Accounting Analysis- CISI Securities

Define goodwill

A premium paid over the fair value of assets during the purchase of a company (investment cost> net assets) Represents the intangible assets that are harder to parse out individually or measured directly. e.g. Customer loyalty, brand reputation etc

What is a group financial statement?

A statement that presents finances of parents company and subsidiaries together as though they are the same company.

What is depreciation?

A systematic expensing of an asset based on the asset's estimated life to account for loss of value (efficiency, speed, usefulness) as it gets used.

What is liquidity (for a company)?

Ability of a company to produce the cash to pay its liabilities.

How do TNC assets tend to be recorded in the balance sheet?

Actual cost (book value) but they require depreciation measures

What is net income?

All revenues- all expenses

How do financial statements tend to influence share price?

Alter price according to how they meet expectation. Exceed expectation - rise Do not meet- fall Meet - rel constant

Give examples of current liabilities.

Amount company owes to suppliers, trade payables or buying goods/services, tax.

What is revenue?

Anything a company sells, regardless of whether it has received the cash yet.

What is an asset?

Anything owner and controlled by the company - confers right to future economic benefits.

How is D&A recorded in P&L statements?

As an operating cost (expenses)

How are current assets listed in the balance sheet?

Ascending order of liquidity

What is net book value (NBV)?

Asset cost- depreciation accrued to date

How must a balance sheet 'balance'?

Assets = Equity + Liabilities, where LHS = what company owns, RHS= what company owes to its owners and to third parties

What are current assets?

Assets purchased with the intent to convert to cash within 12 months e.g. stock (inventories), cash balances and prepayments

What is a the statement of financial position?

Balance sheet snapshot of company's financial position at given date

Give examples of non-current liabilities

Bond issues, bank borrowing, long-term leases. Provisions- liabilities with yet to be established timing of expenditure

What are operating activities? (CF statement)

Cash generated from trading activities of the company

What are financing activities? (CF statement)

Cash spent during the year on paying dividends, borrowing or issuing shares less cash on debt or buybacks

What is the role of the P/E?

Compared to market or industry average to see if stock overvalued, undervalued or in line. If undervalued, attractive investment prospect. Small ratio if it is 1/x vs 1/y, will pick company with larger earnings (e.g. x>y) as pay the same price but with larger EPS.

What is current ratio?

Current Assets / Current Liabilities = Current Ratio higher the result, the more liquid a company should be.

What is price to earnings ratio (P/E)?

Current market price per share/ EPS trailing if retrospective forward if prospective

What is dividend cover?

DC= EPS/ dividend per share Reveals proportion of profits reinvested into company. If DC>1, the remaining proportion of EPS is reinvested. DC is the number of times the dividend could be paid out by the profit made. e.g. if DC is 2.5. 1.5/2.5% is reinvested into the company.

How to calculate debt to equity?

DTE= Debt (NC liabilities)/ equity Net debt to equity if using (debt- cash and short term investment)

How is depreciation calculated using the straightline method?

Depreciation charge = (cost-disposal value)/useful life in economic years NON-CASH CHARGE - NOT RECORDED ON CASH FLOW STATEMENT

What is cost of sales?

Direct costs to the company of generating revenue e.g. raw materials, wages of staff making products etc.

What is profit before tax?

EBT (operating profit- fin cost + fin income)

What is earnings per share? (EPS)

EPS= (net income - dividends on pref shares) / no of ordinary shares company's profit on a per share basis

What is operating profit?

Earnings before interest and tax (EBIT) EBIT= Gross profit- indirect expenses Indirect expenses (SG&A, depreciation and amortisation etc).

What is a liability?

Economic obligation to third party (owed)

What is profit?

Excess of revenues over the period over expenses. Shows the money left overall.

What is the quick ratio (acid test)?

Excludes inventory from current assets as inventory is potentially not liquid. QR= (CA-inventory)/current liabilities If QR>1, indicate company has sufficient short term assets to cover short term liabilities. If QR<1, may need to undertake financing.

What is enterprise cash flow?

FCF before considering any payments to creditors.

What is equity cash flow?

FCF to shareholders. Net income is considered after removing debts but before dividends.

What are the accounting regulations called? Who is trying to harmonise them globally?

General accepted accounting principles (GAAP)* International Accounting Standards Board (IASB) *US has its own GAAP

What does EPS reveal to investors?

How much profit made during the year available to be paid out in shares. EPS= (net income - div on preferred shares- non-controlling interests)/number of ordinary shares in issue

How do interest rates influence P/E interpretation?

If interest low and inflation benign, larger P/E supportable (discount factor is low so NPV of future revenues is higher). Less competition is coming from fixed-income securities (e.g. bonds) since their prices rise when IR fall.

What types of audit reports accompany financial statements to attest to their validity?

If valid, true, fair - publishes 'UNQUALIFIED REPORT' If issues - 'QUALIFIED REPORT' and reasons for qualification

What is the benefit of using EV/EBIT ratio?

Incorporates both equity and debt Smaller EV/EBIT, the cheaper the company is. You are paying less (EV) for more earnings (EBIT).

When tangible assets are revalued, how is the balance sheet maintained?

Increase in the asset value is accounted by an increase in the revaluation reserve (equity).

Why does high leverage have higher risk?

Increases risk the company cannot meet its financing commitments. Interest on debt must be paid every period, while dividends can be paid only in profitable years and share capital never has to be repaid (unless the company goes under).

Financial costs to a company include what?

Interest incurred on borrowings.

What are the standards issued by the IASB?

International Financial Reporting Standards (IFRSs)

What are NC investments?

Investments that will not mature or be sold within the next year

How is purchased goodwill treated as an asset?

It is capitalised - the expenditure will appear in the balance sheet, rather than the P&L statement

What is capital expenditure?

Money spent to buy non-current assets. Reflected on the balance sheet.

How is free cash flow generated from the P&L?

Net income + DA - Capex

What is interest cover?

Operating profit/ interest costs ie. the number of times the interest on debts could be paid by the operating profit.

What is the income statement?

P&L statement Summarises revenue earned and expenses incurred over an accounting period

What is amortization?

Process of allocating cost of an intangible asset over useful life in a systematic and rational manner. Indefinite life is not amortized. Limited life intangibles are amortized.

How do you calculate ROA?

ROA= OP/ total net assets *100 total net assets = all assets - C liabilities

How do you calculate ROCE?

ROCE= operating profit/ capital employed *100 capital employed = equity + NC liabilities

How do you calculate return on shareholder equity?

ROE= net come/ shareholder equity x 100

What are the limitations of ratio analysis?

Ratios are not predictive Alternative accounting methods make ratios incomparable Inter-person judgement differences lead to divergence - comparability of results diminish

What is a profitability ratio?

Represent percentage return generated on revenues.

How is management performance of a company best measured?

Return on capital employed (ROCE) Return generated as a percentage of the finance put into the business (capital employed = equity + long term debt)

What is gross profit?

Revenue - COGS

What is financial gearing?

Risk arising from company debt (AKA leverage)

What 3 sub elements form equity for a balance sheet?

Share capital Capital reserves - revaluation reserves, share premium account (not distributable as dividends but can be for a bonus issue) Revenue reserves- accumulated, retained earnings Non-controlling interests EQUITY= SHARE CAPITAL + RESERVES

What is a cashflow statement?

Shows cash generation and spending over the accounting period. Divides cash into: -operating -investing -financing

the total at the bottom of the CF statement should equal what?

The difference between two balance sheets over the time period concerned.

What is enterprise value (EV)?

The sum all debt and equity claims on a company- 'what you'd buy the company for' Market cap + debt - minority interests and preferred shares - cash

What is asset turnover?

This indicates how efficiently a company uses it's assets to generate sales. AT (number of times) = revenue/ total net assets

What is gross dividend yield?

Total dividends per share paid out relative to current share price. =dividend/ current share price* 100 high yield means share price is low compared to the return it offers - market may not have confidence n continued dividends low yield - high confidence in the company's ability to deliver dividend

What is the purpose of diluted EPS?

Warn shareholders of potential EPS changes if company has many convertible instruments in issue that dilute the net income. instruments- convertible loan stock or shares, issued options or warrants

When are group financial statements required?

When a company assumes control over a subsidiary

When is cash generated?

When cash generated > cash paid out. Cash reflects ability of company to pay liabilities (LIQUIDITY).

What are non-controlling interests?

When parent company owns some but not all shares of a subsidiary, the remaining % of ownership is non-controlling interests. Means some of the net assets will be owned by non-controlling interests.

What are intangible NC assets?

assets that generate benefits but are without physical substance e.g. IP, capitalised development costs

What are tangible NC assets?

assets with physical substance e.g. plants, property and equipment (PPE).

What is ROCE also known as Return on Assets (ROA)?

capital employed is equivalent to net assets (assets- liabilities)

What are investing activities? (CF statement)

investment income (interest and dividends) received, cash to purchase non-current assets, cash from sale of NC assets and investments

What are non-current assets?

items owned by a company and in use for a long period of time (more than a year). Major investments from which a company hopes to make money.

What is revenue expenditure?

money spent to the day to day running of business, reflected on the P&L e.g. wages, SG&A