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