Component 3 - Fundamental Analysis - PDF

COMPONENT 3 – FUNDAMENTAL ANALYSIS Photo by Stefan Els Economic and Manag...

COMPONENT 3 – FUNDAMENTAL ANALYSIS Photo by Stefan Els Economic and Management Sciences | EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en Bestuurswetenskappe INTRODUCTION Fundamental Analysis: Determining the intrinsic value of shares by considering current and future financial performance Intrinsic value = discounting future income and dividends If current market value (market price) < intrinsic value: under valuedndervalued If current market value > intrinsic value: over valuedvervalued Financial analysis is used to determine which shares to buy To evaluate the financial position of a company – investigate financial statements using financial ratios. Economic and Management Sciences | EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en Bestuurswetenskappe STAKEHOLDERS IN FINANCIAL ANALYSIS Four different groups of stakeholders: Shareholder: potential earnings EPS and DPS Debt: current amount of debt in the capital structure and if the business can settle capital and interest payments Management: to ensure efficient decision-making; long-term survival of business Diverse groups (clients, competitors, suppliers): Not necessarily directly involved in the activities of the business but also interested in the financial performance Economic and Management Sciences | EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en Bestuurswetenskappe PART 1: FINANCIAL STATEMENTS - Statement of financial position - Statement of profit or loss & comprehensive income  For the purposes of this chapter, the focus is placed only on the Statement of Profit or Loss since it contains the information required for the financial analysis - Focus on Standardised financial statements Economic and Management Sciences | EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en Bestuurswetenskappe  STATEMENT OF FINANCIAL POSITION Summary of a company’s financial position on a specific date (year-end) Assets: amount of capital invested in assets Equity and liabilities: sources of capital Summary of the capital obtained by, and application thereof in a company Economic and Management Sciences | EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en Bestuurswetenskappe  STATEMENT OF FINANCIAL POSITION Non- Assets utilised for longer than one year current Equity assets Non- Assets utilised for less than one current year Included in the physical production Current liabilities process of an enterprise assets Current Can be converted into cash relatively quick and easy liabilities Distinction based on: Turnover Total Total period of capital, ease of equity and assets realisation and Economic and Management physical Sciences | EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en Bestuurswetenskappe liabilities  STATEMENT OF FINANCIAL POSITION OF LMMR LTD AS AT 28 FEBRUARY LMMR statements are provided 20X9 in the PDF document on SUNLearn, under Component 3. ASSETS 20X9 20X8 PPE at cost price 645 800 651 400 - Accumulated depreciation (32 900) (22 300) Total PPE at carrying value 612 900 629 100 Goodwill 3 400 5 700 Patents at carrying value 2 000 3 000 Intangible assets 5 400 8 700 Share investments 4 200 3 600 Long-term loans granted (10%) 13 400 18 600 Financial assets 17 600 22 200 NON-CURRENT ASSETS 635 900 660 000 Inventory 66 000 54 700 Trade receivables 83 600 48 250 Cash 14 500 2 650 Prepayments - - CURRENT ASSETS 164 100 105 600 TOTAL ASSETS 800 000 765 600 7 Economic and Management Sciences | EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en Bestuurswetenskappe  EQUITY AND LIABILITIES 20X9 20X8 Ordinary share capital (20X9 = 260 000; 20X8 = 240 000) 423 193 384 000 Revaluation reserve (Non distributable reserve) - - Capital redemption reserve (Non distributable reserve) - - General reserves (Distributable reserve) 48 500 40 500 Retained earnings (Distributable reserve) 25 057 24 200 Ordinary shareholders’ equity 496 750 448 700 Preference shares (5,5%) 100 000 100 000 Shareholders’ equity 596 750 548 700 EQUITY 596 750 548 700 Mortgage loan (12%) 80 000 87 000 Debentures (6,25%) 40 000 50 000 NON-CURRENT LIABILITIES 120 000 137 000 Trade payables 67 300 52 400 Short-term loans (12%) 12 000 18 000 Dividends payable 3 200 5 900 Bank overdraft (8%) 750 3 600 Current tax liabilities - - CURRENT LIABILITIES 83 250 79 900 TOTAL EQUITY AND LIABILITIES 800 000 765 600 Economic and Management Sciences | EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en Bestuurswetenskappe  STATEMENT OF FINANCIAL POSITION (SFP) NON-CURRENT ASSETS: Property, plant and equipment @ cost price Physical assets, e.g. property, equipment, vehicles, buildings Usually shown at the original cost price Major weakness of SFP: if assets are in use for long, the cost price no longer reflects the replacement (current) value of the asset Solution: revaluation reserve Economic and Management Sciences | EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en Bestuurswetenskappe  STATEMENT OF FINANCIAL POSITION NON-CURRENT ASSETS: Accumulated depreciation Provided for in Statement of profit or loss, accumulated in SFP Indication of the total depreciation provided for PPE PPE at carrying value PPE @ Carrying value = PPE @ cost price – accumulated depreciation Carrying value compared to proceeds when PPE is sold to determine gain/loss Economic and Management Sciences | EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en Bestuurswetenskappe STATEMENT OF FINANCIAL POSITION (SFP) NON-CURRENT ASSETS: Intangible assets Goodwill and patents Utilised to generate an income Difficult to allocate monetary value Financial assets Usually indicated at their original price, while their current market price can also be included. Investments (shares in other companies, listed/delisted) Loans to other parties Economic and Management Sciences | EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en Bestuurswetenskappe  STATEMENT OF FINANCIAL POSITION CURRENT ASSETS: Inventories Stock necessary for continuous operation Production vs retail Trade receivables Outstanding portion of credit sales Economic and Management Sciences | EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en Bestuurswetenskappe  STATEMENT OF FINANCIAL POSITION CURRENT ASSETS: Cash Cash on hand (petty cash) and cash in bank accounts Also includes cash equivalents (short-term investments) Prepayments Paid an expense before payment was required Payments made for transactions that will only occur in the following accounting period Economic and Management Sciences | EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en Bestuurswetenskappe  EQUITY AND LIABILITIES 20X9 20X8 Ordinary share capital (20X9 = 260 000; 20X8 = 240 000) 423 193 384 000 Revaluation reserve (Non distributable reserve) - - Capital redemption reserve (Non distributable reserve) - - General reserves (Distributable reserve) 48 500 40 500 Retained earnings (Distributable reserve) 25 057 24 200 Ordinary shareholders’ equity 496 750 448 700 Preference shares (5,5%) 100 000 100 000 Shareholders’ equity 596 750 548 700 EQUITY 596 750 548 700 Mortgage loan (12%) 80 000 87 000 Debentures (6,25%) 40 000 50 000 NON-CURRENT LIABILITIES 120 000 137 000 Trade payables 67 300 52 400 Short-term loans (12%) 12 000 18 000 Dividends payable 3 200 5 900 Bank overdraft (8%) 750 3 600 Current tax liabilities - - CURRENT LIABILITIES 83 250 79 900 TOTAL EQUITY AND LIABILITIES 800 000 765 600 Economic and Management Sciences | EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en Bestuurswetenskappe  STATEMENT OF FINANCIAL POSITION EQUITY: Ordinary share capital Proceeds from the sale of ordinary shares Represent the shareholders’ stake in the management of the company Ordinary share capital = # of issued ordinary shares X average issue price Non-distributable reserves Reserves that cannot be paid out to ordinary shareholders as dividends Revaluation reserve and capital redemption reserves Economic and Management Sciences | EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en Bestuurswetenskappe STATEMENT OF FINANCIAL POSITION EQUITY: Distributable reserves Can be paid out to ordinary shareholders as dividends Retained earnings General reserve Ordinary shareholder’s equity Total shareholding of the company Ordinary share capital + non-distributable reserves + distributable reserves Economic and Management Sciences | EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en Bestuurswetenskappe STATEMENT OF FINANCIAL POSITION EQUITY: Preference share capital Selling of preference shares Preference right above ordinary shareholders to receive dividends Fixed dividend proceed, guarantee of dividend payout Shareholder’s equity Total capital provided by shareholders (ordinary + preference) Economic and Management Sciences | EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en Bestuurswetenskappe  STATEMENT OF FINANCIAL POSITION LIABILITIES NON-CURRENT CURRENT LIABILITES LIABILITIES Short-term debt capital Interest bearing Less than one year borrowings: long-term Types: debt capital where Trade payables, bank interest payments and a overdraft, ST loans, final redemption of the dividends payable, capital is required current tax liabilities Types: LT loans, mortgage loans, debentures Economic and Management Sciences | EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en Bestuurswetenskappe  STATEMENT OF FINANCIAL POSITION CURRENT LIABILITIES: Trade payables Outstanding amount as a result of purchasing on credit Future obligation Bank overdraft Overdraft facility on bank account Usually applied over short-term due to high finance costs Economic and Management Sciences | EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en Bestuurswetenskappe STATEMENT OF FINANCIAL POSITION CURRENT LIABILITIES: Short-term loans Loans or portions of long-term debt expected to be redeemed in the following financial year Dividends payable Dividends declared but not yet paid by year-end Current tax liabilities If the amount of tax that must be paid is known (calculated), but payment has not yet been made Economic and Management Sciences | EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en Bestuurswetenskappe MORE ON ORDINARY & PREFERENCE SHARES ORDINARY SHARES PREFERENCE SHARES Characteristics Characteristics Co-owners of the company Voting power is limited or non-existent Voting power (1 share = 1 vote) Fixed dividend guaranteed (% par Vote on take-overs, mergers but value) not amount of div they will Market price is more stable than receive ordinary SH Receive dividends – no legal right but entitled to claim to the profits Types Pre-emptive right to new shares (to Cumulative: dividends accumulate maintain their % interest in and will be paid when funds are company) available Limited liability – only lose the Non-cumulative: No outstanding value of shares dividends from previous years will be Shares are negotiable (tradable) & paid back Participating: SH may receive a higher very liquid Potential to generate capital gains - dividend if company experiences a Last claim to assets & profit (after larger profit than expected Economic and Management Sciences | EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en Bestuurswetenskappe Convertible: Shares can be converted  STATEMENT OF PROFIT OR LOSS Summary of a company’s financial performance for a specific period of time (usually one year). Does not necessarily represent cash-flows as non-cash flow items (depreciation, credit sales and credit purchases) are also included. NOTES: 1. Opening 54 700 ADDITIONAL INFORMATION to the inventory LMMR example (in additional PDF document) + Purchases 320 000 2. 50% of sales are cash sales; 374 90% of purchases are credit purchases. 3. The market price of ordinary700 shares at: 28/02/20X9 28/02/20X8 - Final (66 000 350c 280c 4. Ordinary share dividends of R28 000 )were declared during the year. inventory 5. During the year, a vehicle was sold at a profit of R6 000, and equipment was sold at a loss of R640. Cost of sales 308 Economic and Management Sciences | EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en Bestuurswetenskappe STATEMENT OF PROFIT OR LOSS OF LMMR LTD FOR THE YEAR ENDED 28 FEBRUARY 20X9 Revenue 460 450 - Cost of sales (308 700) GROSS PROFIT 151 750 - Operating expenses (85 400) OPERATING PROFIT 66 350 + Investment income 2 400 + Gain on the disposal of PPE (vehicle) 6 000 - Loss on the disposal of PPE (equipment) (640) - Finance costs (13 600) PROFIT before TAX 60 510 - Income tax expense (30%) (18 153) PROFIT after TAX 42 357 - Preference share dividends (5 500) ATTRIBUTABLE EARNINGS 36 857 - Transfer to general reserves (8 000) - Ordinary share dividends (28 000) RETAINED EARNINGS 857 Economic and Management Sciences | EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en Bestuurswetenskappe STATEMENT OF PROFIT OR LOSS OF LMMR LTD FOR THE YEAR ENDED 28 FEBRUARY 20X9 Compensation for products or services delivered Revenue 460 450 (308 70 Opening inventory + purchases – Closing inventory - Cost of sales 0) Profit from sales activities GROSS PROFIT 151 750 Eg. Wages, salaries, depreciation - Operating expenses (85 400) Profit from primary activities OPERATING PROFIT 66 350 Interest received on loans granted; dividends received on share investments + Investment income (interest = R1 340 + 2 400 Total investment income (in SPL) = R2 400 Div = ?) - Interest received (R13 400 x 10%) = R1 340 = Dividends received = R1 060 + Gain on the disposal of PPE (vehicle) 6 000 (note 5) Gain: SP > CV; Loss: SP < CV - Loss on the disposal of PPE Interest paid on long-term and short-term interest (640) (equipment) (note 5) bearing debt - Mortgage loan: R 80 000 x 12% = 9 600 - Finance costs (13 600) - Debentures: R40 000 x 6.25% = 2 500 - Short-term loans: R12 000 x 12% = 1440 PROFIT before TAX Economic and Management Sciences | EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en Bestuurswetenskappe 60 510  STATEMENT OF PROFIT OR LOSS OF LMMR LTD FOR THE YEAR ENDED 28 FEBRUARY 20X9 PROFIT before TAX 60 510 - Income tax expense (30%) (18 153) Profit available to pay preference share dividends PROFIT after TAX 42 357 % of preference share capital amount in SFP - Preference share dividends (R100 (5 500) 000 x 5.5%) Profit available to pay ordinary dividends ATTRIBUTABLE EARNINGS 36 857 Difference between opening and closing balance in SFP - Transfer to general reserves (48 500 Cent amount per ordinary share x number of shares; (8 000) – 40 500) additional information Reinvested into the enterprise (part of distributable - Ordinary share dividends (note nr.4) (28 000) reserves) = Difference between opening and closing balances in RETAINED EARNINGS (25 057 – 24 857 SFP 200) EQUITY AND LIABILITIES 20X9 20X8 General reserves (Distributable reserve) 48 500 40 500 Retained earnings (Distributable reserve) 25 057 24 200 Ordinary Economic shareholders’ and Management equitynoLawulo | Ekonomiese en Bestuurswetenskappe Sciences | EyeNzululwazi ngoQoqosho 496 750 448 700  PREREQUISITES FOR FINANCIAL STATEMENTS Relevant & must contain necessary information that is required Information - reliable & complete Statements must be understandable for the users thereof Objective version of company’s financial situation Timely because since outdated information is of no value 1.Statements must be comparable and therefore information should be dealt with in a consistent manner. Economic and Management Sciences | EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en Bestuurswetenskappe. COMPONENT 3 CLASS EXERCISE: Olympics Ltd. (PDF version of question on SUNLearn) Economic and Management Sciences | EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en Bestuurswetenskappe Economic and Management Sciences | EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en Bestuurswetenskappe Economic and Management Sciences | EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en Bestuurswetenskappe Class exercise: Olympics Ltd. Statement of financial position 20X5 20X4 PPE at cost price 175 000 160 000 - Accumulated depreciation (42 400) (37 800) PPE at carrying value 132 600 122 200 Goodwill 4 000 4 000 Intangible assets 4 000 4 000 Long-term loans granted (10%) 3 400 2 800 Share investments 10 000 6 000 Financial assets 13 400 8 800 NON-CURRENT ASSETS 150 000 135 000 Trade receivables 13 700 11 200 Inventory 19 000 16 400 Cash and cash equivalents 16 600 12 100 Prepayments 700 300 CURRENT ASSETS 50 000 40 000 TOTAL ASSETS 200 000 175 000 30 Economic and Management Sciences | EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en Bestuurswetenskappe  EQUITY AND LIABILITIES 20x5 20x4 Ordinary share capital 80 000 56 500 (20X5: 35 000; 20X4: 27 000) General reserve - - Retained earnings 9 000 5 500 Ordinary shareholders’ equity 89 000 62 000 Preference share capital (9%) 6 000 10 000 Shareholders’ equity 95 000 72 000 EQUITY 95 000 72 000 Mortgage loan (5%) 50 000 60 000 Long-term loan (7%) 9 000 3 000 Debentures (6%) 20 000 16 000 NON-CURRENT LIABILITIES 79 000 79 000 Trade payables 18 100 12 500 Bank overdraft (10%) 6 700 9 800 Dividends payables 800 1 200 Current tax liabilities 400 500 CURRENT LIABILITIES 26 000 24 000 TOTAL Economic EQUITY and Management Sciences |AND LIABILITIES EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en Bestuurswetenskappe 200 000 175 000 Class exercise: Olympics Ltd. STATEMENT OF PROFIT OR LOSS 20x5 REVENUE 125 000 - Cost of sales GROSS PROFIT 50 000 - Operating expenses (23 700) OPERATING PROFIT + Investment income 750 + Gain with disposal of PPE 500 - Finance costs (2 500 + 630 + 1 200 + 670) PROFIT BEFORE TAX - Income tax expense (28%) PROFIT AFTER TAX - Preference dividends ATTRIBUTABLE EARNINGS - Ordinary dividends declared - Transfer to general reserve RETAINED Economic EARNINGS and Management Sciences | EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en Bestuurswetenskappe Class exercise: Olympics Ltd. STATEMENT OF PROFIT OR LOSS 20x5 REVENUE 125 000 - Cost of sales (75 000) GROSS PROFIT 50 000 - Operating expenses (23 700) OPERATING PROFIT 26 300 + Investment income 750 + Gain with disposal of PPE 500 - Finance costs (5 000) (2 500 + 630 + 1 200 + 670) PROFIT BEFORE TAX 22 550 - Income tax expense (28%) (6 314) PROFIT AFTER TAX 16 236 - Preference dividends (540) ATTRIBUTABLE EARNINGS 15 696 - Ordinary dividends declared (12 196) - Transfer to general reserve - RETAINED EARNINGS 3 500 Economic and Management Sciences | EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en Bestuurswetenskappe Class exercise: Olympics Ltd. Economic and Management Sciences | EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en Bestuurswetenskappe  PART 2: FINANCIAL RATIOS Used to evaluate the financial performance of a company Ratios must meet the following requirements: 1. Comparison made must be meaningful 2. Provide true indication of financial performance 3. Comparable over time 35 Economic and Management Sciences | EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en Bestuurswetenskappe CLASSIFICATION OF RATIOS 1. Profitability, rate of return % 2. Profit margins % 3. Liquidity no unit 4. Turnover ratios and time times / days 5. Solvency % 6. Coverage ratios times 7. Investment ratios varies IMPORTANT: NOTE THE USE OF AVERAGE VALUES FOR SFP ITEMS FOR CALCULATING CERTAIN RATIOS Economic and Management Sciences | EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en Bestuurswetenskappe  1. PROFITABILITY Effectiveness in utilising capital (assets) to generate income Possible to calculate the profitability of different capital items. Total Assets Shareholders’ Equity Debt Capital Financial assets Economic and Management Sciences | EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en Bestuurswetenskappe The following ratios are based on the financial statements of LMMR Ltd. 1. Return on total assets Ro = Operating profit + Investment Income x 100 Average total assets 1 66 350 + 2 400 100 = 0,5(800 000 + 765 600) x 1 8.78% = Economic and Management Sciences | EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en Bestuurswetenskappe  1. PROFITABILITY 2. Return on equity Operating profit + investment income − finance cost 100 × Re Average equity 1 = = 66 350 + 2 400 − 13 600 100 x 0,5(596 750 + 548 700) 1 = 9.63% Economic and Management Sciences | EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en Bestuurswetenskappe 1. PROFITABILITY 3. Cost of debt (return on debt capital) Finance costs 100 Rv  Average debt capital 1 = 13 600 x 100 = 0,5(203 250 + 216 900) 1 Non-current liabilities + current liabilities (20x9) = 6.47% Economic and Management Sciences | EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en Bestuurswetenskappe 1. PROFITABILITY 4. Return on financial assets Investment income 100 = × Average financial assets 1 2 400 100 x 0,5(17 600 + 22 200) 1 = = 12.06% Economic and Management Sciences | EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en Bestuurswetenskappe  2. Profit margins Percentage of revenue (sales) that is eventually realised as some form of profit: Gross Profit Operating Profit EBIT (earnings before interest and tax) Net Profit Economic and Management Sciences | EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en Bestuurswetenskappe 2. Profit margins 1A. Gross profit margin Gross profit 100 = × Revenue 1 = 151 750 100 × 460 450 1 1B. Mark-up percentage Gross profit 100 = = × Cost of sales 1 32.96% = 151 750 × 100 308 700 1 = Economic and Management Sciences | EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en Bestuurswetenskappe PROFIT MARGINS: Example (not LMMR percentages) Gross profit Mark-up R margin percentage (%) (%) Revenue 100 000 100 125 Cost of sales 80 000 80 100 Gross profit 20 000 20 25 Economic and Management Sciences | EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en Bestuurswetenskappe  2. Profit margins 2. Operating profit margin Operating profit 100 = Revenue × 1 = 66 350 × 100 460 450 1 = 14.41% Economic and Management Sciences | EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en Bestuurswetenskappe  2. Profit margins 3. EBIT-margin Profit before tax + finance cost 100 × Revenue 1 = 60 510 + 13 600 100 × = 460 450 1 = 16.10% Economic and Management Sciences | EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en Bestuurswetenskappe 2. Profit margins 4. Net profit margin Profit after tax 100 × Revenue 1 = 42 357 100 × = 460 450 1 = 9.20% Economic and Management Sciences | EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en Bestuurswetenskappe 3. Liquidity Enterprise’s ability to meet short-term liabilities Sufficient current assets cover current liabilities Insufficient liquidity can eventually lead to solvency problems Economic and Management Sciences | EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en Bestuurswetenskappe 3. Liquidity 1. Current ratio 2. Acid test ratio (Quick ratio) Current assets Current assets− Inventory − Prepayments Current liabilities Current liabilities = = 164 100 164 100 − 66 000 − 0 83 250 = = 83 250 = 1.97 (no unit) = 1.18 (no Economic and Management Sciences | EyeNzululwazi ngoQoqosho noLawulo |unit) Ekonomiese en Bestuurswetenskappe 4. Turnover Ratios & -Times Turnover Ratio: How many times per year the value of certain assets are transformed into turnover / sales Turnover Time: How many days it takes to turn the value of certain assets into turnover / sales once 1. Current Assets 2. PPE 3. Trade Receivables 4. Inventory Economic and Management Sciences | EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en Bestuurswetenskappe 4. Turnover Ratios & -Times There are two ways a Turnover ratio/time question could be asked: 1. Given an amount of information (word problem) 2. Given financial statement information Economic and Management Sciences | EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en Bestuurswetenskappe  EXAMPLE (page 38): An enterprise invests R500 in inventories. It is possible to sell the items either on cash or on credit terms. The sales price amounts to R750 (thus a markup of 50%). The inventories are sold after 15 days. If cash sales are used, the income will be collected immediately, and it can be reinvested in inventories again. If credit sales are used, the trade receivables will only pay a further 15 days after the transaction takes place (at the end of the month). The effect of the two sales methods on the profit of the enterprise can be calculated as follows: Economic and Management Sciences | EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en Bestuurswetenskappe  4. Turnover Ratios & -Times CASH SALES 1 April 15 April 30 April Invest R500 15 Days 15 Days in inventory Sell: R750 (30th) Receive: Sell: R750 R750 Receive: (Profit: R250) R750 Invest R500 in inventory (Profit: R250) Turnover ratio per month 2 times Profit per transaction R250 Total profit per month R500 Return on investment per month R500/R500 x 100/1 = 100% Investment required Economic and Management Sciencesto make R1 | EyeNzululwazi 000noLawulo ngoQoqosho profit R1 000 per en Bestuurswetenskappe | Ekonomiese  4. Turnover Ratios & -Times CREDIT SALES 1 April 15 April 30 April Invest R500 15 Days 15 Days in inventory Sell: R750 (30th) Receive: Receive: R0 R750 (Profit: R250) Turnover ratio per month 1 time Profit per transaction R250 Total profit per month R250 Return on investment per month R250/R500 x 100/1 = 50% Investment required to make R1 000 profit per R2 000 Economic and Management Sciences | EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en Bestuurswetenskappe  4. Turnover Ratios & -Times Turnover ratio of current assets Net revenue Average current assets = 460 450 = 0,5(164 100 + 105 600) = 3.41 timesofTurnover Number times per time year that current assets of current assets are converted into revenue Average current assets 360 × = Net revenue 1 0.5(164 100  105 600) x 360 = 460 450 1 How long does one conversion = 105.43 cycle take? Economic and Management Sciences | EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en Bestuurswetenskappe 4. Turnover Ratios & -Times Turnover ratio of PPE Net revenue Average PPE @ carrying value = 460 450 0,5(612 900 + 629 100 ) = = 0.74 Turnover time of PPE times Average PPE @ carrying value 360 × = Net revenue 1 0,5(612 900 + 629 100) 360 x 1 = 460 450 = 485.53 Economic and Management Sciences | EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en Bestuurswetenskappe  4. Turnover Ratios & -Times Turnover ratio of trade receivables Credit revenue Average trade receivables = 460 450 x 50% 0,5(83 600 + 48 250) = = 3.49 times Turnover time of trade receivables Average trade receivables 360 × = Credit revenue 1 0,5(83 600 + 48 250) x 360 = 230 225 1 = 103.09 Economic and Management Sciences | EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en Bestuurswetenskappe 4. Turnover Ratios & -Times Turnover ratio of inventory Cost of sales Average inventory = 308 700 0,5(66 000 + 54 700) = = 5.12 times Turnover time of inventory Average inventory 360 × = Cost of sales 1 0,5(66 000 + 54 700) x 360 308 700 1 = = 70.38 Economic and Management Sciences | EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en Bestuurswetenskappe  5. Solvency Ability of company to meet all its financial obligations over the long-term. 1. Debt-to-assets ratio (Debt ratio) Debt capital 100 × Debt capital 100 OR × Total assets 1 Total capital 1 = 120 000 + 83 250 100 800 000 x 1 = 25.41% Economic and Management Sciences | EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en Bestuurswetenskappe 6. Coverage ratios The ability to meet certain obligations. All the ratios focus on an obligation and then compare it to the profits available to pay that particular obligation: 1. Finance cost cover Profit before finance cost and tax = Finance cost 60 510 + 13 600 = 13 600 = 5.45 times Economic and Management Sciences | EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en Bestuurswetenskappe  6. Coverage ratios 2. Ordinary dividend coverage Earnings per share Earnings yield OR Dividend yield OR Profit after tax − PS dividends Dividend per share Ordinary dividends declared = 14,74 4.2% 42 357 − 5 500 = 11,20 = 3.2% = 28 000 = 1.32 Economic and Management Sciences | EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en Bestuurswetenskappe  7. Investment ratios Attributable earnings Earnings per share = Average number of ordinary shares issued 36 857 0,5(260 000 + 240 000) = 14,74c per share = Earnings per share 100 Earnings yield = × Market price per share 1 14,74 x 100 350 1 = = 4.21% Economic and Management Sciences | EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en Bestuurswetenskappe  7. Investment ratios Ordinary dividends declared Dividend per share= Average number of ordinary shares issued 28 000 = 0,5(260 000 + 240 000) = 11.20 cents per share Dividend per share 100 Dividend yield= 𝑥 Market price per share 1 11,20 100 x 350 1 = = 3.20% Economic and Management Sciences | EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en Bestuurswetenskappe 7. Investment ratios Market price per share Price−earnings ratio= Earnings per share 350 14,74 = = 23.74 (no unit) How much Rand investors are willing to pay for every R1 of EPS Economic and Management Sciences | EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en Bestuurswetenskappe  7. Investment ratios At year end – not average number of shares 596 750 − 100 000 − 5 400 260 000 = = R1.89 / 188.98c per share Economic and Management Sciences | EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en Bestuurswetenskappe  Homework for the next lecture: Do the financial ratios for Olympics Ltd – Additional exercise Economic and Management Sciences | EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en Bestuurswetenskappe. COMPONENT 3 CLASS EXERCISE: Olympics Ltd. - Ratios Economic and Management Sciences | EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en Bestuurswetenskappe  Statement of financial position 20X5 20X4 PPE at cost price 175 000 160 000 - Accumulated depreciation (42 400) (37 800 ) PPE at carrying value 132 600 122 200 Goodwill 4 000 4 000 Intangible assets 4 000 4 000 Return on total assets: Long-term loans granted (10%) Share investments 3 400 10 000 2 800 6 000 Financial assets 13 400 8 800 NON-CURRENT ASSETS 150 000 135 000 Ro = Operating profit + Investment Income Trade x 100receivables 13 700 11 200 Average total assets Inventory 1 Cash and cash equivalents 19 000 16 600 16 400 12 100 Prepayments 700 300 CURRENT ASSETS 50 000 40 000 26 300 + 750 = 100 STATEMENT OF PROFIT OR LOSS 20x5 x TOTAL REVENUEASSETS 200 000 125 175 000 000 0,5(200 000 + 175 000) 1 - Cost of sales GROSS PROFIT (75 000) 50 000 - Operating expenses (23 700) =14,43 OPERATING PROFIT 26 300 + Investment income 750 % + Gain with disposal of PPE - Finance costs 500 (5 000) (2 500 + 630 + 1 200 + 670) PROFIT BEFORE TAX 22 550 - Income tax expense (28%) (6 314) PROFIT AFTER TAX 16 236 - Preference dividends (540) ATTRIBUTABLE EARNINGS 15 696 - Ordinary dividends declared (12 196) - Transfer Economic and Management Sciences | EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en to general reserve Bestuurswetenskappe -  Statement of financial position 20X5 20X4 PPE at cost price 175 000 160 000 - Accumulated depreciation (42 400) (37 800 ) PPE at carrying value 132 600 122 Return on financial assets: Goodwill 4 000 200 4 000 Intangible assets 4 000 4 000 Long-term loans granted (10%) 3 400 2 800 = Investment income 100 Share investments 10 000 6 000 × Financial assets NON-CURRENT ASSETS 13 400 150 000 8 800 135 Average financial assets 1 Trade receivables 13 700 000 11 200 Inventory 19 000 16 400 Cash and cash equivalents 16 600 12 100 750 = x 100 Prepayments 700 300 0,5(13 400 + 8800) 1 CURRENT ASSETS STATEMENT OF PROFIT OR LOSS TOTAL ASSETS 50 000 40 000 200 000 20x5 175 REVENUE 125 000 000 - Cost of sales (75 000) GROSS PROFIT 50 000 = 6,76 - Operating expenses (23 700) OPERATING PROFIT 26 300 % + Investment income 750 + Gain with disposal of PPE 500 - Finance costs (5 000) (2 500 + 630 + 1 200 + 670) PROFIT BEFORE TAX 22 550 - Income tax expense (28%) (6 314) PROFIT AFTER TAX 16 236 - Preference dividends (540) ATTRIBUTABLE EARNINGS 15 696 - Ordinary dividends declared (12 196) - Transfer to general reserve - Economic and Management Sciences | EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en Bestuurswetenskappe Net profit margin: STATEMENT OF PROFIT OR LOSS 20x5 REVENUE 125 000 100 tax Profit after - Cost of sales (75 000) = x GROSS PROFIT 50 000 1 Revenue - Operating expenses OPERATING PROFIT (23 700) 26 300 + Investment income 750 + Gain with disposal of PPE 500 16 236 x 100 - Finance costs (5 000) = 125 000 (2 500 + 630 + 1 200 + 670) 1 PROFIT BEFORE TAX 22 550 - Income tax expense (28%) (6 314) PROFIT AFTER TAX 16 236 - Preference dividends (540) ATTRIBUTABLE EARNINGS 15 696 = 12,99 - Ordinary dividends declared (12 196) - Transfer to general reserve - % RETAINED EARNINGS 3 500 Economic and Management Sciences | EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en Bestuurswetenskappe  Statement of financial position 20X5 20X4 PPE at cost price 175 000 160 000 - Accumulated depreciation (42 400) (37 800 Current ratio: PPE at carrying value 132 600 ) 122 200 Goodwill 4 000 4 000 Current assets Intangible assets Long-term loans granted (10%) 4 000 3 400 4 000 2 800 = Current liabilities Share investments Financial assets 10 000 13 400 6 000 8 800 NON-CURRENT ASSETS 150 000 135 000 Trade receivables 13 700 11 200 50 000 Inventory 19 000 16 400 = Cash and cash equivalents 16 600 12 100 26 000 Prepayments CURRENT ASSETS 700 300 50 000 40 000 EQUITY AND LIABILITIES 20x5 20x4 TOTAL ASSETS 200 000 175 Ordinary share capital (20X5: 35 000; 20X4: 27 80 000 56 500 000 000) General reserve - - = 1,92 Retained earnings 9 000 5 500 Ordinary shareholders’ equity 89 000 62 000 None Preference share capital (9%) 6 000 10 000 Shareholders’ equity 95 000 72 000 EQUITY 95 000 72 000 Mortgage loan (5%) 50 000 60 000 Long-term loan (7%) 9 000 3 000 Debentures (6%) 20 000 16 000 NON-CURRENT LIABILITIES 79 000 79 000 Trade payables 18 100 12 500 Bank overdraft (10%) 6 700 9 800 Dividends payables 800 1 200 Current tax liabilities 400 500 CURRENT Economic and Management Sciences | EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en LIABILITIES Bestuurswetenskappe 26 000 24 000  Statement of financial position 20X5 20X4 PPE at cost price 175 000 160 000 - Accumulated depreciation (42 400) (37 800 ) PPE at carrying value 132 600 122 200 Goodwill 4 000 4 000 Intangible assets 4 000 4 000 Debt-to-asset ratio: Long-term loans granted (10%) Share investments 3 400 10 000 2 800 6 000 Financial assets 13 400 8 800 NON-CURRENT ASSETS 150 000 135 Debt capital 100 000 × Trade receivables Inventory 13 700 19 000 11 200 16 400 Total assets 1 Cash and cash equivalents 16 600 12 100 = Prepayments 700 300 CURRENT ASSETS 50 000 40 000 EQUITY AND LIABILITIES 20x5 20x4 TOTAL ASSETS 200 000 175 Ordinary share capital (20X5: 35 000; 20X4: 27 80 000 56 500 79 000 + 26000 100 000) 000 200000 x General reserve - - = 1 Retained earnings 9 000 5 500 Ordinary shareholders’ equity 89 000 62 000 Preference share capital (9%) 6 000 10 000 Shareholders’ equity 95 000 72 000 EQUITY 95 000 72 000 52,50 Mortgage loan (5%) 50 000 60 000 Long-term loan (7%) 9 000 3 000 = % Debentures (6%) 20 000 16 000 NON-CURRENT LIABILITIES 79 000 79 000 Trade payables 18 100 12 500 Bank overdraft (10%) 6 700 9 800 Dividends payables 800 1 200 Current tax liabilities 400 500 CURRENT Economic and Management Sciences | EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en LIABILITIES Bestuurswetenskappe 26 000 24 000  Finance cost cover: STATEMENT OF PROFIT OR LOSS 20x5 REVENUE 125 000 - Cost of sales (75 000) Profit before finance cost and tax GROSS PROFIT - Operating expenses 50 000 (23 700) = Finance cost OPERATING PROFIT 26 300 + Investment income 750 + Gain with disposal of PPE 500 22 550 + 5 000 - Finance costs (5 000) (2 500 + 630 + 1 200 + 670) = 5 000 PROFIT BEFORE TAX 22 550 - Income tax expense (28%) (6 314) PROFIT AFTER TAX 16 236 5,51 - Preference dividends (540) = times ATTRIBUTABLE EARNINGS 15 696 - Ordinary dividends declared (12 196) - Transfer to general reserve - RETAINED EARNINGS 3 500 Economic and Management Sciences | EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en Bestuurswetenskappe  STATEMENT OF PROFIT OR LOSS 20x5 REVENUE 125 000 - Cost of sales (75 000) Earnings per share: GROSS PROFIT - Operating expenses 50 000 (23 700) OPERATING PROFIT 26 300 + Investment income 750 Attributable earnings + Gain with disposal of PPE 500 ¿ - Finance costs (5 000) Average number of ordinary shares issued (2 500 + 630 + 1 200 + 670) PROFIT BEFORE TAX 22 550 - Income tax expense (28%) (6 314) 15 696 PROFIT AFTER TAX 16 236 - Preference dividends (540) 0,5(35 000 + 27 000) ATTRIBUTABLE EARNINGS 15 696 = - Ordinary dividends declared (12 196) - Transfer to general reserve - 50,63 RETAINED EARNINGS 3 500 c EQUITY AND LIABILITIES Ordinary share capital (20X5: 35 000; 20x5 20x4 80 000 56 500 20X4: 27 000) General reserve - - Retained earnings 9 000 5 500 Ordinary shareholders’ equity 89 000 62 000 Preference share capital (9%) 6 000 10 000 Shareholders’ equity 95 000 72 000 EQUITY 95 000 72 Economic and Management Sciences | EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en Bestuurswetenskappe Price-earnings ratio: Market price per share Price−earnings ratio= Earnings per share 800 = 50,63 15,80 = none Economic and Management Sciences | EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en Bestuurswetenskappe  FINANCIAL RATIOS ANSWERS Class exercise: Olympics Ltd. Economic and Management Sciences | EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en Bestuurswetenskappe Self study exercises with voice notes on SUNLearn Additional exercises document: Cash vs credit – Problem 1 – See additional slides with voice notes Santova Ltd.: Financial statements and ratios – See slides with voice notes Economic and Management Sciences | EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en Bestuurswetenskappe  PART 3: Corporate actions Decisions made by management that have effect on securities issued Mandatory corporate actions Participation of shareholders is mandatory E.g., dividends, capitalisation (bonus) issues, subdivisions (stock splits) and mergers Voluntary (elective) corporate actions Shareholders elect to participate E.g., rights issues and share buy-backs Economic and Management Sciences | EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en Bestuurswetenskappe  Corporate actions: Dividends Portion of profit after payment of tax, subdivided amongst shareholders Retained earnings Preference and ordinary shareholders Interim (after 6 months) + Final dividend = Total dividend for the year Economic and Management Sciences | EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en Bestuurswetenskappe Timeline of dividends (JSE settlement cycle = T + 3) Announcement/Declaration At least 13 business days before the record date Cum-dividend Buy shares cum-dividend: including right to dividends Ex-dividend One business day after end of cum-dividend until payment date Can buy shares but is not entitled to dividends Record date Company closes share register; always on a Friday for mandatory corporate actions Payment date Economic and Management Sciences | EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en Bestuurswetenskappe  Timeline of dividends Last day of cum trading Start of ex trading Announcement Date Payment Date No Dematerialisation 3 business days Monday Tuesday Wednesday Friday Monday 2 Jan 28 March 29 March 31 March 3 April