Week 20 - Long-term Solvency 2023_24.pptx

Accounting and Finance

1. Week 20 – Long-term Solvency Donna Kavanagh

2. Lecture Programme 2 Week Lecture Content 17 Stewardship and Users of Accounts 18 Profitability Ratios 19 Liquidity Ratios 20 Long-term Solvency

3. Long-term Solvency - Objectives By the end of this week you should be able to: Understand the importance and advantages of using ratios to evaluate long-term solvency Calculate appropriate ratios for long-term solvency Suggest economic and performance related reasons for changes in ratios. Long-term Solvency 3

4. Importance of Long-term Solvency High debt = lenders unlikely to advance further funds High debt is especially risky for low profit companies. Potential liquidation of the company? Long-term Solvency 4

5. Debt Ratio (%) Measures the amount of debt per £ of assets   Long-term Solvency 5

6. Gearing (%) Gearing measured the extent to which a company is financed by debt, compared to equity capital Long-term Solvency 6 For the exam, debt is anything that is interest bearing

7. Gearing (%) x 100 Gearing measures the extent to which a business is financed by debt rather than equity capital   Long-term Solvency 7

8. Gearing There is no optimum gearing ratio for a company Individual shareholders, boards of directors, and finance directors will have a specific ratio in mind based on their knowledge of the business, industry and competitors Long-term Solvency 8

9. Gearing - example Long-term Solvency 9 Company A Company B Operating profit 100,000 100,000 Finance costs (50,000) - Profit before tax 50,000 100,000 Tax (@20%) (10,000) (20,000) Profit for the year 40,000 80,000 Available to distribute to shareholders

10. Gearing Gearing levels vary across companies due to: Management’s and shareholders’ attitudes of risk Level of available cash in the business Expectations of returns from shareholders Nature of the business Long-term Solvency 10

11. Interest Cover Interest cover considers how many times a company can afford to pay its annual interest charge out of its profit before interest and taxation   Long-term Solvency 11

12. Other information It must be stressed that ratio analysis on its own is not sufficient for interpreting company accounts, and that there are other items of information which should be looked at. Long-term Solvency 12

13. Long-term Solvency 13

14. a) Gearing (%) Long-term Solvency 14

15. a) Gearing (%) Long-term Solvency 15 easyJet Plc Barratt Developments Plc Gearing x 100 =56.06% easyJet Plc Barratt Developments Plc Gearing =56.06%

16. a) Gearing (%) Long-term Solvency 16

17. a) Gearing (%) Long-term Solvency 17 easyJet Plc Barratt Developments Plc Gearing x 100 x 100 =56.06% = 3.63% easyJet Plc Barratt Developments Plc Gearing =56.06% = 3.63%

18. b) Interest Cover Long-term Solvency 18

19. b) Interest Cover Long-term Solvency 19 easyJet Plc Barratt Developments Plc Interest cover = - 3.96 times easyJet Plc Barratt Developments Plc Interest cover = - 3.96 times

20. b) Interest Cover Long-term Solvency 20

21. b) Interest Cover Long-term Solvency 21 easyJet Plc Barratt Developments Plc Interest cover = - 3.96 times = 29.01 times easyJet Plc Barratt Developments Plc Interest cover = - 3.96 times = 29.01 times

22. Link to the Exam Ratio questions will come up in section A and section C of the exam In section C, You could be asked to analyse: 2 different companies, or 1 company over 2 years The calculations will only form part of the requirement. Analysis is necessary to maximise marks. Exam standard question during next week’s seminar. Long-term Solvency 22

23. Any Questions??? send me an email Add title here 23