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  Analysing and Interpreting Financial Statements Part II

Analysing and Interpreting Financial Statements Part II

Investment ratios

There are several ratios presented that are designed to assist shareholders assess the returns on their investment.

  • The list widely used ration are as follow:
  • Dividend payout ratio
  • Dividend yield ratio
  • Earnings per share
  • Cash generated from operations per share
  • price/earnings ratio.

Dividend payout ratio

The dividend payout ratio computes the proportion of earnings which a business pays out to shareholders in the form of dividends.

The ratio is expressed as follows:

Dividend payout ratio = (Dividends announced for the year/Earnings for the year available for dividends) x 100

In the matter of ordinary shares, the earnings that are available for dividend will generally be the profit for the year (i.e. the profit after taxation) less any preference dividends relating to the year. This ratio is generally expressed as a percentage.

Dividend cover ratio. Here the calculation is:

Dividend cover ratio = Earnings for the year avialable for dividend/Dividends announced for the year

Dividend yield ratio

The dividend yield ratio describes the cash return from a share to its present market value. This can assist investors to assess the cash return on their investment in the business.

The ratio described as a percentage is as follow:

Dividend yield = [Dividend pr share/(1-t)]/[Market value per share] x 100

Where, t stands for 'dividend tax credit' rate of income tax. This needs some description. In the UK (United Kingdom), investors who receive a dividend from a business as well receive a tax credit. Like this tax credit can be offset against any tax liability taking place from the dividends received, the dividends are efficiently issued net of income tax, at the dividend tax credit rate.

Earnings per share(EPS)

The earnings per share (EPS) ratio describe the earnings produced by the business, and presented to shareholders, throughout a period, to the number of shares in issue. For equity (ordinary) shareholders, the amount that available will be presented through the profit for the year (profit after taxation) less any preference dividend, in which applicable.

The ratio for equity shareholders is expressed as follows:

Earnings per share = Earnings avialable to ordinary shareholders/Number of ordinary shares in issue

Cash generated from operations per share

It can be disputed that, in the short term at least, cash produced from operations (found in the statement of cash flows) gives an improved guide to the ability of a business to pay dividends and to take on planned expenditures than the earnings per share figure.

The cash generated from operations (CGO) per ordinary share ratio is expressed as follows:

Cash generated from operations per share = Casg generated from operations less preferance dividend/Number of ordinary shares in issue

Price/earnings (P/E) ratio

The price/earnings ratio describes the market value of a share to the earnings per share. This ratio can be expressed as follows:

P/E ratio = Market value per share/Earnings per share

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