Managing Finance

and Operations

Long Term Finance

Gearing Analysis
Tim Price
Sources and Uses of Capital
 Sources of capital
Owners’
Profits
Equity Investment

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“Retained Profit”
“Share Capital”
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Borrowings Pay later

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Ex

Debt
“Loans” “Payables”
Sources and Uses of Capital
 Sources of capital
Owners’
Profits
Equity Investment
“Retained Profit”
“Share Capital”

Borrowings Pay later

Debt
“Loans” “Payables”
Types of Long Term Finance
 Equity
 Investment in the company to share in
potential future growth and income
 Debt
 A liability
to repay a fixed amount at a certain
future date plus periodic interest
 Hybrids
 Financial instruments sharing characteristics
of debt and equity
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Types of Long Term Finance
The concept of leverage/gearing
 Buy a house for £100,000
 Borrow £90,000, invest £10,000
 House price increases to £115,000
 Pay £5,000 interest to bank
 Return to equity provider (owner) – 100%

 Return to bank – 5.5%

 House price falls to £90,000

 Total loss of equity…

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Types of Long Term Finance
Equity
 Ordinary shares
 Limited rights and highest risk
 Voting
 Equal treatment eg non-dilution

 Rank behind all other finance providers

 No guarantee of dividend or future value

 …but highest potential return

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Types of Long Term Finance
Equity
 Shares have a nominal value
 Usually between 1p and £1
 Shares have a market value
 Quoted on a public exchange
 Agreed by private sale

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Types of Long Term Finance
Equity
 New shares are issued (sold) to investors
 at a premium to the nominal price
 related to the market price
 Market and nominal price are not related
 The difference is recorded in the Share
Premium Account

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Types of Long Term Finance
Debt
 Private Debt
 Bank facilities and overdrafts
 Leasing, factoring
 Shareholder loans
 Public Debt
 Bonds/High yield/Commercial paper
 Traded on exchanges like shares
 Multiple lenders
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Types of Long Term Finance
Hybrids
 Convertibles
 A bond paying a coupon with a right to
convert into shares at pre-set price
 Preference shares
 Rank above ordinary shares, below debt
 Pay fixed dividend at company’s option
 May be convertible
 May have voting rights

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Ratio Analysis
5 main groups of analysis
 Profitability
 Efficiency
 Liquidity
 Gearing
 Investment
Ratio Analysis - Liquidity
Current ratio
 Ability
to convert assets into cash quickly
 Use with care….
 Unsuitable for some businesses
 What actually happens if there is a problem?
Ratio Analysis - Liquidity
Current Ratio

Current Assets
Current Ratio = ---------------------
Current Liabilities
Ratio Analysis – Financial Gearing
 Gearing ratio
 Debt relative to total long term capital

 Interest cover ratio

 Ability to meet interest due
Ratio Analysis – Financial Gearing
 Gearing

Non Current Liabilities

Gearing = ---------------------
Shareholders Funds
+ Non Current Liabilities
Ratio Analysis – Financial Gearing
Interest Cover

Operating Profit
Interest Cover = ---------------------
Finance Expense
Ratio Analysis - Investment Ratios
 Dividend Payout Ratio
 Proportion of earnings paid to shareholders

 Earnings per share (Eps)

 Key measure of performance over time
 Reflects return on equity investment

 Price/earnings ratio (P/E)

 Measure of market view of future performance