Unit 5. Chapter 32. Analysis of published accounts

Question 1

Profitability ratios

Answer 1

Compare the gross and operating profits of the business. ( also return on capital employed ratio)

Question 2

Liquidity ratios

Answer 2

a measure of how easily a business could meet its short-term debts or liabilities.
(current ratio, acid-test ratio)

Question 3

Financial efficiency ratios

Answer 3

give an indication of how efficiently a business is using its resources and collecting its debts.
(inventory turnover ratio, days’ sales in receivables ratio)

Question 4

Shareholder ratios

Answer 4

can be used by existing or potential shareholders to assess the rate of return on shares and the prospects for their investment.
(dividend yield ratio, dividend per share, dividend cover ratio, price/ earnings ratio, earnings per share)

Question 5

Gearing ratio

Answer 5

examine the degree to which the business is relying on long-term loans to finance its operations.
reflection of a business’s financial strategy.

Question 6

Dividend yield ratio (Points to note)

Answer 6

• Share price rises, unchanged dividend -> Dividend yield will fall
• Increased dividend, share price doesn’t change -> Dividend yield increase
• > Rate of return can be compared with other investments, such as bank interest rates and dividend yields from other companies.
• Compare results with previous year, other companies in a similar industry.

Question 7

High dividend yield ratio

Answer 7

• Attract potential shareholders as long as the share price is not expected to fall in coming months.
• May not indicate a wise investment - could be high due to falling in share price, possibly because the stock market is concerned about the long-term prospects of the company.

Question 8

Director actions

Answer 8

• Keep share loyalty: directors decide to pay a dividend from reserves even when profits are low/ loss has been made.
• Further investment into expanding the business: directors decide to reduce the annual dividend even if profits have not fallen -> increase retained profit

Question 9

Dividend

Answer 9

the share of the company profits paid to shareholders

Question 10

Share price

Answer 10

the quoted price of one share on the stock exchange

Question 11

Dividend yield ratio (%)

Answer 11

dividend per share x 100 / current share price

- measured the rate of return a shareholder gets at the current share price.

Question 12

Dividend per share

Answer 12

total annual dividends / total number of issued shares

Question 13

Dividend cover ratio

Answer 13

profit after tax and interest / annual dividends
- the number of times the ordinary share dividend could be paid out of current profits. The higher, the more able the company is to pay the proposed dividends, leaving a considerable margin for reinvesting.

Question 14

Dividend cover ratio (Points to note)

Answer 14

• Increase dividends, unchanged profits -> cover ratio gall. Potential investors start to query whether this level of dividend can be sustained in future.
• Low result: retaining low profits for future investment and this could raise doubts about the company’s future expansion.