Statements Exam 1

market value / market cap

number of common shares outstanding X company's stock price

Non current liabilities

obligations due after one year - long term debt - other long term liabilites

cash flow pattern in 4 stages of product life cycle

often emphasis on financing at first, not making much money in the beginning

excluded assets

often relate to knowledge-based or intellectual property (IP) assets, such as a strong management team, a solid supply chain, or superior technology

using "quants" alone

only working out ratios/ numbers can be misleading if you do not dig deeper

gain or loss from operating item

operating

is notes payable operating or non operating

operating

what is the important part of the income statement

operating, its recurring, the stuff that will persist

external aspects of SWOT

opportunities and threats

how do investment analysts use financial statements

predicting companies future performance

unearned revenue

receive cash before recording revenue, become a liability until obligation performed

revenue recognition for non refundable upfront fees

recognize as revenue when the goods or services are provided

revenue recognition for consignment sales

recognize commission when goods are sold

expense recognition principle

recognize expenses when incurred

revenue recognition for promise of access licenses

recognize over a period of time

cost to cost method

recognize revenue as a proportion of total costs incurred to fulfill the contract ie: long term construction contracts

revenue recognition for franchises

recognize revenue as goods or services are delivered

revenue recognition principle

recognize revenue when a performance obligation is satisfied by transferring to a customer a promised good or service

revenue recognition for right to use licenses

recognize revenue when the customer can first use the licensed IP

revenue recognition for variable consideration

recognize the expected amount to be received when good or services are provided

revenue recognition for gift cards

recognize when gift card is used or expires (unearned revenue until used)

statement of stockholders equity

reconciles the beginning and ending balances of stockholders equity accounts

4 step accounting cycle

record transactions prepare accounting adjustments construct financial statements close the books

repurchase and retirement of stock

reduces RE essentially a dividend

publicly traded debt

regulated by the SEC commercial paper (ST) or Bonds/debentures (LT)

canceled treasury stock

removed from treasury stock account and reduces RE

canceled treasury stock

removed from treasury stock account and reduces RE -when stock is repurchased and retired it is essentially treated as a dividend

stockholders equity

represents capital that has been invested by the stockholders: -directly via the purchase of stock -indirectly in the form of retained earnings and OCI that reflect earnings that are reinvested in the business and not paid out as dividends

Regulation G

requirement my SEC that companies reconcile non GAAP numbers to GAAP numbers

Reg FD

requires that any information disclosed to one individual or group must be made available to everyone -designed to curb selective disclosure

indirect stockholders equity

retained earnings accumulated other comprehensive income or loss

adjustments for sales allowances

revenue and COGS must be adjusted company must deduct from gross sales expected sales returns and other allowances

2 principles of accrual accounting

revenue recognition expense recognition

types of sales allowances

rights of return sales discounts retailer promotions

asset turnover

sales generated from each dollar invested in assets

ways to assess productivity

AR turnover inventory turnover accounts payable turn over Cash Conversion Cycle PPE Turnover

treasury stock

amount the company paid to reacquire its common stock from shareholders "held" by the company for potential resale on the open market if canceled, it reduces RE

additional paid in capital

amounts received from the original sale of stock to investors in excess of the par value of stock

form 10-K

audited annual report with 4 financial statements, notes, and management's discussion and analysis

loss given default

the amount that could be lost if the company defaulted on its obligations -creditors wan to minimize this

what do we infer from a decrease in deferred revenue liabilities

the company's current reported revenue was collected from customers in a prior accounting period and there have been fewer new prepayments for which revenue will be recognized in the future could predict future declines in revenue and profit

which part of the reason markets respond to change is visible

current period earnings current share price

purpose of collateral

incentive to make payments and assurance for the bank

turnover

income statement item/ Avg Balance Sheet Item

complications of revenue recognition

nonrefundable upfront fees bill and holding arrangements consignment sales licenses (right to use and promise of access) franchises variable consideration multiple element contracts right of return gift cards

pro forma income statements

non GAAP numbers that company management believes provide a better measure of their financial performance (may be opportunistic)

Gain/ loss from non operating item

non operating

other forms of financing

nonbank private financing (angel investor) lease financing

transitory items on the income statement

nonoperating expenses(and revenues) income tax expense discontinued operations (net of tax)

quality of income ratio <1

lower quality income, less likely to persist

how is AR reported

net of the allowance for doubtful (uncollectible) accounts

factors that limit the usefulness of ratios

- GAAP rules omit many assets -mergers divestitures and strategy changes can impair comparability -consolidated statements are hard to analyze -they reduce the myriad complexities of a company's operations to single number

analysis of financial leverage typically involves

- level of borrowed money relative to equity capital - level of profit or cash flow relative to required debt payments

two methods to measure ROE drivers

-DuPont analysis -ROE analysis with an operating focus (operating activities drive firm values)

investing activities involve

-PPE assets -intangible assets -stocks and bonds as investments -lending and collection of money loaned

3 metrics to analyze sales allowances

-additions charged to gross sales -allowance as percentage of gross sale -adequacy of allowance amount

supplier credit terms

-amount and timing of any early payment discounts -maximum credit limit -payment terms (2/10,n/30)

usefulness of Statement of cash flows

-boils it down to cash -looking at financial information from a different angle -quality of earnings (what comes from operations)

why does book value not equal market value

-book reports historic values and market tries to estimate fair values -GAAP excludes assets that cannot be reliably measured -market value adjusts for companies' market characteristics -GAAP does not consider expected future performance

supplemental disclosures required for the indirect method

-cash paid for interest -cash paid for income taxes - a description of all noncash investing and financing transactions

steps to analyze credit risk

-evaluate nature and purpose of loan -assess macro economic environment -perform financial analysis -perform prospective analysis (projecting out)

5 steps for revenue recognition

-identify contracts with customer -identify performance obligations -determine transaction price -allocate transaction price -recognize revenue when each performance obligation is satisfied

how can NOAT be increased

-increasing sales while operating assets remain at the same level -reducing operating working capital while keeping sales at the same level (easier)

assess macro economic environment

-industry competition -bargaining power of buyers -bargaining power of suppliers -threat of substitution -threat of entry

how a firm can make money

-industry competition -threat of substitution

interpretation of AR growing faster than sales

-lower accounts receivable turnover ratio -higher percentage of AR to sales -lengthening of DSO not a favorable trend for 2 possible reasons: -company is becoming more lenient in granting credit to it's customers -credit quality is deteriorating

demand for credit

-operating needs, cyclical cash needs or to cover losses -investing activities, to put money towards growth -financing activities (less common, companies often use financing activities to fund investing activities)

three classes of credit risk ratios

-profitability and coverage (includes TIE) -liquidity (more ST) -solvency (more LT)

general revenue recognition principle

-recognize revenue when company transfers the good or service to the customer -when customer obtains control of good or service -it is not necessary to receive cash to recognize revenue

supplemental disclosures for the direct method

-reconciliation of NI to net cash flow from operating activities (essentially indirect method) -description of all noncash investing and financing transactions -firms policy for determining which highly liquid, short-term investments are treated as cash equivalents

types of bank loans

-revolving credit line -letters of credit -term loans -mortgages

lease financing

-secured by the asset being leased (collateral built in) -typically used for PPE acquisition -leasing firm considered credit risk of the lessee and collateral

indirect method for statement of cash flows - operating section

-start with net income -adjust for non cash items -adjust for changes in operating assets and current liabilities

hard numbers

-things like cash, harder to fudge

three common types of covenants

-those that require borrower to take certain actions (ie submit financial statements) -those that restrict the borrower from taking certain actions (ie prevent mergers or other major investments) -those requiring borrower to maintain specific financial conditions (ie ratios and minimum equity)

parties offering credit

-trade creditors -banks -public debt investors -private lenders

non bank private financing (angel investor)

-used when bank financing is limited or unavailable -provided by private lenders that have experience in industry -lender creatively structures loan repayment and may act as a management consultant

evaluate nature and purpose of loan

-why is loan necessary if you need loan bc you are going to go bankrupt, you probably won't get the loan

investment grade securities

BBB or Baa level normally pension plans can only invest here

NOA and FS manipulation

FS manipulation will often leave a trail of growing NOA, after years of manipulation NOA will grow and become more prominent relative to other firms (because you will create fake non cash assets to hide fake revenue)

international accounting standards

IASB--> IFRS FASB--> GAAP

difference in IFRS balance sheet and GAAP balance sheet

IFRS shows LT first and ST last

LGD

Loss given default

information beyond financial statements

MD&A independent auditor report FS footnotes regulatory filings including proxy statements and other SEC filings - google (cautiously)

users of financial statements

Manager and employees investment analysts creditors and suppliers stockholders and directors customers and strategic partners regulators and tax agencies voters and their representatives

ROA vs RNOA

ROA is aggregate of Operating and Non Operating RNOA Strips away the Non Operating

where to find approximation of gross interest expense

SCF

discontinued operations

a disposal of a business unit that represents a strategic shift that has or will have a major effect on the company's financial results includes: -net income/ loss from the business prior to sale -any gain or loss on the actual sale of the business

term loans

a set loan amount (principal) with specified periodic payments (principal and interest) interest rate are either fixed or floating for the duration of the loan

why is R&D expensed as incurred

accounting is conservative and product may never reach market

current liabilities

accounts payable accrued liabilities unearned revenues short term debt current maturities of long term debt

change in investments

an increase in investments means that the company used cash to purchase more investments

credit rating

an opinion of an entity's creditworthiness captured in alpha-numeric scales

why is segregating discontinued operation from continuing operations on the income statement helpful

analysts can better isolate the core reoccurring profit and cash flow of the business

form 10-K / 10-Q

annual/ quarterly report

how does net income affect stock price

as net income goes up stock price goes up

letters of credit

bank is interposed between the company and its supplier bank provides a guaranty of payment

combined effect of all activities on cash flow statement

beginning cash balance + change in cash during the period --------------------------------------- ending cash balance for the current year

what does ROE reflect

both company performance (measured by ROA) and how assets are financed (as measured by financial leverage) ROE is higher when there is more debt and less equity financing, but that means higher risk for the company

what determines market value

buys and sells -more buys=price goes up -more sells= price goes down

current assets

cash cash equivalents short term investments accounts receivable, net inventories prepaid expenses

revolving credit line

cash available on demand, balance fluctuates floating interest rate max cap

operating cycle is also known as

cash cycle cash conversion cycle

cash flows from investing activities

cash flows from acquisitions and divestitures of investments and long term assets Capital expenditures

cash flows from financing activities

cash flows from issuances of and payments toward borrowings and equity relate to long term debt and SE

format of statement of cash flows

cash flows from operating activities cash flows from investing activities cash flows from financing activities

cash flows from operating activities

cash flows from the company's transactions with customers and events that relate to its operation

how can ADA be used as cookie jar

company can build up ADA to use when they want higher net income ( they can reduce BDE but still have sufficient ADA)

what does operating cash flow to current liabilities ratio measure

company's ability to liquidate current liabilities

direct stockholders equity

contributed capital: -common stock -additional paid in capital -preferred stock -treasury stock

benefits of supplying accounting information

cost of capital recruiting efforts improved supplier-customer relations

costs of disclosure

costs of preparing and distributing financial information competitive disadvantage (competitors can see your information) potential for litigation political costs

trade credit

credit from suppliers routine and often not interest bearing mostly AP

to minimize potential loss, lenders structure credit terms including

credit limits collateral repayment terms covenants

2 possibilities for why BDE would decrease but ADA remains sufficient

credit quality has improved underestimating allowance account

accumulate other comprehensive income or loss

cumulative changes in asset liability fair values that are not reported in the income statement

retained earnings

cumulative net income that has not been distributed to stockholders via dividends or share repurchases

how do managers and employees use financial statements

current and future financial health

why does the market respond to changes in net income

current period earnings are linked to expected future earning which are liked to expected future dividends which is linked to current share price

TCJA changes to foreign profits and repatriation

deemed foreign earning repatriated and decreased repatriation tax

DuPont analysis

disaggregates ROE into components of profitability, productivity, and leverage

fundamental firm specific data

dividends cash flows earnings

what is adjusted ROA

does not use net income which includes the effects of financing decisions excludes the effects of financing

market mulitples

earnings book value

how do voters and their representatives use financial statements

economic, social, taxation, and other initiatives, and to monitor government spending

revenue recognition for right of return

estimate the expected return and recognize NET revenue when control of the goods transfers to customers

opportunity for fraud in cost to cost method

estimated cost of construction could be wrong, mistaken, or biased management could use cookie jar strategy by estimating higher and recognizing less revenue in year one and more in year two

which part of the reason markets respond to change is invisible

expected future earnings expected future dividends

depreciation

expensing/ using up future benefits

how do regulators and tax agencies use financial statements

for antitrust assessments, public protection, setting prices, import-export analyses, and setting tax policies

Additional SEC information

form 10-K and 10-Q form 8-K

2 camps of valuation models

fundamental firm specific data and market multiples

asset

future economic benefits -owned or controlled by the company -arise from a past transaction or event

liabilities

future economic sacrifices -future cash outflows or unearned revenues -unavoidable obligation for the company -must arise from a past transaction or event -can be interest bearing or non interest bearing

ways to assess profitability

gross profit margin operating expense margin profit margin

what does operating cash flow to capital expenditures ratio measure

helps assess firms ability to replace and expand its PPE from internally generated cash flows (higher indicated growth)

tradeoff of maximizing financial leverage

higher leverage (more debt) means higher risk, but also ROE is magnified from ROA

quality of income ratio >1

higher quality income, more likely to persist

what does NOPM reveal

how much operating profit the company earns from each sales dollar

other long term liabilities

ie pension liabilities and long term tax liabilities will be settles a year or more in the future

how to increase ROA

increase profit margin (profitability for a given level of assets) increase asset turnover ( reduce assets while still generating the same profit level)

form 8-K

informational form for a wide range of corporate events, reported within 4 days

how does judicial use of financial leverage benefit stockholders

it is a relatively inexpensive source of capital but it adds risk because debt repayment is mandatory

is income tax expense operating or not operating

it is both operating and nonoperating

benefit of using EBITDA coverage

its a better measure of actual cash flow the company has to pay interest bc depreciation and amortization are not cash flows

why are most assets reported at historical cost

its verifiable and objective current market value is more subjective

why is it important to read tax footnotes

large benefits or changes in provision may be due to tax conflict with IRS that was settled

term of loan

length of time the creditor has to repay the debt shorter=less risk longer= more risk= more chance of default= higher cost of debt financing as compensation for risk

covenants

loan terms and conditions designed to limit the loss given default includes credit limits, collateral, and repayment terms

what is a preferrable cash conversion cycle

lower bc it indicates the operating cycle is generating profit and cash flow quickly

forecast

make realistic assumptions assumptions must also be rational and achievable

problem with sales allowances

management judgement is baked in, potential for fraud

matching principle

match expenses with related revenues

income statement

measures income using GAAP principles and provides information about the economic viability of the company's products and services

ROA

measures return from perspective of the entire company company must be profitable and manage assets to have high ROA managers must focus on IS and BS

financial leverage

measures the relative use of debt versus equity to finance the company's assets

more unearned revenue means

more future revenue

research and development expense

must be expensed immediately (as incurred) expenses and revenues are mismatched (exp in early years, rev in later years)

soft numbers

net AR ( ADA is the soft part) easier to fudge

Accounts Receivable (net)

net means after uncollectable accounts have been subtracted

common sotck

par value received from the original sale of common stock

revenue recognition for multiple element contracts

performance oligations fulfilled at various points in time recognize revenue when each performance obligation is satisfied ( rev generally allocated based on FMV)

long term debt

principal loan amounts that are scheduled to be repaid more than one year -includes bonds, notes, debentures, mortgage, and other long term loans

ways to achieve competitive advantage

product differentiation cost leader

collateral

property pledged by the borrowers to guarantee repayment, most often real estate

Long term assets

property, plant, and equipment (PPE), net long term investments intangible and other assets

statement of cash flows

provides information about the company's ability to generate cash from those same transactions

how to improve profitability

raise prices cut costs

internal aspects of SWOT

strengths and weaknesses

SWOT analysis

strengths, weaknesses, opportunities, threats

Altman's Z score

stronger company has higher score (>3) lower score more risk of bankruptcy (<1.8)

tax shield

taxes that a company saves by having tax-deductible nonoperating expenses

mortgages

term loan based on collateral, typically real estate

what is NOPM affected by

the level of gross profit the level of operating expenses the level of competition

credit limits

the maximum that a creditor will allow a customer to owe at any point in time

What does NOAT measure

the productivity of the company's net operating assets

operating cycle

the time between paying cash for goods and receiving cash from customers - affects the amount of net working capital required to conduct business

what does times interest earned tell us

the wiggle room the company has/ if they could take on more debt 1= barely paying the interest they have, want it to be higher than 1 (more like 10-20)

how do customers and strategic partners use financial statements

to assess a company's ability to provide products or services and to assess the company's staying power and reliability

how do stockholders and directors use financial statements

to assess the profitability and risks of companies and other information useful in their investment decisions

how do creditors and suppliers use financial statements

to help determine loan terms, loan amounts, interest rates, and required collateral

what is the purpose of analyzing credit risk

to quantify the risk of loss from non payment

why does full credit analysis include an assessment of the number of existing liens on the collateral

to see where you may fall in the line of preference

financing activities involve

transactions with lenders and shareholders

form 10-Q

unaudited quarterly report that includes summary versions of the 4 financial statements and limited disclosures

preferred stock

value received from the original sale of preferred stock to investors

what does a negative average cash conversion cycle indicate

very good company can invest cash it receives from customers before paying suppliers

profit margin

what the company earns on each sales dollar

schedule II of 10-K

where companies provide a reconciliation of their sales allowances to try to prevent fraud

cookie jar strategy

where net income is stored when not needed in a given year (for example by inflating ADA) and then used when needed (by decreasing bad debt expense and allowing ADA to shrink)

why is improving PPE turnover difficult

you have to consider the affects it would have on other ratios to make this look better

closing process

zeroing out of temporary income, expense, and dividend accounts