Introduction 1

Bookkeeping 14

Company law 2 22

Accounting policies and standards 24

Depreciation and amortization 29

Auditing 31

The balance sheet 1 32

The balance sheet 2: assets 35

The balance sheet 3: liabilities 38

The other financial statements 41

Financial ratios 1 43

Financial ratios 2 46

Cost accounting 49

Pricing 52

Personal banking 55

Commercial and retail banking 59

Financial institutions 62

Investment banking 65

Interest rates 73

Money markets 76

Islamic banking 78

Money supply and control 81

Venture capital 83

Stocks and shares 1 87

Stocks, shares and equities 87

Going public 87

Ordinary and preference shares 88

Stocks and shares 2 90

Buying and selling shares 90

New share issues 90

Categories of stocks and shares 91

Shareholders 92

Investors 92

Dividends and capital gains 93

Speculators 93

Share prices 96

Influences on share prices 96

Predicting prices 96

Types of risk 97

Bonds 99

Government and corporate bonds 99

Prices and yields 100

Other types of bonds 100

Futures 102

Commodity futures 102

Financial futures 103

Derivatives 105

Options 105

In-the-money and out-of-the-money 106

Warrants and swaps 106

Asset management 108

Allocating and diversifying assets 108

Types of investor 109

Active and passive investment 109

Hedge funds and structured products 111

Hedge funds 111

Leverage, short-selling and arbitrage 111

Structured products 112

Describing charts and graphs 115

Mergers and takeovers 117

Mergers, takeovers and joint ventures 117

Hostile or friendly? 118

Integration 119

Leveraged buyouts 120

Conglomerates 120

Raiders 121

Financial planning 123

Financing new investments 123

Discounted cash flows 123

Comparing investment returns 124

Financial regulation and 125

Government regulation 125

Internal controls 125

Sarbanes-Qxley 126

International trade 129

Trade 129

Balance of payments 129

Protectionism 130

Exchange rates 133

Why exchange rates change 133

Fixed and floating rates 133

Government intervention 133

Financing international trade 135

Documentary credits 135

Bills of exchange 135

Export documents 136

Incoterms 137

Insurance 141

Insuring against risks 141

Life insurance and saving 142

Insurance companies 142

Expansion and contraction 145

Fiscal policy 145

Monetary policy 145

Taxation 149

Direct taxes 149

Indirect taxes 149

Non-payment of tax 150

Business plans 152

Market opportunities 152

The company, the product and the market 152

The financial analysis 153

Saying and writing numbers 158

Saying amounts of currency 158

Decimals 159

Fractions 159

Ordinals 159

Saying sequences of numbers 160

Numbers as adjectives 160

Answer key 165

Index 200

Acknowledgements 228

Total 14,209

Total liabilities and Shareholders' equity 34,959

Accrued expenses

Because of the matching principle, under which transactions and other events are reported in the periods to which they relate and not when cash is received or paid, balance sheets usually include accrued expenses. These are expenses that have accumulated or built up during the accounting year but will not be paid until the following year, after the date of the balance sheet. So accrued expenses are charged against income - that is, deducted from profits - even though the bills have not yet been received or the cash paid. Accrued expenses could include taxes and utility bills, for example electricity and water.

Shareholders' equity on the balance sheet

Shareholders' equity is recorded on the same part of the balance sheet as liabilities, because it is money belonging to the shareholders and not the company.

Shareholders' equity includes:

• the original share capital (money from stocks or shares issued by the company: see Units 29-30)

• share premium: money made if the company sells shares at above their face value - the value written on them

• retained earnings: profits from previous years that have not been distributed to shareholders

• reserves: funds set aside from share capital and earnings, retained BrE" share premium* for emergencies or other future needs. | AmE: paid-in surplus

1. Are the following statements true or false? Find reasons for your answers in A, B and C opposite.

   1. A current liability will be paid before the date of the balance sheet.

   2. A liability that must be paid in 13 months time is classified as long-term.

   3. A company's accrued expenses are like money an individual saves to pay bills in the future.

   4. Shareholders' equity consists of the money paid for shares, and retained earnings.

   5. If companies retain part of their profits, this money no longer belongs to the owners.

   6. Companies can sell shares at a higher value than the one stated on them.

2. Find words in A, B and C opposite with the following meanings.

   1. money that will be paid in less than 12 months from the balance sheet date

   2. the money that investors have paid to buy newly issued shares, minus the shares' facc value

   3. delayed, put off or postponed until a later time

   4. built up or increased over a period of time

"Oh, that three billion dollars. "

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Look at the last two annual reports and balance sheets of your company or one you would like to work for. What differences do you notice in the balance sheets and what reasons can you find for these?

3. Sort the following into assets and liabilities. Look at A and B opposite to help you. You may need to look at Unit 12.

Accounts payable	Land and buildings
Accrued expenses	Investments
Dividends	Cash and equivalents
Inventory	Deferred taxes
Accounts receivable	Long-term debt

Assets Liabilities

The other financial statements

The profit and loss account

Companies' annual reports contain a profit and loss account. This is a financial statement which shows the difference between the revenues and expenses of a period. Non­profit (or not-for-profit) organizations such as charities, public universities and museums generally produce an income and expenditure account. If they have more income than expenditure this is called a surplus rather than a profit.

At the top of these statements is total sales revenue or turnover: the total amount of money received during a specific period. Next is the cost of sales, also known as cost of goods sold (COGS): the costs associated with making the products that have been sold, such as raw materials, labour, and factory expenses. The difference between the sales

revenue and the cost of sales is gross profit. There are many other costs or expenses that have to be deducted from gross profit, such as rent, electricity and office salaries. These are often grouped together as selling, general and administrative expenses (SG&A).

The statement also usually shows EBITDA (earnings before interest, tax, depreciation and amortization) and EBIT (earnings before interest and tax). The first figure is more objective because depreciation and amortization expenses can vary depending on which system a company uses.

After all the expenses and deductions is the net profit, often called the bottom line. This profit can be distributed as dividends (unless the company has to cover past losses), or transferred to reserves.

BrE: net profit; AmE: net income BrE: profit and loss account; AmE: income statement

The cash flow statement

British and American companies also produce a cash flow statement. This gives details of cash flows - money coming into and leaving the business, relating to:

• operations - day-to-day activities

• investing - buying or selling property, plant and equipment

• financing - issuing or repaying debt, or issuing shares.

The cash flow statement shows how effectively a company generates and manages cash. Other names are sometimes used for it, including funds flow statement and source and application of funds statement.

Searby PLC

Annual Profit and Loss Account, 1/20

(£'000) 48,782 33,496 15,286

10,029

5,257 1,368 3,889 257 1,064 2,568

Sales Revenue Cost of Sales Gross Profit Selling, General and Administrative Expenses Earnings before Interest, Tax, Depreciation and Amortization Depreciation and Amortization Earnings before Interest and Tax Interest expenses Income Tax Net Profit

British companies also have to produce a statement of total recognized gains and losses (STRGL), showing any gains and losses that are not included in the profit and loss account, such as the revaluation of fixed assets.

1. Which figure in each of the following pairs is higher for a profitable company? Look at A opposite to help you.

   1. cost of sales / sales revenue 4 net profit / pre-tax income

   2. gross profit / net profit 5 income tax / net profit

   3. EBIT / EBITDA

2. Complete the text with words from the box. You will need to use each word more than once. Look at B opposite to help you.

financing investing operations

(1) means making money by selling goods and services. (2)

is spending cash, for the businesses future growth, including cash acquired by selling

assets. (3) involves raising money by issuing stocks and bonds (and also

paying dividends and interest and repaying bonds). It is better for the company if it can pay for future growth out of money from (4) , without having to use

5. ) So a 'healthy' cash flow means that the amount of cash provided by

6. ) is greater than the cash used for (7)

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Look at cash flow statements in company annual reports, and at the share prices of those companies over the past years. What happened to the share price of companies that generated more cash than they spent, and what happened to those that spent more than they generated?

14-3 Would the following appear as operating, financing or investing activities on a cash flow statement? Look at the example below to help you.

Changes in operating assets and liabilities	Payments to repurchase stock
Dividends paid	Sale of property
Purchase of plant and equipment	Depreciation and amortization expenses
Net income	Income taxes payable
Issuance of stock	Repayment of debt

Godwin-Malone Ine, New York
Cash flow statement ($ 000)	20	20
Earnings	1,811	1,274
Amortization	924	683
Other adjustments to Earnings	33	-6
Net cash provided from operations	2,768	1,951
Proceeds from issuing new stock	234	167
Stock dividends paid	-14
Net cash provided from financing	220	167
Additions to property, plant and equipment	-2,351	-1,755
Net cash used for investing	-2,351	-1,755
Change in cash and equivalents during year Cash and equivalents, beginning of year Cash and equivalents, end of year	356 2,150 2,506	97 2,014 2,111

Financial ratios 1

Types of financial ratio

Financial ratios express the relationships between two or more items on financial statements. They allow investors and creditors to compare a company's present situation and performance with its past performance, and with other companies. Ratios measure:

• liquidity: how easily a company can turn some of its assets into cash

• solvency: whether a company has enough cash to pay short-term debts, or whether it could go bankrupt - have its assets sold to repay creditors

• efficiency: how well a company uses its resources.

Liquidity and solvency ratios

current assets This is the current ratio, which is a calculation of current assets

current liabilities divided by current liabilities. It measures liquidity and shows how

much of a company's assets will have to be converted into cash in the next year to pay debts. The higher the ratio, the more chance creditors have of being paid. For example, if MacKenzie Inc (see Units 12-13) has current assets of $23,244,000 and current liabilities of $15,197,000, its current ratio is 1.53, which is acceptable. It is often argued that the current ratio of a healthy company should be closer to 2.0 than 1.0, meaning that it has nearly twice as many assets as liabilities.

Suppliers granting short-term credit to a company prefer the current ratio to be high because this reduces their risk. Yet shareholders usually prefer it to be low, because this means that the company has invested its assets for the future.

liquid assets This is the quick ratio or acid test, which is a calculation of liquid

current liabilities assets divided by current liabilities. It measures short-term solvency.

Liquid assets are current assets minus stocks or inventory, as these might be difficult to sell. MacKenzie Inc's quick ratio is 1.15.

Earnings and dividends

Shareholders are interested in ratios relating to a company's share price, earnings, and dividend payments.

total earnings for the year This is earnings per share (EPS). It tells investors how

the number of ordinary shares ^{much of the} company's P^{rofit bdon}8^s_r ^{t0 each If}

a company makes a post-tax profit of €1.5 million,

and it has issued 2 million shares, EPS = €0.75.

the market price of an ordinary share This is the price/earnings ratio or P/E ratio. It

t|_le p_ast ye ar's EPS shows how expensive the share is. If a company

has EPS of €0.75 and the share is selling for €9.00, the P/E ratio is 12 (€9 per share divided by €0.75 earnings per share = 12 P/E.) A high P/E ratio shows that investors are prepared to pay a high multiple of the earnings for a share, because they expect it to do well in the future.

ordinary share dividend This is dividend cover or times dividend covered, which

_net p_rofj_t shows how many times the company's total annual dividends

could have been paid out of its available annual earnings. If a company has EPS of 75 cents and it pays out a dividend of 30 cents, the dividend cover is 75 / 30 = 2.5. A high dividend cover shows that the company has a lot of money, but that it is not being very generous to its shareholders. A ratio of 2.0 or higher is generally considered safe (it means that the company can easily afford the dividend), but anything below 1.5 is risky. A low dividend cover - below 1.0 - means the company is paying out retained surpluses from previous years.

1. Find words in A opposite with the following meanings.

   1. the ability to sell an asset for cash

   2. how well a business uses its assets

   3. the relationship between two figures

   4. how easily a business can pay bills or debts when they are due

2. Make word combinations using a word from each box. One word can be used twice. Then use the word combinations to complete the sentences below. Look at B and C opposite to help you.

assets cover ratio test

acid

current

dividend

liquid

quick

1. consist of cash and things that can be easily sold and converted

to cash.

2. A high shows that the company is retaining a lot of money belonging

to its shareholders.

3. The or doesn't count stock or inventory

because this might be difficult or impossible to turn into cash.

4. The shows a company's ability to pay its short-term debts.

1 5.3 Match the two parts of the sentences. Look at B and C opposite to help you.

1. If a company pays out retained surpluses from past years

2. Some investors are worried that the new stock issue

3. A high current ratio indicates short-term financial strength but

4. Wall Street is on a historic price-earnings ratio of around 35, which

a it does not measure how efficiently the company is utilizing its resources, b its dividend cover will fall below 1.0.

from the profit and loss account?

c makes the market very expensive, as the long-term average is 14.45. d will dilute the company's earnings per share.

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Look at a company's financial statements. Which of the financial ratios mentioned in this unit can be calculated:

• from the balance sheet?

• using both these statements?

Which ratios require additional information?

Financial ratios 2

Profitability

There are various profitability ratios that allow investors to compare a company's profit with its sales, its assets or its capital. Financial analysts usually include them in their reports on companies.

gross profit (sales - cost of goods sold) This is the gross profit margin. It is the money a

_saj_es company has left after it pays for the cost of the goods

or services it has sold. A company with a higher gross profit margin than competitors in its industry is more efficient, and should be able to make a profit in the future.

net profit This is return on assets. It measures how efficiently the firm's assets are being used

total assets ^to §^enerate P^rofits'

net profit This is return on equity (ROE). It shows how big a company's profit is

16

shareholders⁵ equity (after interest and tax) compared with the shareholders' equity or funds.

This is gearing or leverage, often expressed as a percentage. It shows how far a company is funded by loans rather than its own capital. A highly geared or highly leveraged company is one that has a lot of debt compared to equity.

Leverage

debt

shareholders' equity

EBIT (see Unit 14) interest charges

This is interest cover or times interest earned. It compares a businesses annual interest payments with its earnings before interest and tax, and shows how easily the company can pay long-term debt costs. A low interest cover (e.g. below 1.0) shows that a business is having difficulties generating the cash necessary for its interest payments.

3.2 1.0

15.7 .2

14.5 2.5

■

:

Citigroup Inc Key Ratios, 2005

Citigroup

BrE: gearing; AmE: leverage

Banking Industry Average

S&P 500 Average

Growth Rates %
Sales	1 1.5	29.4	10.7
EPS	3.2	21.2	1 1.2
Price Ratio
P/E Ratio	13.9	14.5	20.6
Profit Margins
Pre-Tax Margin	21.8	23.7	47.3
Net Profit Margin	15.5	16.3	7.6
Financial Condition
Debt/Equity Ratio	1.9	1.32	I.I
Interest Cover	2.0	2.1	3.4