550 Accounting: Business Reporting for Decision Making
price) rather than a dividend which fluctuates according to the profitability of the company. Preference
shares are usually not issued as partly paid. In this, they mimic debt. A company issuing preference
shares does so to collect the full amount of funds that they represent at the time of issue.
Companies issue preference shares to gain the following advantages:
- ownership rights are not diluted by the issue of preference shares, while the preference shares do not
normally have voting rights attached to them
- non-participation, being the norm, gives companies certainty in the cost of this form of funding
- cumulation or non-cumulation, non-payment of preference dividends, cannot pose the solvency risk of debt
- the fixed cost of preference share capital allows companies to enhance earnings per ordinary share.
Rights and options
A rights issue is the issue of new shares to existing shareholders. The ‘rights’ terminology refers to the
entitlement of existing shareholders to subscribe. Normally, there is a benefit attached to the right, in that
the new issue of shares is made available at a price that is below the current market price.
Most rights issues are renounceable. That is, shareholders are free to sell their rights to subscribe
on the market. (Some issues are non-renounceable, which means that investors are not able to sell the
rights even though they may decline to subscribe more funds.) The value of each right to subscribe to
one share naturally depends on the discount implied with the rights subscription price.
Another method that companies use to raise further capital is that of options. An option to purchase
shares is the right to subscribe to shares at a price and time that are predetermined. Companies issue
options for four main purposes:
- to set in place a programmed raising of funds in the future
- to reward and motivate employees so that their financial health is aligned with that of the company
- as an additional benefit attached to an equity issue to make the current issue more attractive, but also
to put in place the opportunity to raise more capital
- as an additional benefit attached to a debt contract to secure the funds or to benefit from a lower
interest rate.
The reality check below illustrates JB Hi-Fi Ltd’s capital management policy.REALITY CHECKJB Hi-Fi Ltd’s capital management
21 Contributed equity (cont.)
(d) Capital management
The Board reviews the capital structure on an ongoing basis. The Group’s objective is to maintain an
optimal capital structure which seeks to reduce the cost of capital and to ensure the Group has access
to adequate capital to sustain the future development of the business.
In order to maintain or adjust the capital structure, the Group may adjust the level of dividends paid
to shareholders, return capital to shareholders, buy back shares, issue new shares or sell assets to
reduce debt.
As part of its capital management program, the Group monitors the return on invested capital and
the gearing ratio. The Group defines return on invested capital as earnings before interest and tax
(EBIT) divided by the sum of total equity plus net debt and gearing as term debt excluding capitalised
borrowing costs, plus bank overdrafts and hire purchase liabilities, divided by earnings before interest,
taxation, depreciation and amortisation (EBITDA).
The Board has adopted a policy of monitoring the dividend payout ratio and targeting a payout ratio
of approximately 65% of net profit after tax as it seeks to strike a balance between shareholder returns
and ensuring adequate capital is retained for the growth of the business so as to maximise long-term
shareholder returns.
There were no changes in the Group’s approach to capital management during the year.
Source: JB Hi-Fi Ltd 2015, annual report, p. 88.