Earnings Per Share:
It is the amount that a shareholder get for every shares on the profit available to the equity shareholders on a per share basis.
It is calculated by dividing the profits available to the equity shareholders by the number of outstanding shares.
EPS is most widely used in estimation of firm’s value and performance.
EPS is a measure of profitability of a firm.
It helps to compare with past performance, comparison with other firms and comparing with the industry average.
Return on Ordinary Shareholders’ Equity (Net worth):
It measures the return on the total equity funds of ordinary shareholders.
Preference shareholders are also the owners of firm, but equity shareholders are real owners who bears all risk, participate in management and are entitled to all the profits remaining after all outside claims including preference dividends are met in full.
It is calculated by dividing the profits after taxes and preference dividend by the average equity of the ordinary shareholders.
It helps to judge the firm has earned
a satisfactory return for its equity-holders or not.
It helps to compare with past results, inter-firm comparison, comparison with the overall industry average.
Return on Total Shareholders’ Equity:
It is measured by dividing the net profits after taxes(but before preference dividend) by the average total shareholders’ equity.
Shareholders’ equity includes here as follows:
(i) Preference share capital,
(ii) Ordinary shareholders equity consisting of
(a) Equity share capital,
(b) Share premium, and
(c) Reserves and surplus less accumulated losses.
It helps to compare the relative performance and strength of the firm to other firms.
Return on Shareholders’ Equity:
The relationship between return and the shareholders’ equity or owners’ funds.
It measures the return on the owners investment in the firm.
The shareholders of a firm fall into 2 categories:
Preference Shareholders,
Equity shareholders.
Preference shareholders will give preference right over dividends first than to the equity shareholders.
Return on shareholders’ equity classified into:
(1) Rate of return on
(i) Total shareholders’ equity,
(ii) Equity of ordinary shareholders.
(3) Dividends per share,
(5) Dividends and Earnings yield,
(6) Price-earnings ratio,
(8) Book value per share,
(9) Price-to-book value per share.
Return on capital employed:
ROCE is the second type of ROI. It is the relationship between the profits and capital employed.
The term capital employed refers to long-term funds supplied by the lenders and owners of the firm.
There are 2 ways. First, non-current liabilities(long-term liabilities) plus owners’ equity.
Alternatively, its equivalent to net working capital plus fixed assets.
Second, it is equal to long-term funds minus investments made outside firm.
It is to estimate how efficient the long-term funds have been used?
If the ratio is higher, the more efficient is the use of capital employed.
Return on assets:
Profitability ratio is measured in terms of the relationship between n
et profits and assets.
ROA can be called as profit-to-asset ratio.
Profit and assets defined in different approaches on the bas
is of purpose and intent of the calculation of ratio.
Net profit may be defined as,
(i) Net profit after taxes,
(ii) Net profit after taxes plus interest,
(iii) Net profit after taxes plus interest minus tax savi
ngs.
Assets may be defined as,
(i) Total assets,
(ii) Fixed assets,
(iii) Tangible assets.
Profitability Ratios Related to Investments:
Return on Investments(ROI):
It is computed by relating the profits of a firm to its investments. Such ratios are popularly termed as ROI. There are three different concepts of investments for computation:
Assets,
Capital employed,
Shareholders’ equity,
They are
(2) Return on capital employed,
(3) Return on shareholders’ equity.
Material Cost Variance.
It represents the difference between actual cost of material used and standard cost of material specified for output achieved. Material cost variance arises due to variation in prices and usage of materials. Difference b
etween (actual quantity of materials used x actual rate) and (standard quantity of material required for the specified output x standard rate) will be material cost variance.
Material Price Variance.
It is the difference occurred between actual price paid and standard price specified for the material which leads to material cost variance. It is not controllable but it gives information for the purpose of planning and decision-making. It helps in making decision to increase the price of product, use of substitute materials.
Material Usage or Volume variance.
It is also called quantity variance. It is part of cost variance occurred due to difference between actual quantity used and standard quantity specified for output.
It helps to identify whether the materials are used in proper manner. A debit balance of material usage variance indicates that material used was in excess of standard requirements. Credit balance shows will show savings in the use of material.
Material usage variance consists of (a) Material mix variance, (b) Material yield variance.
Material Mix Variance.
The variance is that part of material usage variance which is due to difference between actual composition of mix and standard composition of mixing the different types of materials. Short supply is the most common reason for this variance.
Material Yield Variance.
In certain cases, output depends on input of material. In this circumstances, if 10% of input material in course of normal loss of production. Then, 90% of total input of material will be expected output. If actual yield obtained happens to be different from the standard yield specified, there will be a yield variance. Thus material yield variance is that portion of material usage variance, which due to difference between actual yield obtained and standard yield specified.
Expenses ratio:
It is calculated by dividing expenses by sales.
“Expenses” includes:
(1) Cost of goods sold,
(2) Administrative expenses,
(3) Selling and distribution expenses,
(4) Financial expenses but doesn’t include taxes, dividends and extra-ordinary losses due to theft of goods, goods destroyed by fire etc.,
Profit margin:
It measures the relationship between profit and sales. As the profits may be gross or net, there are two types of profit margins:
Gross profit margin:
It is also known as gross margin. It is calculated by dividing gross profit by sales.
Net profit margin:
It is also known as net margin. This measures the relationship between net profits and sales of a firm.
Depending on the concept of net profit employed, this ratio can be computed in 3 ways:
Classification and computation of variances.
Variances can be classified under the following headings :
(i) Cost variance,
(ii) Sales margin variance,
(iii) Sales value variance,
Cost variance
It represents the difference between the costs actually incurred for production and the costs specified for the same. It is the sum total of following variances:
(a) Direct material cost variance.
(b) Direct wage variance.
(c) Variable overhead variance.
(d) Fixed overhead variance.
Limitations:
Standard costing is a very good system, but it should be used giving regard to following limitations:
Uses:
- Establishing budgets.
- Controlling costs and motivating and measuring efficiencies.
- Promoting possible cost reduction.
- Simplifying cost procedures and expediting cost reports.
- Assigning cost to materials, WIP and finished goods inventories.
- Forms basis for establishing bids and contracts and for setting selling prices.
Favorable and unfavorable variances(Standard costing):
Variances may be favorable [ Positive or Credit ] or unfavorable [ Negative or Adverse or Debit ] depending upon whether the actual resulting cost is less or more than the standard cost.
Favorable variance:
When the actual cost incurred is less than the standard cost, the deviation is known as favorable variance. The effect of the favorable variance increase the profit.
Unfavorable variance:
When the actual cost is incurred is more than the standard cost, there is variance is known unfavorable or adverse variance. Unfavorable variance refers to deviation to the loss of business.
Definition of standard costing:
(1) CIMA (
(2) According to Prof. Eric L. Kohler, “Standard is a desires attainable objective, a performance, a goal, a model”. Standard may be used to a pre-determined rate or a pre-determined cost or a pre-determined amount.
(3) According to ICMA technology defines “standard costing is the preparation and use of standard costs, their comparison with actual costs and analysis of variances to their causes and points of incidence”.
Standard Costing:
One of the most important functions of management accounting is to facilitate managerial control.
The major aspects of managerial control is cost control. The efficiency of management among other things depends upon the effective control of costs. For controlling costs, management should not only know actual cost.
The actual cost actually incurred but also pre-determined costs, the cost which should have been incurred. Standard costs are the widely used form of pre-determined costs.
The system of standard costing is the most efficient way of controlling costs.
It is a managerial device to determine efficiency and effectiveness of cost performance.
STANDARD: It is pre-determined measurable quantity set in defined conditions.
It seeks to establish the cost of a product, operations or process under standard operating conditions. The aim of standard cost is to eliminate the influence of abnormal changes in prices. It is used as a guide for future decision and action over a period of time.
Standard costing is effective tool for planning, decision making, co-ordination and control of business. The object of determination of price policy. It is a technique of cost control.
It is a scientifically pre-determined cost, which is arrived at assuming a particular level of efficiency in utilization of material, labour and indirect services.
CIMA defines standard cost as “a standard expressed in money. It is built up from an assessment of the value of cost elements. Its main uses are providing bases for performance measurement, control by exception reporting, stock valuation and establishing selling prices”.
Profitability ratio:
Owners invest funds in order to expect reasonable returns. The operating efficiency depends upon the profits earned out of investment made by shareholders/owners.
It helps to identify the requirements of management:
1) Is the profits earned are adequate?
2) What rate of return does it represent?
3) What is the rate of profit for different divisions and segments of the firm?
4) What are the earnings per share?
5) What was the amount paid in dividends?
6) What is the rate of return to equity-holders?
Profitability ratios can be determined on the basis of either sales or investments.
The profitability ratios in relation to sales are
(a) Profit margin(gross and net),
(b) Expenses ratio.
The profitability ratios in relation to investment are
(a) Return of assets,
(b) Return on capital employed,
(c) Return on shareholders’ equity.
Calculation:
o Debt services coverage ratio.
Ability of firm to make contractual payments required on a scheduled basis over the life of debt.
o Cash flow coverage ratio.
Firms ability to meet its various financial obligations to its earnings.
These payments are met out of cash available with the firm.
So its appropriate to relate cash with various financial obligations of firm.
o Total fixed charges coverage ratio.
While the interest coverage and preference dividend coverage ratios consider the Fixed obligations of a firm to the respective suppliers of funds, that is, creditors and preference shareholders, the total coverage ratio has a wider scope and takes into account all the committed fixed obligations of a firm, that is, (i) interest on loan; (ii) preference dividend, (iii) lease payments; (iv) repayment of principal.
o Dividend coverage ratio.
Measures about the ability of the firm to pay dividend on preference shares which carry a stated rate of return. Ratio is based on earnings after taxes and the amount of preference dividend.
o Interest coverage ratio.
Ratio measures the debt servicing capacity of a firm insofar as fixed interest on long-term loan is concerned. It can be calculated on the basis of the dividing the operating profits or earnings before interest and taxes(EBIT) by the fixed interest charges on loans.
Turnover ratios:
It is the ratio of getting cash out of converting current assets quickly.
Classified into different types.
They are as follows:
§ Inventory turnover ratio
Calculation:
Calculation:
§ Creditors turnover ratio
It is the ratio between quick current assets and current liabilities
Calculation:
Quick Assets are current assets which can be converted into cash or at short notice without decrease in value. Quick Assets which excludes prepaid expenses and inventory from current assets.
Calculation:
Calculation:
o Debt-Equity ratio.
This is the ratio of the total outside liabilities to owners’ total funds
In other words, it is the ratio of the amount invested by the outsiders to the amount invested by the owners of the business
Leverage/Capital Structure Ratios:
v Long term creditors/lenders to verify the ability of the firm to pay interest and instalment of the principal on due dates and lump sum at the time of maturity.
v Long-term solvency of a firm can be measured by using leverage or capital structure ratios.
v Types of Leverage Ratios are as follows:
ü The First type of capital Structure rat
is as follows:
ü The Second type of capital structure ratio’s are as follows:
o Total fixed charges coverage ratio.
o Debt services coverage ratio.
Direct Method Cash Flow Statement
Cash flow From Operating Activities
Cash receipts from customers
Cash paid to suppliers and employees
Cash generated from operations
Income tax
Cash flow before extraordinary items
Proceeds from earthquake disaster settlement
Net cash from operating activities
Cash flow from Investing Activities
Purchase of fixed assets
Proceeds from sale of operations
Interest received
Dividends received
Net cash from investing activities
Cash flow from Financing Activities
Proceeds from issuance of share capital
Proceeds from long-term borrowings
Repayments of long-term borrowings
Interest paid
Dividends paid
Net cash used in financing activities
Net increase in Cash and Cash-equivalents*
Cash and cash-equivalents at the beginning of a period
Cash and cash-equivalents at the end of a period
