Capital Employed/ Proprietor Fund/ Owner’s Equity/ Networth etc. similar terms

Ratio Analysis and its formulas are very important for any Accounts or Finance Student. But before plunging into the various ratios i.e. comparing of one element in terms with another, let me discuss few terms in Finance which has always kept me rolling my eyes while learning it. 

These terms seem similar with very little change or no change at all i.e. different names for one term.

Note: One more thing is that Accounting and Managerial Accounting will have little difference in the formulas and I am going to focus more on the Management Accounting. So if you find more detailed formulas elsewhere then don’t scratch your head as it is probably accountancy formulas.

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Here we go

1.     Owners’ Fund / Net Worth / Shareholders’ Fund/ Proprietor’s Fund

All of these are same. Thank God!!  It shows the value or worth of the owners or the shareholders of the company after deducting all the liabilities.

*** When we talk of TOTAL LIABILITIES it doesn’t mean the whole Liability side of Balance Sheet but it means the whole Long term and Short term Liabilities.

Formula: 

1)      Total Assets – Total Liabilities      OR

2)      (Equity+ Preference + Reserves  and Surplus) OR

3)      (Equity+ Preference + Reserves  and Surplus)- Misc/Prelim Exp

2.     Owner’s Equity / Shareholder’s Equity

It is what is available for the Equity Shareholders

 
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Shareholder’s Fund – Preference Shares – Pref Dividend

3.     Proprietary Ratio / Equity Ratio / Net Worth Ratio/ Shareholders’ Equity Ratio

This ratio shows the capital structure of the company. It is used to see how much of the Asset is contributed or invested by the capital (in percentage). Higher rate is considered risk free or better. Extreme high would also be considered inefficient usage of debt financing

Formula:

1)      (Shareholders’ Equity  / Total Assets ) x  100

2)      (Shareholders’ Equity  / (Total Assets- Intangible Asset) ) x  100

Example:  If Equity Ratio is 60% then 60% of the assets of the company is contributed by Equity rest from other capital and/or borrowed funds.

4.     Capital Employed

Capital Employed is to see how much capital is invested by the company to reap the profits or for the working of the company

Formula:

1)      Total Asset – Current Liabilities OR

2)      Shares Capital + Long Term Loans – Misc Exp OR

3)      Fixed Assets + Working capital

I hope this article helped you.  You can give your feedback and even rate the post now. Thankyou

DRISHYA.V.P

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FAIR VALUE, FACE VALUE, NOMINAL VALUE, MARKET VALUE, REAL VALUE, BOOK VALUE

Confused with several terms

These are some terms often used in Accounting and Finance. Many really understand the difference or simply get confused between the jargons. So, this is a little article trying to uncomplicated and give you a better understanding of the terms.

Face Value/ Nominal Value/ Par Value

Face value is the price of the security at the time of its Issue.  It doesn’t change over the time.  And guess what? Nominal Value and Par Value are just another name for it

Market Value

It is the price listed in the exchange or the price at which it is traded in Market

Book Value

It is the price calculated by the company and recorded in their books. They deduct all debt and arrive at a price or value. For shares it is calculated as: (Total Shareholders’ Equity – Preference Shares)/Number of Outstanding Shares

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In terms of Assets, Book value is what investors look at to know how much a company is worth if it ceased its operation today. All the tangible assets – Debt gives you Book Value. More the value better the position of the company.

Fair Value

It is rightly valuing or estimating the price of an asset or share or services. It is used by the investors to get a clear picture of prices which may otherwise be overpriced or under-priced by the market. A company calculates its fair value annually and in case of takeovers or mergers shares/assets are bought at the fair value. It is individually calculated based on various factors such as demand-supply, risk factors, returns, actual utility, etc

Bond fair value is formula based to calculate the present value of future cashflows.

Real Value

Real value is when the price is corrected for the inflation rate.

I hope this article helped you.

-D.V.P

Enterprise value (EV)

When you are asked to value a company for any reasons like merger, acquisition, buyout or simply a valuation, etc the Enterprise value of a company has a significant place which every analyst looks for.

More believe it that EV provides a much precise value of a company though it is more of a theoretical value. When a company buys another company, it takes over its’ Debts. This debt is lightened when the company receives the Cash of the acquired company. That is the reason why Cash and its equivalent are reduced in the Enterprise value. It shows the value to buy the company deducting the amount that would be received.

Hence the formula:

EV = Market Capitalization( total public share value) +Minority Interest+ Preference Shares +Debt – Cash and Cash equivalent

 

-D.V.P

24^th September 2012

 

FCF FCFF and FCFE uncluttered

Now that Cash Flow Statement is briefly explained, let us go through the various Cash Flow terms which is little

FCF FCFE FCFF

confusing i.e. Free Cash Flow (FCF), Free Cash Flow to Firm (FCFF) and Free Cash Flow to Equity (FCFE)

Free Cash Flow

It is the Cash flow recorded by the Company as availablefor the company growth after taking care of its Operating expenses and Capex. Capex is the expense incurred during the year on assets and investments. The company might have added a new plant or replaced a plant and/or invested more in some securities or so on. It is a very essential expense which company can’t ignore. It is already calculated in the Cash flow statement as Cash from Investing Activities. We may also remove Dividends from it.

Basically it can be calculated as

FCF= Operating Cash Flow – Capex

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OR

FCF= Operating Cash Flow – Cash from Investing Activities

Free Cash Flow to Firm (FCFF)

The cash flow available to the overall security holders of the company whether it is owners/equity-holders and debt-holders of the company. What makes it different from FCF is that we include the  INTEREST for the debenture holders after removing the tax from the interest.  Be clear that usually Tax is already removed from the Operating Cash Flow but we never calculate Interest which we pay there. So we add back the Interest and deduct the tax applicable on Interest towards Debt-holders. Now, this cash flow is what is available to all the firm

It can be calculated as

FCFF = Operating Cash Flow + [Interest *(1- tax)] – Capex

OR

FCFF = Operating Cash Flow + [Interest *(1- tax)] – Cash from Investing Activities

Free Cash Flow to Equity (FCFE)

As the name suggests it is the cash flow available for the equity shareholders after paying off all the obligations towards to the expenses and debt-holders. It shows how much of debt affects the company’s cash flow. The FCF would be adjusted after deducting the Interest or the Debt Repayment amount and adding any new Debt received as it indicates Cash inflow

FCFE = Operating Cash Flow – Capex – Debt Repayment + New Debt

OR

FCFE = Operating Cash Flow – Cash from Investing Activities – Debt Repayment + New Debt

D V P

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Cash Flow Statement Explained

Cash flow statements are one of the essential Financial Statements that help you to understand the financial health and movement of the company.  It can be derived from the Balance sheets and the Income statements. Given an option of choosing only one statement among all these to analyse you may choose Cash Flow statement to know how the company is performing during a course of time. It is provided in the annual report of the listed company

So what exactly is a Cash Flow Statement? And what makes it the so important?

Cash Flow statement is a part of Fundamental Analysis showing the usage of cash and cash equivalents within an organisation for an ascertained period of time mostly a year or a quarter. It is not same as the Net Income of the company.

 It has three components namely

Cash Flow from Operating Activities

Cash Flow from Investing Activities

Cash Flow from Financing Activities

1. Cash Flow from Operating Activities

As the name suggest it involves the principal revenue generating activities. Net Income includes future incomes and expenses and non cash adjustments like depreciation and amortisation.  We need to know how cash has been utilised during a year. So we add back the depreciation to the Net income and add the Net Working Capital i.e. add or subtract the cash received from Debtors or paid to Creditors.  When the debtors pay you, the Bills receivable in Balance sheet reduces and we add in Cash flow and vice versa.

Operating Activity

Net Income

Add: Depreciation

Add: Cash received from Sales	Less: Cash Purchases
Cash from Debtors	Payment to creditors
Cash from Commission and fees	Cash Operating Expense
Royalty and other revenue	Payment of wages
	Income Tax
TOTAL CASH FROM OPERATIONS

If e.g. Balance sheet of Year 1 show Creditor as Rs.10,000 and Year 2 shows it as Rs.8,000 that means, Rs.2000 of cash outflow has happened to pay off the Creditors. So we subtract it from the cash flow. Similarly every cash expense and income is checked in the same way.

2. Cash Flow from Investing Activities

It takes into consideration the cash used to buy new equipment, buildings or short-term assets such as marketable securities.

Add:	Less:
Sale of fixed Asset	Purchase of Fixed Asset
Sale of Investment	Purchase of investments
Interest Received
Dividend Received
TOTAL INVESTING ACTIVITY

3. Cash Flow from Financing Activities

A company receives money when it issues equity or debentures to the public or get a loan. It shells out its money when it has to pay dividend to shareholders and interest to debenture holders and also while redeeming it.  These changes decide the cash flow from financing activity

Add:	Less:
Issue of shares	Dividends paid
Issue of debentures in cash	Interest paid on Loan/ Debenture
Loan Received	Loan Repayment
TOTAL FINANCING ACTIVITY

All the three sub cash flows would be totalled and added to the Opening balance of Cash to reach Cash and Cash equivalent at the end of the year

Cash Flow Statement

Add: Cash from Operating activity

Add: Cash from Investing Activity

Add: Cash from Financing Activity

Add: Opening Balance of Cash & Equivalent

Cash & Equivalent at the end of the year

Negative Cash Flow is not preferred as seen as sign of weak business but we need to check whether the company has followed any growth strategy and hugely made investments which led to the cash outflows.

-D.V.P