Analyzing Financing Activities: FAR340 Exercise 4

Negative Covenants

Limit management behaviors that might be harmful to the lenders. Such covenants typically consist of two parts: (1) constraints, which specify when a com pany has violated a covenant; and (2) penalties or restrictions that arise when a covenant has been violated.

Terms of indebtedness

Maturity, interest rate, payment pattern, & amount.

Short Term Debt

Obligation that requires settlement within one year. Short- term debt is primarily used for financing working capital and other liquidity needs. Short-term borrowing is classified as a current liability.

Financing Liabilities

Obligations that arise from financing activities. Example: Short & long term debt, bond, notes , leases & the current portion of long term debt.

Operating Liabilities

Obligations that arise from operating activities. Example: Accounts payable, tax payable, unearned revenue, & other accruals of operating activities.

Long Term Debt

Obligations that requires settlement not within one year. Examples of long-term debt are bonds, debentures, and notes issued to the public (public debt); and term loans and long-term notes (private debt).

Sources of increases in Shareholders Equity

Issuances of stock in acquisitions & mergers

Amotized Cost

Amortization is an accounting technique used to lower the cost value of a finite life or intangible asset incrementally through scheduled charges to income. Amortization is the paying off of debt with a fixed repayment schedule in regular installments over time like with a mortgage or a car loan.

Security (collateral)

Assets that are set aside during dissolution to specifically satisfy a particular claim. A claim that is backed by collateral is called secured.

Equity

Claims of owners on the net assets of a company. Equity holders are exposed to the maximum risk associated with a company but also are entitled to all residual returns of a company.

Equity Analysis

Classifying & distinguishing different equity sources. Examining rights for equity classes & priorities in liquidation. Evaluating legal restrictions for equity distribution. Reviewing restrictions on Retained Earnings distribution. Assessing terms & provisions of potential equity issuances.

Debt Financing: Private Debt

Firm borrows from financial institutions such as banks.

Debt Financing: Public Debt

Firm issues securities such as bonds directly to investors for financing.

Fair value accounting

Reflects the present value of debt. However, fair values diverge from amortized cost because they reflect current interest rates, unlike amortized cost, which reflects interest rates at the time of issue.

Lender Protections

Seniority, Security/Collateral Covenants

Sources of decreases in Shareholders Equity

Share Buybacks

Affirmative Covenants

Specify actions that management needs to take to keep the debt in good standing. An example of an affirmative covenant is the requirement that the company must file audited financial statements that are in accordance with GAAP/IFRS within a specified time period.

Seniority

The order in which different parties will be paid when a company's business is dissolved. Senior claims will be paid before junior claims.

Book Value per Share

Total stockholders' equity / Number of common shares outstanding Valuable analytical tools but must apply it with discrimination & understanding

Short term debt accounting

Unlike long-term debt, short-term debt is typically reported at face value. The reasoning behind reporting short-term debt at face value is that face values rarely diverge from present values given the short-term nature of the debt."