200910 Chapter 7: financing -week 7 - Google Docs
![](https://new-preview-html.oneclass.com/L7W93pro8dXxmoloMGg2j1VKzkbBJv2e/bg1.png)
Week7)EnterpriseGearing,CostofCapitalandProfitabiity:ratioand
trendanalysis
Financialgearing/Leverage:
occurswhenabusiness
occurswhenabusinessisfinancedatleastinpart,bycontributionsfrom
fixedchargecapitalsuchasloans,debentures,leasecontractsand
preferenceshares.
levelofgearingimportantfactorsinassessingbusinesslevelsofrisks
andreturnstoordinaryshareholder.
Gearingincreasesearningperssharewhenreturnonassetsexccedsthe
aftertaxcostofdebt
higherlevelofprofitperyearearningpershareincreases
interestpaymentsattracttaxreliefmakesborrowingcheaper
highlevelsofgearinghighlevelofcommitmenttomakecashinterest
payment.
significantdefaultandforcedliquidationrisk.
longtermhighdebtincreaseincostofdebtandequity
averagecostofdebt/equityWeightedaveragecostcapital(WACC)
WACCHigherwacc,lowervalueoffirm(negdailyoperation)
suitablefinancialgearingpolicybalancesbenefitfromtaxreliefandgoing
bust.
tradeofftheory.
optimalcapitalstructurepointwhereaveragecostofcapitaliskeptat
minimum.
higherOPlowerearningspershareamountofearningspersharewasn’t
sufficientenoughtoabsorbreductionintaxincome.
![](https://new-preview-html.oneclass.com/L7W93pro8dXxmoloMGg2j1VKzkbBJv2e/bg2.png)
Financialstatementanalysis
a)Internalfinancialanalysisevaluateperformanceofemployeesto
determinepayrisesandbonuses
comparetheperformanceofdifferentdivisions
preparefinancialprojections(e.glaunchofnewproducts)evaluate
firmsperformancecomparedtocompetitors+howtoimproveown
operations
Externalfinancialanalysis
banksandotherlendersdecidingtolendmoney
suppliersdecidingtograntcredit
creditratingagenciesdeterminingcreditworthiness
proffessionalanalystswhoworkforinvestmentcompaniesdecidingto
investincompany
individualinvestorswhodecidetoinvestincompanies
Commonsizefinancialstatementstandardisedfinancialstatementinwhich
allentriesarepresentedinpercentages
ithelpscompareafirmfinancialstatementwiththoseofotherfirms,evenif
firmsarenotofequalinsiz.
Howtoprepareacommonsizefinancialstatements
a)commonsizeincomestatementdivideeachentryentryinthestatement
bysales(100%)
commonsizeincomestatementsfirmscandeterminehowvarious
expensesasapercentageoftotalsaleschangedfromperiodtoperiod
![](https://new-preview-html.oneclass.com/L7W93pro8dXxmoloMGg2j1VKzkbBJv2e/bg3.png)
b)commonsizebalancesheetdivideeachentrybalancesheetbytotal
assets(100%)
helpusdeterminehowmuchourcompanykeepsfromeverydollarofsales
Liquidityandcapitalstructureratios
Financialratiossecondmethodforstandardisingfinancialinfoonthe
incomestatementandbalancesheet
ratioitselfmayhavenomeaning
givenratiocomparedto:
a)ratiosfrompreviousyears
b)ratiosofotherfirmsinthesameindustry
TypesoffinancialratiosLPACM
Liquidityratios:CQAI
Liquidityratios:Currentratio
Currentratio:CurrentAssets/Liabilities
currentassetsdon’tearnanyrateofreturnusuallylongtermdoeshasto
maketradeoff
e.g)2.33Thefirmhad2.33assetsforevery$1itowedincurrentliabilities
ratiolessthanonecompanynormallyhasliquidityissues
morethanone–financialhealthy
b)Liquidityratio:Quickratio
excludesinventoryfromcurrentassetsasitmaynotbeliquid.
Quickratio/Acidtest:CurrentAssetsinventory/Currentliabilitiese.g)quick
ratio0.92
Thefirmonlyhas$0.92incurrentassets(lessinventory)tocover$1in
currentliabilities