Financial Ratios and International Accounting Standards Essay
The company’s has a dividend per share as 20 cents which is double the dividend per share of its competitor Pemberton.
• The company has ploughed back only [ 11,150,000 – 10,000,000 = 1,150,000 ] as a reserve because 10M it has paid out to its investors .
• If the DPS of Orrell can be compared with its Competitor then investing in ORRELL will give a higher return as compare to if they invest in Pemberton .
• At the same time if Orrell is not retaining too much from the profit, it may doesn’t have any intentions to expand its business, which for a long term investor is not very satisfactory.
And if at any point of time Orrell wants to expand its business then it will have to contact the bank or any financing firm for the money . 2. Dividend cover : Dividend cover is the ratio of how much the company is paying in the form of dividends from its earning of the year. = Earning Per Share (EPS) ________________________ Dividend per Share (DPS) = 22. 3 20 = 1. 115 times
• The Dividend Cover of Orrell is 1. 115 times as compare to its Competitor Pemberton which has
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• A Dividend cover of 1. 115 of Orrell as compare to 5 of Pemberton shows that the company is not reserving much money. Whereas 5 time dividends cover of Pemberton suggest that the company is just giving $1 from its earning of $ 5.
• Pemberton higher dividend cover suggest that the company wants to retain as much profit as It can . It can be for many reasons such as it has expansion plans in future or it may wants to maintain the same level of dividend pay out if in any year the company makes less earning
• But at the same time we have to look at how the earning fluctuates for Orrell and Pemberton ,If the earning of Orrell is somewhat similar in all the years then it doesn’t need to retain much profit for itself , the high dividend cover ratio is suitable or recommended to those companies whose earning fluctuates heavily from year to year
• A long term investor generally go for a company whose dividend pay out is somewhat the same and because of that they pick companies like Pemberton to invest in as they know that this company will be able to pay out dividend at a regular interval and similar rate .
• According to the above point , if the objective of the Upholland Plc management is to invest in Orrell for more years then they should keep a very close eye on its year to year earning and its dividend cover ratio .
3. Earnings per share (EPS) Earning per share is the amount of earning allocated to each outstanding share holder. The more the EPS the more earning each outstanding shareholder has earned. Net Income – Dividend on Preferred shares Average Outstanding Shares = 11,150,000-050,000,000 = 22. 3 Cents
• The Earning Per share of Orrell is slightly higher than its competitor Pemberton which means that every shareholder of Orrell has earned more bucks as compare to any shareholder of Pemberton.
• A higher Earning per share doesn’t suggest that the company is very good, but we should also look at the number of outstanding shares the company has.
• A lower earning per share of Pemberton may be because the company has a higher outstanding share as company to Orrell.
• By looking at the EPS we can also predict about the future earning of the company, so if the earning of Orrell is high as compare to Pemberton then the management of Upholding should invest in Orrell. Given that the outstanding share of Orrell remains the same throughout.
4. Price earnings ratio (PE ratio) PE ratio compares the Market price of the share with its earning, the more the Market price the higher the PE ratio there will be. Market Price per share Earning Per share = 1. 5 . 223 = 6. 73
• As the definition suggests the higher the Market price the higher the PE ratio.
• Companies with same EPS and different Marker Price per share can have Different P/E Ratios.
• Orrell’s P/E ratio is almost half as compare to Pemberton but it is because of high Market Price per share of Pemberton.
• The management of Upholding should not only make any decision by just seeing the P/E ratio of Orrell but they should also look at the EPS of Pemberton which is lower than Orrell as well as the Market price per share of Pemberton should be seen that may have risen because of speculation .
• Moreover a higher Earning ratio also happens because investors expects that the Earning of the company will be higher in the following years as with the case of Pemberton. Investors are keen to invest in the shares of Pemberton because they also see that the company is retaining its earning most probably for expansion.
5. Debt/equity ratio This ratio measures the amount of total liability with the total shareholder’s equity to find out how much of business is financed by debt and how much is financed by the shareholder’s own equity.
The higher the ratio the more risky the business is because if the Debt to Equity ratio is high it means that the company has more liabilities as compare to its own shareholder’s equity. Total Liability Common shareholders’ equity = 2,480,000 x 100 25,000,000 = 9. 92 %
• Orrell’s Debt to Equity Ratio is way less than its competitor Pemberton.
• A debt to equity ratio such as of Orrell suggests that the company is not risky to invest in, as well as the creditors will be keen to loan them the money because of there lower debt amount.
• At the same time A lower Debt to equity ratio may also not be good for the company because a lower debt to equity ratio means that the company is not taking loans to expand its business.
• It should be noted here that the debt to equity ratio of Pemberton is also not very high and therefore there is also no risk of bankruptcy in it just like Orrell.
6. Interest cover This ratio tells about how many times the business can pay off its interest of loan from its EBIT . The higher it is the less risky it is for the creditors / banks to give the company loan.
Earning Before Interest and Tax Interest Expense = 12,715,000 50,000 = 254. 3 times
• Orrell’s Interest Cover ratio is way high as company to its Competitor, Pemberton.
• As company to Pemberton, Orrell is less risky to invest in, and also the banks and other creditors will be keener to loan money to Orrell as compare to Pemberton.
• A higher Interest cover is also not very suitable for the company, because a higher interest cover means the company can take other loans too but it is not taking it.
• Orrell Interest Cover is 254.
3 which mean that the company can finance its interest 254. 3 times from its earnings whereas Pemberton will only be able to pay its interest 100 times from its earnings.
• Upholding should also see how stable the earning or Orrell is before driving any conclusion about the interest cover of Orrell because may be the interest cover of Orrell is high due to its unstable earning in different years. PART B a) Explain the main purposes of the International Accounting Standards Board’s ‘Framework for the Preparation and Presentation of Financial Statements’.
International Accounting Standard Board has laid out a framework know as ‘Framework for the Preparation and Presentation of Financial Statements’ which main purpose is to assist wide range of financial accounts users in getting the information about the financial performance, position and about the changes that occurs in the entity in the most useful manner as that stakeholders/users can make well informed and smart decisions.
The IASB’s ‘Framework for the Preparation and Presentation of Financial Statements’ purpose is also to describe the concept which the accountants or the prepares of the financial statements should follow when making the financial statements of a entity. The Framework has different sections what guides in developing financial statements according to the accounting standards but has also some guidelines regarding the conflicts in accounting issues that International Accounting Standard has not addressed directly .
To fulfill its purpose of assisting financial users the Framework is divided into sections or parts that are mentioned below:
1. Purpose and status
4. Underlying assumptions
5. Qualitative characteristics of financial statements
6. Elements of financial statements
7. Recognition of elements of financial statements
8. Measurement of the elements of financial statements
The Framework lays down the objective of the financial statement that it is that statement which provide useful informational about the performance and position of the entity in question.
Underlying assumptions The two assumptions that must be kept in mind when making financial accounts are , Accrual basis – The transactions should only be recognized when it occurs and not when the cash is actually paid or received . Going concern – When making financial statements it should be assumed that the entity has a going concern and it will continue to operate in the future also. Qualitative characteristics of financial statements The Framework purpose is also to inform the preparers of the financial statements of the following,
• Understandability – The statement should be easily understandable , it should not be complex to read
• Relevance – Information provided in the financial statement should be so relevant that can influence the economic decision made by the users. It should provide them with the evaluation of the past, present and future, and it can be used to evaluate the past decision made by the users.
• Reliability – The information contained in the financial statement should not be bias and the user can make decision by their own judgment and not by how the financial results are stated in the statement.
• Comparability. – The financial statement should be in such a way that allows comparisons with the past result of the entity and between different entities also . For comparing, disclosure of accounting policies is important. Elements of financial statements The Framework has also set some guidelines about the use of Different Accounts in the balance sheet and income statement which are Assets – Any thing that the entity possesses Liabilities – An obligation that the entity has to pay which maturity is in the current year or after any time
Equity – This is the owner’s share in the business . Income – Revenue earned by the entity Expenses – Cost incurred by the entity which generating income or revenue. Recognition of elements of financial statements The Framework states that in the financial statements those items should be recognized that have the chances of flowing economic to or from an entity and items which costs can be measure with reliability. Measurement of the elements of financial statements All those items should be recorded in the financial statement that have some monetary value .
The Framework acknowledges that there are different varieties of measuring techniques used today in reporting of financial statements. Moreover the Framework has not included any guidelines about which type of measuring techniques should be used in different circumstances .
The Different Measurement Techniques are
• Historical cost
• Current cost
• Net realizable (settlement) value
• Present value (discounted) The IASB’s Framework for the Preparation and Presentation of Financial Statements purpose is to guide people who prepare the financial statements for the entities .
It covers almost all the important points that are important for making the financial statement readable and easily understandable by the interested parties. b) Identify any four user groups of financial statements and explain what information they are likely to want from them. The financial statement is a very useful tool as it is a published document which illustrates the fiscal health of the organization. It consists of the balance sheet, income statement and the cash flow statement. These statements are published on periodic bases.
The users of these statements include managers, lenders, investors, competitors, employees, government officials etc Investors can be of two types either existing or prospective; moreover investors include individual shareholders, financial institutions investing in a corporation such as mutual funds, banks and insurance companies. Investors can either be interested in the company for long or short time periods. These can include companies who are concerned with the dividends a company is paying to its investors or a financer who is just looking at opportunities for day to day trading.
Investors are more interested to look at the income statement of the company as their main objective is towards profitability. For the investors they are usually interested in earnings of a company and the earning per share ratio which shows the profit associated with each share. The debt to equity ratio to see how the firm is financed, if the company is financed more by debt and less by equity investors will be reluctant to invest in the company. Additionally the dividend yield of a company will be a point of attention for the long term investors as they are looking forward to the dividends paid by the company.
The price earning ratio is important especially for the investors who trade on a daily basis as it shows how the company is valued by its investors the greater the price earning ratio it signifies that the investors value the company very high and believe that the company has bright prospects hence the share price of the company will increase and investors can benefit through capital gains. Managers use financial statements to make decisions regarding the financial aspects of the company.
The managers use these statements to gather key financial information about the performance of the company . Also to formulate companies funding and operating decisions. For this purpose the companies management uses the current assets and the current liability form its balance sheet part to measure the company’s liquidity position. Also the managers can calculate the interest coverage ratio to calculate how much further then can attain debt for financing purpose while managing to pay the interest expense for it.
Managers want the company to function well that is why they are interested in the efficient running of the company. Hence they will see that there is sufficient cash to administer the daily operations, the asset turnover ratio, inventory turnover ratio and the receivable turnover ratio of the company. Managers are usually interested to see the complete picture of the financial information rather than focusing on some parts of it.
Lenders fully analyze a company’s financial statement before deciding to provide loan to a company their focus is more towards the balance sheet and cash flows. They provide loans for short or long time durations, the lenders are more willing to lend money to more stable and profitable companies. A bank is an example of a lender if a company goes to a bank to get a loan the bank will see the earnings of the company and calculate its profitability ratios such as the profit margin ratio, return on equity and earning per share ratios.
Moreover lenders will be interested to see how much percentage the firm is tied up in debt already, a lender will be hesitant to provide leverage to a company who has already borrowed a great deal. Additionally the lender will want to calculate the interest coverage ratio to see for how long the company can pay the interest payments to the lenders. Liquidity of the company will also affect the investors as that will signify if the investors can pay the interest charges to the lenders on time.
Competitors are also keen to analyze competitors financial statement as the ratios of an efficient and profitable company serves as a benchmark for the others. The main focus of attention of the competitor lays in calculating almost all the financial ratios of a company. The liquidity, profitability, efficiency, leverage and market analysis ratios of the company are compared by the competitor to his company’s ratios. These ratios calculated from the financial statements act to serve as a comparative basis to examine the running of the company.
In addition to that these ratios help to predict trends amongst the industry which acts as a guide for the competitors to evaluate if they are better or worse of than their competitors.
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