Case
Final Accounts - Assignment 1, Task 3 - Shareholders ratios - DISTINCTION
- Institution
- PEARSON (PEARSON)
Case of 9 pages for the course Unit 11 - Final Accounts for Public Limited Companies at PEARSON (D)
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Task 3: Shareholder ratiosIntroduction
This report will contain information about the main purposes of shareholders ratios and the
calculation of the shareholder ratios for company A and B. Also, a discussion about the
merits and limitations of ratio analysis, as well as a ratio analysis for company A and B will
be included in this report. Additionally, the financial position of the limited company for
potential and current shareholders will be evaluated using shareholder ratio analysis.
The main purposes of shareholder ratios
The main purpose of shareholder ratios is that show how the shares are performing in a
certain company, offering important information especially for potential investors, but also
for firm, customers, competitors etc. Based on this information, the potential shareholders
will decide if the shares of a company are expensive or not, as well as if they are worth to be
bought by them. Also, the shareholders will know if the dividends are suitable and stable.
Owning shares in a company can bring advantages such as: dividends; obtaining profit from
the sale of sales whose price has risen; certain perks for shareholders (e.g. discounts).
Other purpose of the shareholder ratios is that the company can compare the performance,
liquidity, efficiency of the company between different accounting periods, allowing the
business to identify potential problems, as well as ways to improve the company’s
performance and financial position. Additionally, the shareholder ratios allow the comparison
between a company and its competitors, this aspect being crucial for potential shareholders
that need to decide the shares whose companies are worth buying.
There are six shareholder ratios that are used by Public Limited Companies:
Dividend per share ratio – The companies take the decision on the amount of profit
they will retain and the amount they will give to shareholders as dividends. If the
company decides to retain more profit, they wants to reinvest in the business,
contributing to its expansion and gaining more customers, market share etc. Instead, if
the company offers more dividends, it will attract more shareholders and consequently
more capital available in the business.
Dividend yield ratio (%) – It indicates the amount of dividends paid by the company
each year, in relation to the stock price. It is essential for investors / potential
shareholders to know that a high dividend yield ratio does not always mean that the
investment is profitable because the dividend yield ratio can increase because of a
decrease in the stock price. A high dividend yield ration may indicates that the
company pays more dividends and does not reinvest too much, slowing down the
company’s growth, this case being more common for mature companies.
Earnings per share ratio shows the profitability of the company in present and in the
future, the current and potential shareholders being able to predict their earnings. A
high earnings per share ratio attracts more shareholders, because the company has a
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, good financial performance, existing more profit that will be distributed to the
shareholders. It helps to identify strong investments, considering the value of the
share price and shows how fast the growth of the company is. However, the earnings
per share ratio does not take into consideration the current stock price (a high price
can make the investment to be not very good).
Price earnings ratio is a measure of the market price for a share in comparation with
the its earnings. If this ratio is high, the potential investors and shareholders are
expecting at a high growth level for the company. A low price earning ratio may show
either that the company is undervalued in present or that the business is performing
well relative to the past trends. Price earnings ratio is difficult to be calculated for the
businesses that are not profitable.
Dividend Coverage Ratio shows how many times a company is able to distribute
dividends to its shareholders from its profit in an accounting period. A dividend
Coverage Ratio that is higher than 1 indicates that the business is able to pay
dividends to their shareholders, but a good value of Dividend Coverage Ratio is above
2. A company with a constant Dividend Coverage Ratio that is below 1.5 represent a
potential risk for its shareholders, because the profitability of the company is constant
low and there is the possibility not to be able to pay dividends in the future.
Gearing ratio (%) shows the measure to which the company is financed by
debt/long-term liabilities. Gearing ratio indicates the liquidity of the company; the
stability for a long term of the company, as well as how much the company’s
dependency on borrowed money for a long term is. A company with a high gearing
ratio (above 50%) may use loans in order to be cover its operational costs, but the risk
of financial issues (even bankruptcy) is high if the economic situation is not stable or
the interest rates increase too much. Instead, a company with a low gearing ration
(below 25%) attracts more shareholders that bring money and increase the company’s
capital.
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