital (x 100)Debt capital + Equity capital28The Effects of GearingThe gearing ratio is a measure of the financial risk attaching t

34、o a companys equity shares which arises because of the prior claim that fixed interest capital has on the annual e and assets (in the event of liquidation).Any increase in profit (before charging interest) will result in a proportionately greater increase in the profit available for distribution (an

35、d the EPS) of a highly geared company compared with an equivalent increase for a company with low gearing.Having some debt is a good idea because interest on debt is lower than the required return on equity as equity has more risk. Also, debt interest is a tax deductible expense whereas dividends ar

36、e not. For a profitable company paying corporation tax this can be a big saving. These savings come to shareholders, boosting their returns.29An IllustrationCompany A with Company B with low gearing high gearing 000 000Equity shares 1 each 400 10010% Debentures 100 400 500 500Gearing ratio 20% 80%30

37、Bad Year Company A with Company B with low gearing high gearing 000 000Profit before tax 45 45 Debenture interest (10) (40) Profit before tax 35 5 Tax at 30% (11) (2) Profit after tax 24 3Number of shares 400 100 Earnings per share 6p 3pReturn on equity 6% 3%31Good YearCompany A with Company B with

38、low gearing high gearing000 000Profit before tax 100 100Debenture interest (10) (40)Profit before tax 90 60Tax at 30% (27) (18)Profit after tax 63 42Number of shares 400 100Earnings per share 16p 42pReturn on equity 16% 42%Which company would you prefer to invest in? A or B?32Can a Firm Afford its D

39、ebts?Interest cover - indicates a companys ability to service its borrowing:Earnings before Interest InterestCan replace earnings with cash flows from operations in the above ratio if preferred.You should also look at schedule of debts in the notes to the financial statements when are debts falling

40、due for repayment?33 4. Measures of return on Investment Dividend yieldDividend coverEarnings per share (EPS)Return on equity (ROE)Price-earnings (PE) ratioDividend Valuation ModelMarket to Book Ratio34Dividend YieldAnnual equity dividend x 100Market value of equity sharesMeasures how much a company

41、 pays out in dividends each year relative to its share price and may be compared with what could be obtained by investing in some other company. Investors who require a minimum stream of cash flow from their investment portfolio can secure this cash flow by investing in shares paying relatively high

42、, stable dividend yields. 35Dividend CoverProfit after tax and preference dividendsAnnual equity dividendThis indicates how likely it is that the company will be able to maintain future dividends at their current level if profits were to fall in future years. It is thus a measure of risk. This shows

43、 how many times over the profits could have paid the dividend. Because buyers of high yield shares ( e investors) want a stable e, dividend cover is an important number. Dividend cover is the inverse of the Dividend Payout Ratio or retention ratio which shows if a firm is keeping back profits for in

44、vestment. 36Earnings Per Share (EPS)Profit after tax and preference dividendsNumber of equity sharesThe EPS is a measure of financial performance, where performance is defined from the equity shareholders point of view as relating to the profit available for distribution as equity dividends.The tren

45、d in EPS over time indicates growth or otherwise in the profit attributable to each equity share. 37Price-Earnings Ratio (PE) Current market price of each equity shareEarnings per shareOften between 10 and 25 but varies considerably. The P/E ratio is a measure of risk in that it represents the numbe

46、r of years earnings that investors are prepared to buy at their current level. It is essentially a payback period and indicates the number of years it would take to recoup an investment from its share of the attributable equity profit. The P/E ratio is a reflection of the expected earnings growth po

47、tential of a company. If investors think that a companys earnings are going to decline, the P/E ratio will be lower that the norm. Conversely, if profits are expected to rise, the P/E ratio will be higher than average. 38Return on Equity (ROE)Profit after tax and preference dividends X 100Shareholde

48、rs interests (excluding preference shares)This is a common measure of the equity shareholders return on investment which is used to evaluate profitability, where profitability is defined from the shareholders point of view as relating to the profit available for distribution as dividends.Note -Retur

49、n on equity is the profit attributable to group in the e statementShareholders interests = Share Capital + Reserves + Retained EarningsExclude non-controlling interest39Using Ratios to Value SharesWe assume that firms will move to average over time firms earning supernormal profits will have competi

50、tors and firms earning below normal earnings will get taken over.Industry averages can be used to get an intrinsic value.Intrinsic values can be compared with current market values to get a buy/sell/hold decision.For example, if our intrinsic value of company X is 1 and the current market price is 7

51、5p then we would buy in the hope of a capital gain. However, this is all a waste of time is the market is efficient e.g. is valuing shares correctly. 40Student ActivityAs 20X3 earnings per share (eps) was 68p. In 20X4 As eps is estimated to be 168p. Eps is expected to stay at this level from 20X4 on

52、wards.The current share price is 20.16.The average P/E in the industry is 12.Would you mend buying or selling As shares?41Answer20X3 P/E is 20.61/68p = 29.6 above industry averageIf eps stayed at this level price looks high. If you think 20X4 estimate is too high, SELLUsing forecasted eps P/E will b

53、e 20.16/168p = 12Current price reflects market expectations HOLDThe market is efficient and difficult to beat. It appears to have anticipated future earnings already and multiplied them by the industry average.Conclusion Probably not a buy or a sell, unless we want to bet that we can beat market estimates.42Divid