z_final prep
4.4 What are the most common changes we typically make to a company's financial statements before building a model for the company
Consolidate smaller and less important line items on the BS and CFS. Show Depreciation and Amortization as separate, explicit line items on the IS, if possible. Net together all Deferred Tax line items into one single item on the BS. If the CFS does *not* start with Net Income, modify it so that it does.
2.49 What options does a company have if it generates positive and growing Free Cash Flow
Hire more employees. Spend more on Working Capital items. Spend more on Capital Expenditures. Start investing in financial assets such as stocks and bonds. Repay outstanding debt. Issue dividends or repurchase shares. Acquire other companies.
2.22 Why would a company choose to use accelerated depreciation on the tax version of its financial statements
If certain assets are more useful in the first few years but become less useful over time. To reduce the present value of its tax payments. To reduce cash taxes in earlier years following CapEx spending.
2.31 Why might a company write down its Goodwill balance following an acquisition
If the entire acquired company turns out to be worth less than expected.
2.21 What's one DIFFERENCE between the financial statement impact of raising debt vs. raising equity
In the long-term, debt will impact Net Income, but equity will not.
2.48 What makes the BIGGEST impact on the Change in Working Capital for most retailers
Inventory purchases.
4.10 How should the Amortization of the Debt Discount change over time when you track the book value of a Convertible Bond
It should increase gradually over time as the Discount goes away.
2.30 How does an acquisition impact a company's Net Income vs. Cash Generated
It's impossible to give a general rule since it depends on the acquired company's financials, the method of payment, and so on.
4.7 What happens to a quickly growing company's operating margin if you assume that its Revenue per Employee figure doubles and fully-loaded Costs per Employee rise by 5% per year over 4-5 years
Its margin should increase because it has become twice as efficient with employees, but its costs per employee are only up by ~25-30%.
4.6 What is the key difference between Maintenance Revenue and Subscription Revenue for a software company
Maintenance Revenue corresponds to a percentage of Perpetual License customers who sign up for it; Subscription Revenue does not.
2.40 Why is it more difficult to project the financial statements for companies that follow IFRS
Many international companies use the direct method for preparing the CFS.
2.37 A company issues $100 million of equity in the form of 10 million new shares. How do Common Stock and APIC change if the share price increases from $10.00 to $20.00 the next month
Neither Common Stock nor APIC would change.
2.13 In the FIRST year of CapEx spending, how are Net Income and Cash Generated impacted
Net Income will decrease, and Cash Generated will decrease.
2.14 In the year FOLLOWING initial CapEx spending, how are Net Income and Cash Generated impacted
Net Income will decrease, but Cash Generated will increase.
1.6 Your friend argues that a company's Present Value is negative because its Cash Flow is $100, its Discount Rate is 10.0%, and its Cash Flow Growth Rate is 12.0%. Is he correct?
No - the Cash Flow Growth Rate must always be less than the Discount Rate in this formula
2.39 Which of the following rules do you need to follow when linking the financial statements
On the Asset side, always SUBTRACT items on the CFS if you're linking to the CFS. On the Liabilities & Equity side, always ADD items on the CFS if you're linking to the CFS. If an Asset increases, cash flow should go down; vice versa if a Liability increases. Each change on the Balance Sheet must be reflected once and only once on the CFS, and vice versa.
5.1 How does IFRS 16 affect Operating Income and Net Income for EasyJet
Operating Income will increase, and Net Income will stay the same.
3.4 Which of the following tend to be HIGHER under capital leases and LOWER under operating leases
Operating Income.
3.3 How are operating leases different from capital leases (or "finance leases")
Operating leases do not transfer ownership at the end of the lease term. With operating leases, companies only record a rental expense within operating expenses - no interest or depreciation. With capital leases, the assets and debt to fund the assets are both recorded on the Balance Sheet.
2.29 How Are Goodwill and Other Intangible Assets different
Other Intangible Assets are amortized under both US GAAP and IFRS, whereas Goodwill stays the same unless it is impaired. Other Intangible Assets correspond to IDENTIFIABLE assets, such as trademarks, contracts, or customer relationships - Goodwill does not. Other Intangible Assets are typically created FIRST, and then Goodwill is used to "plug the remaining gap."
3.9 Which of the following points make pension accounting so difficult
Parts of the relevant pension items may be shown explicitly on the statements, but other parts may not be. It's VERY discretionary and depends on far-in-the-future assumptions. It's highly dependent on actuarial assumptions for variables like the mortality rate and average length of employee service. "Smoothing" techniques attempt to reduce volatility in plan asset returns over time, but they also obfuscate what is really happening.
2.43 For which industry are you MOST likely to see Pension Liabilities and other Postretirement Benefit Obligations on the Balance Sheet
Power & utilities companies.
2.50 Which of the following items should NEVER factor into the Free Cash Flow calculation
Purchases and sales of securities.
3.6 If a company switches from capital leases to operating leases, how will its Return on Equity (ROE) be impacted
ROE will likely increase because Net Income will rise.
2.53 How is Return on Invested Capital (ROIC) DIFFERENT from Return on Equity (ROE)
ROIC is based on NOPAT rather than Net Income. ROIC uses Total Debt + Equity in the denominator rather than just Shareholders' Equity. ROIC better reflects funding from all sources.
5.2 How might we determine the proper ASK growth rate for EasyJet in different scenarios
Refer to the company's fleet plans and base the percentage changes on the minimum and maximum aircraft in each period. Look at the company's historical ASK growth rate in periods of growth and downturns. Look at the company's capacity growth plans disclosed in earnings reports and press releases.
2.2 If Net Income equals Cash Generated by the business, which of the following conditions must be true
Revenue must be collected immediately, upfront in cash, from customers. All expenses must be paid out immediately in cash. Products and services must be delivered immediately upon payment. and more!
3.12 Which of the following items INCREASE the Pension Expense shown on the Income Statement
Service Cost.
2.41 What is "Common Stock" typically labeled under IFRS
Share Capital.
2.34 Why might a company's Depreciation number on its Income Statement NOT reflect the total amount of Depreciation
Some of the Depreciation expense may be embedded in other line items.
4.1 Should the operating margin in a 3-statement model change significantly over time
Sometimes, but usually only if there's a significant shift in the market or the company's business model.
2.52 How should you calculate EBITDA when comparing different companies
Take Operating Income from the IS, and add D&A from the CFS.
4.5 For Atlassian, how can we calculate the historical Subscription Revenue Billed & Recognized in a given year
Take Subscription Revenue on the IS and subtract the Subscription Revenue Deferred in the previous year.
4.3 What's the difference between the Book Value and Face Value of a company's Debt balance
The Book Value appears on the Balance Sheet; the Face Value does not. The company pays interest based on the Face Value of the Debt, not the Book Value. Book Value reflects issuance fees, amortization of issuance fees, and issuance discounts and premiums; Face Value does not.
3.17 How does the Deferred Tax Asset (DTA) change when a company with a 40% tax rate records a Pre-Tax Loss of $100 in the first year of its operations
The DTA increases by $40.
5.3 If an airline's ASKs increase by 10%, what might cause its Fuel Expense (the total amount, in dollars or other currency) to *decline*
The airline becomes significantly more fuel efficient by shifting its fleet to newer aircraft. Oil prices drop significantly. FX rates shift, and the airline pays for its fuel in one currency while earning revenue and paying for expenses in another.
2.19 How will a Gain or Loss impact the company's Net Income and cash generated
The asset sale itself will increase cash generated, but the Net Income impact depends on whether it's a gain or a loss.
2.55 What's the problem with using metrics and ratios to compare two arbitrary companies
The companies may be in industries with very different business models. One company may be mature and much lower-growth than the other. Each company may have very different investors and growth and profitability expectations.
2.47 Which of the following are possible reasons why Working Capital might be NEGATIVE
The company might collect a lot of cash upfront from customers, but then take years to recognize it as revenue. The company might turn over its inventory very quickly, but not pay suppliers and vendors quickly. The company might have very high accounts payable and accrued expense balances from owed payments.
4.13 How would the returns calculations in the Atlassian model change if we counted Stock-Based Compensation as a non-cash expense or assumed equity issuances in future years
The investment firm's stake in the company upon exit would be lower than the initial 8.3%. We'd need to estimate the number of new shares created by these activities. The company's Cash balance upon exit might be higher as a result of these activities.
3.5 What conditions must an operating lease satisfy to be counted as a capital lease
The lease term must be 75% or more of the asset's estimated useful life or The NPV of lease payments must exceed 90% of the asset's fair market value or There must be an ownership transfer option at the end of the lease term.
4.9 How can you tell in advance that add-on acquisitions may not make a significant near-term impact on the acquiring company's financials
The multiples paid for the acquisitions are very high, indicating low yields. The margins of the acquired companies are low, and they have far less revenue than the acquirer. The acquisitions initially have fairly low revenue and take many years to grow substantially.
3.15 How is a 30% ownership stake in Another Company represented on the Parent Company's financial statements
The statements only show 30% * Other Company's Net Income at the bottom of the IS, along with an asset for the 30% stake on the BS.
2.25 What is the DIFFERENCE between Dividends and Share Repurchases on the financial statements
They're similar, but they flow into different line items within the "Equity" section on the Balance Sheet.
2.32 How do a PP&E Write-Down vs. a Goodwill Impairment affect the financial statements DIFFERENTLY
They're very similar, but they reduce different Assets on the Balance Sheet.
2.3 Why might a company offer installment payment plans, even if such plans hurt its cash flow
To boost sales and win more customers.
2.26 Why might a company choose to issue Stock-Based Compensation (SBC) to employees
To incentivize employees to stay for the long-term. To "pay them" without really paying them in cash. To take advantage of tax savings, since SBC is tax-deductible.
1.4 What might cause a company's Present Value (PV) to decline?
We believe that its future selling value will decline (i.e., its share price will fall in the future). We expect that its future cash flows will decline, or that they will be more inconsistent than expected. Our opportunity cost changes, so even though the company's future cash flows might stay the same, their present value TO US changes.
4.2 When must CapEx and revenue growth be linked in a 3-statement operating model
When it's an industrial or manufacturing company whose growth depends heavily on hard assets and physical products. When there has been a strong relationship between the two historically. When the company doesn't have other key growth sources, such as acquisitions or purchases of intellectual property.
4.11 When would a company use up some, but not all, of its NOL balance to reduce its Taxable Income
When its current NOL balance is greater than its Taxable Income in a year.
2.17 What is the advantage of raising debt over raising equity
You don't give up any ownership in your company.
1.1 Which of the following steps must you always complete, regardless of the type of financial model you are building?
You must project revenue and expenses for the company you are analyzing.
2.45 Which of the following companies would you expect to have the HIGHEST Deferred Revenue as a percentage of total Liabilities & Equity
A subscription-based software company.
2.8 What is the difference between Accounts Payable and Accrued Expenses
AP is more for items with specific invoices, while AE is for monthly, recurring items without specific invoices.
2.42 Which of the following Balance Sheet items are you likely to see for BOTH restaurants AND retailers
Capital Leases.
3.18 How are Deferred Tax Liabilities (DTLs) different from Income Taxes Payable
DTLs mostly arise from different Depreciation methods or M&A deals, whereas Income Taxes Payable do not.
3.11 TRUE OR FALSE: Changes in actuarial estimates or assumptions could only make the Pension Benefit Obligation INCREASE
False.
2.51 Why might a company's FCF be INCREASING over time
Genuine, organic revenue growth because of increased sales. Higher margins due to economies of scale. Reduction of CapEx spending, whether wise or unwise. A change in business policies, such as paying suppliers more slowly. Restructuring efforts that reduce a company's ongoing operating expenses.
2.4 When would the Change in Accounts Receivable cause cash flow to INCREASE
If AR goes down (i.e., cash is collected), cash flow increases.
2.33 Which of the following conditions must be true for an item to appear on the Income Statement
It must correspond to the period of the Income Statement, and it must impact the company's taxes in some way.
1.5 If the IRR of an investment exceeds WACC, should you always invest?
Maybe - it also depends on the risk and how you want to allocate your money.
5.4 What might explain why an airline's Accounts Receivable % LTM Revenue is increasing in each historical half-year period
More customers have been paying on credit or in installments.
2.11 What happens on the Income Statement when a company orders $100 worth of Inventory
Nothing happens until the Inventory is turned into products, sold, and delivered to customers.
2.18 Which of the following events would impact a company's Income Statement
Selling investments at a different value than what you purchased them for.
2.27 How does Stock-Based Compensation impact the 3 financial statements DIFFERENTLY from an equity issuance
Stock-Based Compensation is tax-deductible, so it reduces Net Income but saves the company on taxes and boosts cash flow.
5.5 How might you surmise that EasyJet's CapEx per ASK should not increase by that much over 4 years
The company anticipates that its CapEx will rise only modestly, despite significant ASK growth.
2.24 Why might a company choose to issue dividends to equity investors
To "pay them back early" with its excess cash flow, and give them more attractive returns.
3.7 What is the MAIN difference between Available for Sale (AFS) vs. Held-to-Maturity (HTM) vs. Trading Securities
Unrealized Gains are treated differently.
2.36 Which of the following items would show up within Accumulated Other Comprehensive Income (AOCI)
Unrealized gains and losses. Foreign currency translation adjustments. Pension-related items and adjustments.
2.54 Why might you sometimes calculate Payables Turnover differently depending on the company
Because for some companies, payables will be more closely linked to COGS, but for others it's more linked to OpEx.
2.12 Why is Inventory considered an Asset
Because it will save the company on taxes in the future, since it paid the expense in cash previously and is recognizing it in a future period.
2.15 Why does the initial purchase of investments not appear on the Income Statement
Because it's not tax-deductible. Because it doesn't correspond to an item that only "lasts" for the period of the Income Statement. Because investments are only taxed based on capital gains when they are sold.
1.7 Why does the "Company Value" formula not always work in all financial modeling scenarios?
Because sometimes you care about "accounting" metrics, such as EPS, rather than cash flow. Because sometimes you pay more attention to the IRR vs. the Discount Rate. Because sometimes you care more about other factors, such as a company's ability to repay Debt over time.
2.28 Why do you almost always need to create Goodwill following an acquisition
Because the buyer almost always pays a premium to the seller's (Shareholders') Equity.
2.6 Why are Prepaid Expenses considered an Asset
Because the company will save on taxes in the future as a result of them. Because the expenses have already been paid in cash, and won't "cost" anything more. Because they will increase the company's cash balance in the future.
2.35 Why is the Prepaid Expenses line item considered an Asset
Because the company will save on taxes in the future since it will be recognized as a non-cash expense on the Income Statement.
1.2 Why is it not necessarily better to pay a higher upfront deposit, but no monthly rent, when renting an apartment?
Because the deposit you receive back at the end will be worth LESS than it is today. Because you could have earned something on that larger deposit in the meantime. Because the amount of rent you pay might be less than the potential earnings you're giving up.
1.3 Why is the Discount Rate higher for stock-market investments than it is for debt investments (i.e., lending money to people)?
Because the potential returns, but also the risk of losing your money, are both higher with stock-market investments.
2.5 Why might a company choose to prepay expenses
Because they might get a better deal by paying in advance.
2.10 Why is Deferred Revenue a Liability
Because you've already collected all the cash you ever will, and in the future you'll have to pay taxes (and maybe other expenses) associated with it.
3.10 Which of the following items impacts a company's Pension Benefit Obligation (the Liability)
Benefits Paid.
2.1 How are Cost of Goods Sold (COGS) and Operating Expenses (OpEx) different
COGS corresponds to per-unit expenses, whereas OpEx is for expenses that can't be linked to individual units sold.
3.2 If Inventory Costs have been increasing, what happens if a company switches from LIFO to FIFO
COGS decreases, but the ending Inventory balance increases.
2.7 What Income Statement line items might Accounts Payable correspond to
COGS. Operating Expenses. Other Expenses. Interest Expenses. Income Taxes.
2.16 How does debt impact Net Income and cash generated
Can't say because it depends on which time period you are in relative to the debt issuance.
2.23 If Deferred Taxes increases by $100, which of the following changes take place on the financial statements
Cash Flow from Operations increases by $100.
3.19 What happens on the financial statements (assuming a 40% tax rate) if a company records $10 of PIK Interest on a loan
Cash increases by $4.
2.38 What's an EXCEPTION to the "rule" that the Change in Working Capital on the CFS includes Current Assets and Current Liabilities
Cash is always excluded. Short-Term Investments are always excluded. Current Deferred Tax Liabilities may be excluded.
2.46 Which of the following are examples of CURRENT ASSETS and CURRENT LIABILITIES that you EXCLUDE from the Change in Working Capital calculation
Cash, Short Term Investments, and Short-Term Debt.
3.1 What makes it difficult to determine the proper COGS and Inventory numbers to use on the financial statements
Companies don't track how much they paid for individual "units" of Inventory. Inventory costs may rise or fall over time. Companies might use the costs of the latest purchases, or the earliest purchases.
3.16 If a Parent Company records Net Income of $100, and a company it owns 80% of records Net Income of $50, what is the Net Income Attributable to Parent on the Income Statement
$140
4.8 Why should CapEx remain higher than Depreciation for a growing company
Because companies typically need to make a net re-investment into their businesses to grow. Because Net PP&E should increase over time for growing companies. Because inflation means that today's capital spending will likely be higher than spending in past periods.
2.20 Which of the following companies would be MOST likely to raise equity rather than debt
A brand new start-up with no profits and no revenue yet. A company that cannot afford additional interest payments. A company that can raise equity at an extremely high valuation.
2.56 For which of the following companies would traditional Returns-based metrics such as ROE, ROA, and ROIC be LEAST meaningful
A high-growth subscription-based software company.
2.9 What's a real life example of Deferred Revenue
A year's worth of a monthly gym membership, paid for entirely in advance. A monthly newsletter that requires payment each quarter, in advance of receiving the newsletter for the first month. A carrier-subsidized phone that you purchase upfront in cash, and then use over the course of 2 years.
3.8 If an AFS Security's market value decreases by $10, what changes on the financial statements, assuming the company hasn't sold it yet
Accumulated Other Comprehensive Income (ADCI) declines by $10.
3.14 Which of the following items does NOT make a DIRECT impact on a company's Pension Expense as shown on the Income Statement
Actual Return on Plan Assets.
2.44 Which of the following line items would BOTH power & utilities companies AND high-growth clean-tech companies likely have in common
Asset retirement obligations (or equivalent).
3.13 What should you check to ensure that a company is following credible pension accounting practices
Assumptions for liability and expense discount rates. Expected vs. actual return on plan assets. Expected rate of salary increases. Targeted vs. actual plan asset allocation.
4.12 If you include add-on acquisitions in a 3-statement projection model, why do you assume that some of the acquisition spending gets allocated to deferred tax line items
Because D&A on write-ups of PP&E and new Intangibles is often not tax-deductible.
