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."
