Accounting 3: profit and loss account

What do profits and loses show?

the gains and losses from both normal and abnormal operation over a period (between the opening and closing balance sheets of an accounting period)

What is operating profit formula?

total revenue - total costs

What are the 6 purposes of the profit and loss account?

• transparency

• understand where impacts are

• comparison

• strength the business

• manage risks

• develop a knowledgeable decision-making process

What are revenues?

total value of goods sold before expenses. Companies typically can grow no faster than their revenues.

What are operating costs?

expenses for a company’s activities including overhead costs.

What are overhead costs?

all expenses not directly related to the product

What is EBITDA?

Earnings before Interest, Taxes, Depreciations and Amortizations. Represent the cash generated by normal trading activities (usually not distorted)

What is depreciation?

how much of an asset’s value has beed used up (loss in value per year)

What is amortization?

depreciations for intangible assets

How is the net book value of something calculated?

Cost - depreciation

What is EBIT and what is the formula?

Earnings before interest and taxes

Represents a company’s operating profit (after subtracting operating expenses) but before interest and taxes

Revenue - operating expenses = how profitable core operations are

What is interest?

Cost to borrow from financers (not shareholders)

What does the EBIT generate?

resources to pay interests, taxes, etc.

What is net interest equal to?

interest income - interest expenses

What is EBT?

Pre-tax income. Some techniques to minimize taxes affect this reported income.

What are taxes?

what a company owes based on taxable income.

How are company’s prepared for taxes?

They usually have an account to cover what it expects to pay

What is net income and what is its formula?

general wealth

revenue - total expenses (revenue is the top and net income is the bottom line)

What are dividends?

The part of earnings that shareholders get

What are retained earnings?

The percentage of net income not paid as dividends but retained to invest. This is especially important to high-growth firms.

What are the stakeholders for revenues?

clients

What are the stakeholders for operating costs?

employees, suppliers, etc.

What are the stakeholders for interests?

banks and debt-holders

What are the stakeholders for taxes?

state

What are the stakeholders for dividends?

shareholders

What are the 5 important ratios for market investors?

• Dividend per share

• Earning per share (EPS)

• Price to earnings ratio (P/E)

• Market to book ratio (MtB)

• Payout ratio

What is the Earning per share (EPS) and what is its formula?

Shows the profit that shareholders get for each share.

Net income (ETA) / number of stocks

How should we analyze Earning per share (EPS?

It is not comparable between firms since different firms have different stock quantities, so it is better to look at changes over time (profitability growth)

What is the Price to earnings ratio (P/E) and what is its formula?

the numbers of years of earning to pay back purchasing price

share price / eanrings per share

What is Price to earnings ratio (P/E) based on?

investor opinion about the potential growth in profits (comparable between firms)

What does the value of Price to earnings ratio (P/E) say?

A high value says investors are paying more for each share and expect high earning, so the market loves the company

What is the Market to book ratio (MtB) and what is its formula?

compares market value to book value of a company’s equity

market capitalization (total market value of shares) / owner’s funds

What is the dividend per share ratio and what is its formula?

dividend earned by each shareholder

dividends paid / number of stocks

What does the change of dividend per share values represent?

if it increases it signals strong performance

staying constant over years shows that the manage trust in the ability of growing profits

What is the payout ratio and what is its formula?

the fraction of earnings payed to shareholders

dividends paid / net income (ETA)

What is interesting about some companies action on dividends per share and payout ration?

Some firms keep the dividends per share free and fix the payout ratio. This allows dividends to increase or decrease with profits while maintaining a consistent proportion of earnings for reinvestment.