Companies' annual reports contain a profit and loss account. This is a financial statement which shows the difference between the revenues and expenses of a period. Nonprofit (or not-for-profit) organizations such as charities, public universities and museums generally produce an income and expenditure account. If they have more income than expenditure this is called a surplus rather than a profit.
At the top of these statements is total sales revenue or turnover: the total amount of money received during a specific period. Next is the cost of sales, also known as cost of goods sold (COGS): the costs associated with making the products that have been sold, such as raw materials, labour, and factory expenses. The difference between the sales
revenue and the cost of sales is gross profit. There are many other costs or expenses that have to be deducted from gross profit, such as rent, electricity and office salaries. These are often grouped together as selling, general and administrative expenses (SG&A).
The statement also usually shows EBITDA (earnings before interest, tax, depreciation and amortization) and EBIT (earnings before interest and tax). The first figure is more objective because depreciation and amortization expenses can vary depending on which system a company uses.
After all the expenses and deductions is the net profit, often called the bottom line. This profit can be distributed as dividends (unless the company has to cover past losses), or transferred to reserves.
BrE: net profit; AmE: net income BrE: profit and loss account; AmE: income statement
The cash flow statement
British and American companies also produce a cash flow statement. This gives details of cash flows - money coming into and leaving the business, relating to:
■ operations - day-to-day activities
■ investing - buying or selling property, plant and equipment
■ financing - issuing or repaying debt, or issuing shares.
The cash flow statement shows how effectively a company generates and manages cash. Other names are sometimes used for it, including funds flow statement and source and application of funds statement.
Annual Profit and Loss Account, 1/20
(£'000) 48,782 33,496 15,286
5,257 1,368 3,889 257 1,064 2,568
Sales Revenue Cost of Sales Gross Profit Selling, General and Administrative Expenses Earnings before Interest, Tax, Depreciation and Amortization Depreciation and Amortization Earnings before Interest and Tax Interest expenses Income Tax Net Profit
British companies also have to produce a statement of total recognized gains and losses (STRGL), showing any gains and losses that are not included in the profit and loss account, such as the revaluation of fixed assets.
14.1 Which figure in each of the following pairs is higher for a profitable company? Look at A opposite to help you.
1 cost of sales / sales revenue 4 net profit / pre-tax income
2 gross profit / net profit 5 income tax / net profit
3 EBIT / EBITDA
14.2 Complete the text with words from the box. You will need to use each word more than once. Look at B opposite to help you.
financing investing operations
(1).................................... means making money by selling goods and services. (2).................................
is spending cash, for the businesses future growth, including cash acquired by selling
assets. (3).................................... involves raising money by issuing stocks and bonds (and also
paying dividends and interest and repaying bonds). It is better for the company if it can pay for future growth out of money from (4)................................................................................. , without having to use
(5 )....................... So a 'healthy' cash flow means that the amount of cash provided by
(6 )..................... is greater than the cash used for (7)...............................................................
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Look at cash flow statements in company annual reports, and at the share prices of those companies over the past years. What happened to the share price of companies that generated more cash than they spent, and what happened to those that spent more than they generated?
14-3 Would the following appear as operating, financing or investing activities on a cash flow statement? Look at the example below to help you.
Changes in operating assets and liabilities
Payments to repurchase stock
Sale of property
Purchase of plant and equipment
Depreciation and amortization expenses
Income taxes payable
Issuance of stock
Repayment of debt
Godwin-Malone Ine, New York
Cash flow statement ($ 000)
Other adjustments to Earnings
Net cash provided from operations
Proceeds from issuing new stock
Stock dividends paid
Net cash provided from financing
Additions to property, plant and equipment
Net cash used for investing
Change in cash and equivalents during year
Cash and equivalents, beginning of year Cash and equivalents, end of year
Financial ratios 1
Types of financial ratio
Financial ratios express the relationships between two or more items on financial statements. They allow investors and creditors to compare a company's present situation and performance with its past performance, and with other companies. Ratios measure:
■liquidity: how easily a company can turn some of its assets into cash
■solvency: whether a company has enough cash to pay short-term debts, or whether it could go bankrupt - have its assets sold to repay creditors
■efficiency: how well a company uses its resources.
Liquidity and solvency ratios
current assets This is the current ratio, which is a calculation of current assets
current liabilities divided by current liabilities. It measures liquidity and shows how
much of a company's assets will have to be converted into cash in the next year to pay debts. The higher the ratio, the more chance creditors have of being paid. For example, if MacKenzie Inc (see Units 12-13) has current assets of $23,244,000 and current liabilities of $15,197,000, its current ratio is 1.53, which is acceptable. It is often argued that the current ratio of a healthy company should be closer to 2.0 than 1.0, meaning that it has nearly twice as many assets as liabilities.
Suppliers granting short-term credit to a company prefer the current ratio to be high because this reduces their risk. Yet shareholders usually prefer it to be low, because this means that the company has invested its assets for the future.
liquid assets This is the quick ratio or acid test, which is a calculation of liquid
current liabilities assets divided by current liabilities. It measures short-term solvency.
Liquid assets are current assets minus stocks or inventory, as these might be difficult to sell. MacKenzie Inc's quick ratio is 1.15.
Earnings and dividends
Shareholders are interested in ratios relating to a company's share price, earnings, and dividend payments.
total earnings for the year This is earnings per share (EPS). It tells investors how
the number of ordinary shares much of the company's Profit bdon8srt0 each If
a company makes a post-tax profit of ˆ1.5 million,
and it has issued 2 million shares, EPS = ˆ0.75.
the market price of an ordinary share This is the price/earnings ratio or P/E ratio. It
t|le past ye ar's EPS shows how expensive the share is. If a company
has EPS of ˆ0.75 and the share is selling for ˆ9.00, the P/E ratio is 12 (ˆ9 per share divided by ˆ0.75 earnings per share = 12 P/E.) A high P/E ratio shows that investors are prepared to pay a high multiple of the earnings for a share, because they expect it to do well in the future.
ordinary share dividend This is dividend cover or times dividend covered, which
net profjt shows how many times the company's total annual dividends
could have been paid out of its available annual earnings. If a company has EPS of 75 cents and it pays out a dividend of 30 cents, the dividend cover is 75 / 30 = 2.5. A high dividend cover shows that the company has a lot of money, but that it is not being very generous to its shareholders. A ratio of 2.0 or higher is generally considered safe (it means that the company can easily afford the dividend), but anything below 1.5 is risky. A low dividend cover - below 1.0 - means the company is paying out retained surpluses from previous years.
15.1 Find words in A opposite with the following meanings.
1 the ability to sell an asset for cash
2 how well a business uses its assets
3 the relationship between two figures
4 how easily a business can pay bills or debts when they are due
15.2 Make word combinations using a word from each box. One word can be used twice. Then use the word combinations to complete the sentences below. Look at B and C opposite to help you.
assets cover ratio test
1 ........................................ consist of cash and things that can be easily sold and converted
2 A high.......................................... shows that the company is retaining a lot of money belonging
to its shareholders.
3 The.......................................... or doesn't count stock or inventory
because this might be difficult or impossible to turn into cash.
4 The.......................................... shows a company's ability to pay its short-term debts.
1 5.3 Match the two parts of the sentences. Look at B and C opposite to help you.
1 If a company pays out retained surpluses from past years
2 Some investors are worried that the new stock issue
3 A high current ratio indicates short-term financial strength but
4 Wall Street is on a historic price-earnings ratio of around 35, which
a it does not measure how efficiently the company is utilizing its resources, b its dividend cover will fall below 1.0.
from the profit and loss account?
c makes the market very expensive, as the long-term average is 14.45. d will dilute the company's earnings per share.
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Look at a company's financial statements. Which of the financial ratios mentioned in this unit can be calculated: