Presentation on theme: "Intro to Financial Management of the Organisation"— Presentation transcript:
1 Intro to Financial Management of the Organisation Week 4More Ratios & Expanding the Annual Report
2 Groups of RatiosDifferent Classes of ratios are available for different classes of userProfitabilityEfficiencyLiquidityGearingInvestor ratios
3 Profitability Ratios Return on Capital Employed (ROCE) Net profit before interest and tax X 100Share capital + reserves + long term loansA ratio that indicates the efficiency and profitability of a company's capital investments.ROCE should always be higher than the rate that the company borrows at, otherwise any increase in borrowings will reduce shareholders' earnings
4 Net Profit MarginNet profit before interest and tax X 100SalesRelationship between turnover and “controllable” profit. How are management controlling business expenses?
5 Efficiency Ratios Average settlement period for debtors Trade debtors X 365Credit salesMeans : How quickly an average debtor takes to pay. Shown in days.The quicker debtors pay up the better.Normal terms .v. actuality
6 Efficiency Ratios Average settlement period for creditors Trade creditors X 365Credit purchasesMeans : How long, on average, it takes a business to pay its trade creditors in daysDeferring paying creditors is free credit
7 Gearing (leverage) Ratios Gearing ratioLong term liabilities X 100Share capital + reserves + long term liabilitiesMeans : contribution of long-term lenders to the long-term capital structure
8 A risky business Borrowing is a risk because… Interest has to be paid whether the investment is a success or not.Even if a company is making a loss it still has to pay interestBorrowing is thus a riskThe more of their capital that is borrowedThe bigger the risk.The higher the gearing ratio, the bigger the proportion of the companies money that is borrowed and therefore the bigger the risk.A company with a high gearing ratio is in a very dangerous situation if interest rates are going up.Their interest payable bill will be rising with no corresponding increase in sales revenue.The first thing to suffer is profit
9 Gearing Ratios Interest Cover Profit before interest and tax Interest payableMeans : Amount of profit available to cover interest paymentsWhat’s Hot : the higher, the more funds available to meet interest payments.So long term lenders more secure
10 Investor Ratios Dividends per share Dividends announced during period Number of shares in issueMeans : cash return an investor can expect from shares held in a companyTip: Frequently shown in notes to accounts
11 Investor Ratios Dividend payout ratio Dividends announced for the year X 100Earnings for the year available for dividendsMeans : Proportion of earnings paid out to shareholders as dividends
12 Investor Ratios Earnings per Share (EPS) Earnings available to ordinary shareholdersNumber of ordinary shares in issueThe earnings of a company is its profit, and so if we change the wording of earnings per share to profit per share the meaning should become a lot clearer.It is literally the amount of profit that has on average been earned by each share.
13 FRS 14 – Earnings per Share FRS 14 requires that EPS is shown as a footnote to the profit and loss account of a quoted company.FRS 14 defines EPS as: “Basic earnings per share should be calculated by dividing the net profit or loss for the period attributable to ordinary shareholders by the weighted average number of shares outstanding during the period.”The trend of EPS is a better indicator of progress than the trend in profit. In order to maintain EPS at the same level after a share issue a company must deploy the proceeds of the issue at least as profitably as the original capital
14 Investor Ratios Price/Earnings ratio (P/E ratio) Market value of sharesEPSMeans : compares market value of the share with its earnings.What’s Hot : A high figure shows the market’s confidence in the future earnings potential of the company.The higher the confidence, the more investors will be prepared to pay for shares in relation to the current earnings level.
15 Price/Earnings ratio (P/E ratio) Recognised by many investors as the KEY investor ratioCapital Radio plc Example2000EPS = 26.3pMarket Price of Ordinary Shares at Balance Sheet date = £14.382001EPS = 23.8pMarket Price of Ordinary Shares at Balance Sheet date = £5.20
16 Capital Radio plc P/E Ratio 200014.38 / = 54.7 times20015.20 / = 21.8 times
17 What do the Directors say? 1 The Chief Executive (upbeat)This year has been challenging for Capital Radio, as the media industry faced difficult trading conditions resulting from the economic slowdown.Our revenues came under pressure as advertising demand fell, requiring us to take a prudent look at the management of our cost base.Though the current market conditions may prevail for some time our strong radio brands, healthy balance sheet and focused management team will ensure we weather the downturn.We are confident of the long-term prospects for radio advertising and retain our belief in the importance of aggressively expanding our national presence.Pass the Bucket…Cool people Hot ideas Real insight
18 What do the Directors say? 2 Finance DirectorTotal revenue of £123.2 million was down 1% on the previous year (down 6% on a like for like basis).Underlying Group profit before tax was £30.1million, down 27%, in line with the guidance we gave at the end of September.The tax charge on our underlying profitability for the year was 28.5% (2000: 26.3%).Our underlying earnings per share were down 33% at 26.3p. Our underlying earnings per share has declined due to a combination of the difficult trading conditions and the planned short-term dilution caused by the acquisitions of Century Radio and Beat.
19 What do the Directors say? 2a Revenue from our established stations was £106.8 million, down 9%, which resulted in the operating profit from our established stations being down 16% at £39.6 million.Development stations losses were £3.0 million compared to a £1.9 million charge in the previous financial yearBut.. With the interim dividend of 6.0p per share, our total dividend per share for the year is unchanged at 18.5p.
20 Benjamin Graham’s Analysis P/E Ratios are a measure of stock market performanceCalculated US average ratios for the periodsLowest = 9.5 ( )Highest was 18.1 ( )Compared these calculations to the rates available on high-class bonds(A P/E ratio of 20 = an earnings yield of 5%Eg 100 / PE ratio = Earnings Yield)
21 Can we predict potential bankruptcy? Edward Altman (1968 & 1981)Calculation of Z-ScoreHistoric BasisKey ratios + weightings = Z-ScoreNote: use as part of an evaluation
22 Altman’s Z-Score RATIO FORMULA WEIGHT FACTOR Return on Total Assets Earnings Before Interest and TaxesTotal Assetsx. 3.3Sales to Total AssetsNet Sales Total Assetsx 0.999Equity to DebtMarket Value of Equity Total Liabilitiesx 0.6Working Capital to Total AssetsWorking Capital Total Assetsx 1.2Retained Earnings to Total AssetsRetained Earnings Total Assetsx1.4
23 The Interpretation of Z Score: Z-SCORE ABOVE 3.0The company is safe based on these financial figures only.Z-SCORE BETWEEN 2.7 and 2.99Grey area/ Zone of ignorance.This zone is an area where one should exercise caution.Z-SCORE BETWEEN 1.8 and 2.7Good chances of the company going bankrupt within 2 years of operations from the date of financial figures given.Z-SCORE BELOW 1.80Probability of financial embarrassment is very high.
24 Worked Example – Somerfield 2001 Return on Assets11.6/ = X3.3 =Sales to Total Assets4612.5/ – X0.999 =Equity to Debt1509.3/800 = X 0.6 =Working Capital to Total Assets(75.2)/ = (0.0498) X 1.2 = (0.0598)Retained Earning to Total Assets548.9/ = X 1.4 =Total of Weighted Scores =
25 Expanding the Annual Report Inflation AdjustmentsIs it an issue?Current Cost AccountingAdjustment of profit by replacement costs of stocks/fixed assetsCurrent Purchasing PowerAdjustment of profit by an index (usually Retail Price Index)
26 Value Added Statements Alternative Method of Stating the Profit & Loss AccountShows “Value Created” rather then profit madeCapital Radio Example
27 Environmental Accounting Companies have a responsibility for the damage that they (may) cause to the environmentThe (potential) effects depend on the type of companyCompanies should deal with thisin the accountsIn the annual report
28 Why?Whether for moral, economic, legal or pragmatic reasons, every organisation is having to make an increasingly explicit assessment of its environmental and social impact and to attempt to re-position itself as the terms of the social contract between business and society come under increasing scrutiny.
29 Should accounts & reports deal with these issues? Pragmatic – accountingProvision for the costs of remedying past contamination should be recognised when an entity is legally or constructively obliged to rectify the damageAbandonment costs - full provision for the total costs should be made when the environmental damage is inflicted.
30 Should accounts & reports deal with these issues? Moral ResponsibilityThere is no FRS that deals with Environmental ReportsIndividual accounting bodies and environmental groups have provided guidanceEnvironmental Report can appearIn annual report orAs distinct report circulated with annual report
31 Suggested Contents CEO statement Organisational profile Key environmental impactsEnvironmental policy statementsManagement system and proceduresPerformance and complianceTargets and achievementsIndependent verification statement
32 Objective should be…The provision of information about the environmental impact and operational performance of an entity that is useful to relevant stakeholders in assessing their relationship with the reporting entityIt should be transparent information on the company’s policies and successesWhich means….
33 Concern for the planet… (or profits?) Benefits from this greater transparency may include:an increase in the number of customers who consider, respect or share the same valuesbeing placed on ‘preferred suppliers’ lists of companies that consider environmental responsibility upstream to their own operationsstronger relationships with stakeholders by involving them in the reporting process andgeneral public approval, thus lowering reputational risk.ACCA Singapore advice publication
34 Examples – the pathetic.. African Gold plcNo policyFirestone Diamonds plcA detailed environmental management programme report covering rehabilitation of both historical and planned mining operations has been completed and submitted to the Department of Minerals & Energy for approval.Why? RSA legislation.
36 Crawling on the bandwagon? Yearly percentage of companies producing a corporate environmental report%%%%
37 The Audit ProblemAuditors have no guidelines on auditing the Environmental ReportSocial Audit Ltd – hidden agendaRole Conflict – auditors as employees of shareholders/stewardship of fundsDo we need audit guidelines?Do we need environmental reports?Should they be highlighted as simply public relations?