1 share investment analysing financial statements
Post on 20-Dec-2015
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TRANSCRIPT
2
Using Ratios
Ratios are used to summarise the data on financial statements in order to capture in one number a particular aspect of operations.
These numbers usually take three forms Ratios (one value compared to another) Percentages (ratios expressed as a value out of 100) Amounts (in £)
In order to see whether a particular value shows a good or a bad investment, you will need to view it in context.
The yellow post-its on the slides try to put the ratio in context.
The yellow post-its on the slides try to put the ratio in context.
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The Different types of Ratio
We will look at three different types of Ratio used in Financial Analysis:
1. ProfitabilityHow successful is the business?
2. LiquidityIs the flow of cash sufficient to meet obligations?
3. InvestmentDoes the company represent a good investment
for shareholders?
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Profitability Ratios
Profitability Ratios attempt to measure whether or not the business is financially successful.
The amount of of profit made by a company in a particular year may give a distorted picture of the company’s position.
A £1.5m profit generated on a turnover of £10m, can look very good. The same profit on a turnover of £100m looks poor.
However there may be reasons why the first company has generated so much profit; there could be a one-off sale of assets, for example, which have increased in value.
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Example Spreadsheet
The Spreadsheet Ratio Analysis gives the full set of examples and the details of the calculations carried out.
We will look at one example of each type of calculation
Managing Finance & Budgets - Ratio Analysis
Profitability (Activity 2) Year 1 Year 2 Profitability (Activity 2) Year 1 Year 2
Sales 2,240,000 2,681,200 Gross Margin% 22.1% 22.7%Cost of Sales 1,745,400 2,072,000 Net Margin% 10.8% 9.2%
Gross Profit 494,600 609,200 ROSF 31.8% 25.8%Overheads 252,000 362,800 ROCE 34.8% 35.4%Net Profit 242,600 246,400
Interest 24,000 6,200Tax 60,200 76,000
Dividends 40,200 60,000Net profit after tax and dividends 118,200 104,200
Share Capital 300,000 334,100Reserves 197,500 301,700LT Loans 200,000 60,000
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Gross Profit or Gross Margin
This is simply the percentage return that the company has made on its sales or services, only taking into consideration what it cost us to sell the items or to undertake the services.
Profit made on what we have soldTotal Income for the Year
This profit is the largest that we can reasonably claim; it is the difference between the money coming in, and the expenditure incurred in order to make the sale or to render the service.
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Activity Two SolutionsGross Margin%
In the spreadsheet:
Profit & Loss Data Year 1 Year 2
Sales 2,240,000 2,681,200Cost of Sales 1,745,400 2,072,000
Gross Profit 494,600 609,200Overheads 252,000 362,800Net Profit 242,600 246,400
Interest 24,000 6,200Tax 60,200 76,000
Dividends 40,200 60,000Net profit after tax and dividends 118,200 104,200
Share Capital 300,000 334,100Reserves 197,500 301,700LT Loans 200,000 60,000
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Gross Margin%
The P & L Account Shows: Sales £2,240,000 Gross Profit £494,600
(NB Gross Profit = Turnover – Cost of Sales)
Gross Margin% = 494600 x 100 = 22.1%
2240000The company makes 22p for every £1 it brings in. This can be used to pay overheads etc.
The company makes 22p for every £1 it brings in. This can be used to pay overheads etc.
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Net Profit or Net Margin
This is simply the real percentage return that the company has made on its sales or services, this time taking into account all operating costs . In other words..
Actual Profit made on what we have sold
Total Income for the Year
This profit is a more conservative estimate. It takes into consideration the overheads (fixed costs) required to run the business.
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Activity Two SolutionsNet Margin%
In the spreadsheet:
Profit & Loss Data Year 1 Year 2
Sales 2,240,000 2,681,200Cost of Sales 1,745,400 2,072,000
Gross Profit 494,600 609,200Overheads 252,000 362,800Net Profit 242,600 246,400
Interest 24,000 6,200Tax 60,200 76,000
Dividends 40,200 60,000Net profit after tax and dividends 118,200 104,200
Share Capital 300,000 334,100Reserves 197,500 301,700LT Loans 200,000 60,000
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Net Margin%
The P & L Account Shows: Sales £2,240,000 Net Profit after Tax and Dividends £118,200
(NB
Net Profit = Turnover – Cost of Sales- Overheads)
Net Margin% = 118200 x 100 = 10.8%
2240000After paying all outstanding costs, the company makes 11p for every £1 it brings in.
After paying all outstanding costs, the company makes 11p for every £1 it brings in.
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Return on ordinary Shareholders’ Funds
ROSF is the profit after tax expressed as a percentage of the shareholder’s investment.
Actual Profit made (after tax)
Total Amount of Shareholders’ claims
This measure indicates to shareholders the growth of their investment.
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Activity Two SolutionsROSF%
In the spreadsheet:
Profit & Loss Data Year 1 Year 2
Sales 2,240,000 2,681,200Cost of Sales 1,745,400 2,072,000
Gross Profit 494,600 609,200Overheads 252,000 362,800Net Profit 242,600 246,400
Interest 24,000 6,200Tax 60,200 76,000
Dividends 40,200 60,000Net profit after tax and dividends 118,200 104,200
Share Capital 300,000 334,100Reserves 197,500 301,700LT Loans 200,000 60,000
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ROSF%
The P & L Account Shows: Net Profit after Tax and Dividends £118,200
Share Capital £300,000 Reserves £197,500
£497,500
ROSF% = 118200 x 100 = 31.8%
497500The company is making 32p for every £1 invested by shareholders.
The company is making 32p for every £1 invested by shareholders.
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Return on Capital Employed
ROCE is the profit (before tax) expressed as a percentage of the total money invested in the company (this includes Long Term Loans).
Actual Profit made (before tax)
Total Amount Invested
This measure indicates the extent to which all funds have been gainfully employed.
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Activity Two SolutionsROCE%
In the spreadsheet:
Profit & Loss Data Year 1 Year 2
Sales 2,240,000 2,681,200Cost of Sales 1,745,400 2,072,000
Gross Profit 494,600 609,200Overheads 252,000 362,800Net Profit 242,600 246,400
Interest 24,000 6,200Tax 60,200 76,000
Dividends 40,200 60,000Net profit after tax and dividends 118,200 104,200
Share Capital 300,000 334,100Reserves 197,500 301,700LT Loans 200,000 60,000
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ROCE%
The P & L Account Shows: Net Profit (before Tax & Interest) £242,600
Share Capital £300,000 Reserves £197,500 LT Loans £200,000
£697,500
ROCE% = 242600 x 100 = 34.8%
697500 Including loans, the company makes 35p for every £1 invested in the business.
Including loans, the company makes 35p for every £1 invested in the business.
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Summary of the Profitability Ratios
We look at four ratios:______________________________________________________________________________________________________________________________________________
Gross Margin% = Gross Profit x 100 Sales______________________________________________________________________________________________________________________________________________
Net Margin% = Net Profit before tax & interest x 100 Sales______________________________________________________________________________________________________________________________________________
Return on Ordinary Shareholders Funds (ROSF) =Net Profit after tax and preference dividends x100
(Share Capital + Reserves) ______________________________________________________________________________________________________________________________________________
Return on Capital Employed (ROCE) = Net Profit before tax and interest x100
(Share Capital + Reserves+ LT Loans)
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Liquidity Ratios
These Ratios seek to answer the question: ‘Can the business pay its way?’
All of these ratios look at the flow of cash in the company, and try to determine whether or not, at a particular point in time, the business has enough cash to pay what it owes.
Liquidity = amount of stock, debt etc., which can be easily converted into cash
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Example Spreadsheet
The ratios in this section refer to the items in the second part of the spreadsheet
Liquidity (Activity 3) Year 1 Year 2 Liquidity (Activity 3) Year 1 Year 2
Trade Debtors 240,800 210,200 Current Assets 574,300 622,000Bank Account 33,500 41,000 Current Liabilities 321,800 364,800
Opening Stock Value 241,000 300,000 Current Ratio 1.8 1.7Closing Stock Value 300,000 370,800 Acid Test 0.9 0.7
Trade Creditors 221,400 228,800Dividends owing 40,200 60,000
Corporation tax owing 60,200 76,000Net Cashflow from Operations 231,000 251,400
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Current Ratio
The Current Ratio is simply the total current Assets compared to the total current Liabilities.
Current AssetsCurrent Liabilities
In order to be solvent, a company should have a ratio greater than 1, in other words, in the day-to-day workings of the company, there should be enough resources available to pay our debts.
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Current Ratio
In the spreadsheet (Liquidity):
Trade Debtors 240,800 210,200Bank Account 33,500 41,000
Opening Stock Value 241,000 300,000Closing Stock Value 300,000 370,800
Trade Creditors 221,400 228,800Dividends owing 40,200 60,000
Corporation tax owing 60,200 76,000Net Cashflow from Operations 231,000 251,400
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Current Ratio
Current Assets : Trade Debtors £240,800 Bank Account £33,500 Closing Stock Value £300,000
£574,300Current Liabilities: Trade Creditors £221,400 Dividends Owing £40,200 Corporation Tax Owing £60,200
£321,800
Current Ratio = 574300 = 1.8 321800 The business owns
almost twice as much as it owes
The business owns almost twice as much as it owes
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Acid-Test Ratio
The Acid Test Ratio is simply the Current Assets (minus the Stock) compared to the total current Liabilities.
Current AssetsCurrent Liabilities
Some Authorities argue that if a company has to sell all its stock to cover its debt, it has a cash-flow problem. Therefore, this ratio too should be greater than 1.
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Acid Test Ratio
In the spreadsheet (Liquidity ):
Trade Debtors 240,800 210,200Bank Account 33,500 41,000
Opening Stock Value 241,000 300,000Closing Stock Value 300,000 370,800
Trade Creditors 221,400 228,800Dividends owing 40,200 60,000
Corporation tax owing 60,200 76,000Net Cashflow from Operations 231,000 251,400
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Acid Test Ratio
Current Assets excluding Stock : Trade Debtors £240,800 Bank Account £33,500
£274,300Current Liabilities: Trade Creditors £221,400 Dividends Owing £40,200 Corporation Tax Owing £60,200
£321,800
Acid Test Ratio = 274300 = 0.9 321800
Excluding stock, the business owns almost as much as it owes..
Excluding stock, the business owns almost as much as it owes..
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Summary of the Liquidity Ratios
We look at two ratios:______________________________________________________________________________________________________________________________________________
Current ratio = Current Assets (Over 1 for solvency)
Current Liabilities
e.g. Current ratio of 1.5 = £1.50 owned for every £1 owed______________________________________________________________________________________________________________________________________________
Acid test = Current Assets excluding stock
Current Liabilities______________________________________________________________________________________________________________________________________________
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Investment Ratios
These ratios all seek to measure the value of the shareholder’s investment in the company, and the return on that investment.
It should be noted that the money the shareholder may have paid for the shares, may not reflect either their current market value, or the actual stake it represents in the company.
For example, shares in TSB were originally sold at £1.00 each in the 1980s. This represents the capital invested in the company. If you had bought these shares in 1996 you would have paid around £11.00 per share. Currently they are trading at around £6.00 per share.
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Spreadsheet
The spreadsheet uses the figures given in sections 2 and 3 above , and the additional figures below, to callculate and comment on shareholder value for the two years shown:
YEAR 1 YEAR 2
Number of Ordinary Shares 600,000 668,200
Preference Dividends/Shares NIL NIL
Market Price Per Share 2.50 3.50
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Dividend per Share
From the spreadsheets:
Shareholder Value Data Year 1
Number of ordinary shares 600,000Market price per share 2.50
Profit & Loss Data Year 1
Sales 2,240,000Cost of Sales 1,745,400
Gross Profit 494,600Overheads 252,000Net Profit 242,600
Interest 24,000Tax 60,200
Dividends 40,200Net profit after tax and dividends 118,200
Share Capital 300,000Reserves 197,500LT Loans 200,000
This is the amount in pence that each shareholder gets for each share that they own.
This is the amount in pence that each shareholder gets for each share that they own.
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Dividend per Share
Dividends Announced £40,200
Number of Shares 600,000
Dividend per Share = 40200600000
= £0.067
Each shareholder gets 6.7p for each share they own.
Each shareholder gets 6.7p for each share they own.
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Dividend Payout
From the spreadsheets:Profit & Loss Data Year 1
Sales 2,240,000Cost of Sales 1,745,400
Gross Profit 494,600Overheads 252,000Net Profit 242,600
Interest 24,000Tax 60,200
Dividends 40,200Net profit after tax and dividends 118,200
Share Capital 300,000Reserves 197,500LT Loans 200,000
Here we are assuming that these are ordinary, rather than preferential dividends
Here we are assuming that these are ordinary, rather than preferential dividends
This is the proportion of the profits that has been distributed to shareholders.
This is the proportion of the profits that has been distributed to shareholders.
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Dividend Payout
Net Profit £242,600 Interest - £24,000 Tax - £60,200 Net profit after interest/tax £158,400
Dividends Announced £40,200 Dividend Payout = 40200 x 100 158400
= 25.4%One quarter of the total profit is paid out in dividends to shareholders.
One quarter of the total profit is paid out in dividends to shareholders.
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Dividend Yield
From the spreadsheet and the first example in this section:
Shareholder Value Data Year 1
Number of ordinary shares 600,000Market price per share 2.50
Dividends Announced £40,200 Number of Shares 600,000
Dividend per Share = 40200 600000
= £0.067In addition, we will be assuming a tax rate of 20%
In addition, we will be assuming a tax rate of 20%
This is the rate of return that shareholders are getting on their investment through dividends.
This is the rate of return that shareholders are getting on their investment through dividends.
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Dividend Yield
Dividend per share £0.067 Market Price per Share £2.50 Tax Rate 20%
Dividend Yield = 0.067/(1 – 0.2) x 100 2.50
= 3.35%
NB: 20% = 0.2NB: 20% = 0.2
Shareholders are currently getting a rate of return of 3.35% on their investment at market value (compare Inflation ~ 2%)
Shareholders are currently getting a rate of return of 3.35% on their investment at market value (compare Inflation ~ 2%)
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Earnings per Share
From the spreadsheets:Profit & Loss Data Year 1
Sales 2,240,000Cost of Sales 1,745,400
Gross Profit 494,600Overheads 252,000Net Profit 242,600
Interest 24,000Tax 60,200
Dividends 40,200Net profit after tax and dividends 118,200
Share Capital 300,000Reserves 197,500LT Loans 200,000
Shareholder Value Data Year 1
Number of ordinary shares 600,000Market price per share 2.50
Here we are again assuming that these are ordinary, rather than preferential dividends
Here we are again assuming that these are ordinary, rather than preferential dividends
This is the amount in pence that the company is earning per share.
This is the amount in pence that the company is earning per share.
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Earnings per Share
Net Profit £242,600 Interest - £24,000 Tax - £60,200 Net profit after interest/tax £158,400
Number of shares issued: 600,000 Earnings per Share: = 158400 600000
= £0.264
The company is making about 26p for every share that is held.
The company is making about 26p for every share that is held.
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Price/Earnings Ratio
From the spreadsheet, and the 4th ratio in this set:
Shareholder Value Data Year 1
Number of ordinary shares 600,000Market price per share 2.50
Net Profit £242,600
Interest - £24,000 Tax -
£60,200 Net profit after interest/tax
£158,400
Number of shares issued: 600,000 Earnings per Share: = 158400
600000
= £0.264
This is the time in years it will take to earn an amount equal to the original investment.
This is the time in years it will take to earn an amount equal to the original investment.
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Price/Earnings Ratio
Market Price per share: £2.50 Earnings per share: £0.264
Price/Earnings Ratio: = 2.50 0.264
= 9.45The market price of a share is about 10 times the profit made by the share. (may be better the other way round – each share earns about one-tenth of its current market value in a year)
The market price of a share is about 10 times the profit made by the share. (may be better the other way round – each share earns about one-tenth of its current market value in a year)
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Comparison of Ratios
Share Price
P/E Share Price
P/E
Date 2/8/00 2/8/00 22/9/01 22/9/01
SAFEWAY 283.5 17.5 319 14
SAINSBURY 322 17.6 327 18.2
TESCO 221 21.9 238 19.6
MAN UTD. 321 54.4 122 20.3
In 2000 was a poor investment, and the share price dropped dramatically. In 2001 the investment improved, but still it was not as good a bet as the supermarkets.
In 2000 was a poor investment, and the share price dropped dramatically. In 2001 the investment improved, but still it was not as good a bet as the supermarkets.
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Summary of the Investment Ratios
Dividend per share = _Dividends announced__ Number of issued shares
_____________________________________________________________________________________________________________________________________________
Dividend payout = Dividends announced x 100 . Net profit after interest/tax/pref.dividends
_____________________________________________________________________________________________________________________________________________
Dividend Yield = Dividend per share/(1-tax rate) x 100 Market value per share
_____________________________________________________________________________________________________________________________________________
Earnings per share = Net profit after interest/tax/pref.dividends Number of issued shares_____________________________________________________________________________________________________________________________________________
Dividend Cover ratio = Net profit after interest/tax/pref.dividends Dividends announced _____________________________________________________________________________________________________________________________________________
Price/earnings ratio = Market price per share Earnings per share
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Analysing a Company’s Performance
The next slide shows five different ratios calculated from the published accounts of J. Sainsbury PLC, summarising the company’s performance over the five-year period 1996-2000
As you look through these figures, you should ask yourself: What trends can be detected? Is the company improving its performance? Would you consider investing in the company?
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Ratio Analysis - J Sainsbury Plc
1996 1997 1998 1999 2000
TURNOVER (£ million) 13,499 13,312 15,496 16,37817,414
PROFIT BEFORE TAX 764 651 728 755 580
NET MARGIN (%) 5.6% 4.6% 4.7% 4.6% 3.3%
EARNINGS PER SHARE 26.8p 22.0p 25.1p 29.2p 18.3p
DIVIDEND PER SHARE 12.1p 12.3p 13.9p 14.32p 14.32p
DIVIDEND COVER 2.21 1.78 1.8 2.03 1.27
Figures taken from J Sainsbury Plc Website - 2 August 2000Dividend cover is the reciprocal form of the Dividend Payout Ratio
Dividend cover is the reciprocal form of the Dividend Payout Ratio
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Ratio Analysis: J Sainsbury Plc
1996 1997 1998 1999 2000
TURNOVER (£ million)
PROFIT BEFORE TAX
NET MARGIN (%)
EARNINGS PERSHARE
DIVIDEND PER SHARE
DIVIDEND COVER
Axis scales have been modified to enable comparisons to be made
Axis scales have been modified to enable comparisons to be made
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Comparison of ratios
It can be noted from the previous slides that while the turnover has increased steadily over the five-year period, the profit before tax, fluctuates somewhat, with a sharp downturn in 2000.
The downward trend is even more evident from the net margin, which has down a steady reduction over the 5 years.
On the other hand, the dividend per share rose steadily over the first 4 years, and maintaining this level in 2000. However, the earnings per share shows a much less impressive performance.
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The Limitations of Ratios
Analyses which only use ratios only give a limited vision: The quality of base data in financial statements may be
suspect. Ratios can measure relative performance, but do not allow
for scale (see Sainsbury example). They give only a basis for comparison – we need to
compare like with like. Some ratios ( balance sheet - e.g.) measuring at a single
point in time, and not over a period. One off events such as disposal of assets can give rise to
major distortions.