Understanding Finance

The legendary investor and ‘Sage of Omaha’, Warren Buffet, CEO/Chairman of Berkshire Hathaway wrote, in 1986, about the important concept of “owner earnings”.

A core method we, as equity analysts, use to calculate and estimate the present value of the companies we invest into on behalf of clients is the discounted cash flow model (DCF).

Return on capital metrics are closely watched by managers and investors alike.

In theory, the definitions of an investment or an expense seem quite clear cut. An investment, so the theory goes, is spending which creates an asset which will help produce profits over a number of…

Conceptually we have a reasonable understanding of inflation. As an economic term, inflation represents the general price rise of goods and services over a predetermined time.

You probably sort of know how index linked gilts, or “linkers,” work. The redemption value is linked to the change in the retail price index, or RPI, that takes place over the life of the gilt. 

Another word for duration could be the average life of a bond. Most bonds pay annual or semi-annual coupons and have a redemption date. So whilst a bond maturing in three years and with a £5 annual…

Younger and more socially conscious investors have increased demand for Environmental, Social and Governance (ESG) compliant portfolios. This in turn has driven demand for a new class of ESG compliant…

The accounting industry hasn’t always had the best reputation for providing financial transparency, but its origins are based on providing consistency to company reporting. Given the millions of…

There are three things that this piece will look to address; what is the yield curve, what do we mean by a yield curve inversion and what is the economic consequence of a yield curve inversion?Imagine…

Maintenance capex can be considered the cost of sustaining current revenue and profits for a business. This type of outlay is equivalent to a normal operating expense; such an example would be the…

Contemporary corporate finance theory says that the value of something is (a) the future expected cash flows discounted back to (b) their net present value.

= Earnings before interest and tax/Interest

As a general starting point, more debt makes a company more valuable to its owners.

There is much speculation surrounding the ‘science’ of profit warnings, their predictability and recurrence in particular. The best publicised being the fabled wisdom that they come in threes.…

= Number of shares * Price per share

Measures the compound annual growth rate (CAGR) of earnings per share.

Profit is Revenue less Costs.

= Earnings before interest (EBIT) and tax/Capital Employed

The simplest definition of beta is that it is a measure of risk. Whilst I won’t derive the mathematics from first principles, it is worth saying that it is calculated by taking the correlation of an…

Revenue is Volume times Price.

Costs can be Fixed or Variable.

An expression of Profit as a percentage of Revenue.

= Earnings before interest and tax + Fixed Charges/Fixed Charges

When a company requires external financing there are three main options; Borrow from a bank (usually from pre-existing bank facilities) 

Borrow from investors (issue corporate bonds)
A rights issue
…

Compound interest is, simply put, the addition of interest upon interest. For example, if in year one I was to place £10 on deposit, on which I were to receive 10% interest, at the end of year one my…

When assessing the profitability of a company, it is important to concentrate not on its reported earnings but on the cash flows that it generates. Earnings can be easily manipulated through…

We all know that in layman’s terms the rate of inflation measures the general level of price increases over a given period of time. But the above quoted figure is more precisely known as the Consumer…

There are two sets of accounting standards which dominate the world. The IFRS Foundation has oversight of the International Accounting Standards Board who publish the IFRS or International Financial…

So what’s the yield? Well, the “7%” coupon income comes as two semi-annual payments of £3.50 in April and October for a total of £7. So you might say that the yield is £7 ÷ £105.90 or 6.61%. That is…

Accountants provide us with something that they call Cashflow from Operations, which is pretty much what the widget machines produce in terms of net cash, after paying interest and tax. This is set…

The truest picture of how well a company is doing comes from understanding not just the profit and loss statement and the balance sheet, but how these describe what is happening to cash in the…

Corporate finance is often about understanding unavoidable conflicts of interest and then making sure that they are dealt with as best can be.

Previously, I have explored the notion that financing companies with debt made them more valuable to the owners because interest payments were tax deductible and so saved the company tax.