Cima F2 Exam Question No 28

Question No 28:

Dividend related ratios?

Growth potential and the ability to generate future wealth in the entity may depend on the amount of profits retained. This relationship may be measured using the profit retention ratio: (Profit after dividends / Profit before dividends )× 100. The higher the proportion of earnings retained, the higher the growth potential. Cash is retained in the entity for growth as opposed to being paid to shareholders.
Dividend yield will indicate the return on capital investment, relative to market price: ( Dividend per share/ Market price per share
) × 100. Dividend cover measures the ability of the entity to maintain the existing level of dividend and is used in conjunction with the dividend yield: Earnings per share / Dividends per share
The higher the dividend cover, the more likely it is that the dividend yield can be maintained.

Cima F2 Exam Question No 27

Question No 27:

Covenants include?

• Dividend restrictions - Limitations on the level of dividends a company is permitted to pay. This is designed to prevent excessive dividend payments which may seriously weaken the company's future cash flows and thereby place the lender at greater risk.
• Financial ratios - Specified levels below which certain ratios may not fall, e.g. debt to net assets ratio, current ratio.
• Financial reports - Regular accounts and financial reports to be provided to the lender to monitor progress.
• Issue of further debt - The amount and type of debt that can be issued may be restricted. Subordinated debt (i.e. debt ranking below the existing unsecured debt) can usually still be issued

Cima F2 Exam Question No 26

Question  No 26:

What is Covenants?

A further means of limiting the risk to the lender is to restrict the actions of the directors through the means of covenants. These are specific requirements or limitations laid down as a condition of taking on debt financing

Cima F2 Exam Question No 25

Question No 25:

What is Security - charges?

1. Fixed charge - The debt is secured against a specific asset, normally land or buildings. This form of security is preferred because, in the event of liquidation, it puts the lender at the 'front of the queue' of creditors.
2. Floating charge - The debt is secured against the general assets of the business. This form of security is not as strong; again it confers a measure of security on liquidation as a 'preferred creditor', meaning the lender is higher in the list of creditors than otherwise.