2 Pager Flashcards
Walk me through the three major financial statements.
“The three major financial statements are the Income Statement, Balance Sheet and Cash Flow Statement.
The Income Statement gives the company’s revenue and expenses, and goes down to Net Income, the final line on the statement.
The Cash Flow Statement begins with Net Income, adjusts for non‐cash expenses and working capital changes, and then lists cash flow from investing and financing activities; at the end, you see the company’s net change in cash.”
The Balance Sheet shows the company’s Assets – its resources – such as Cash, Inventory and PP&E, as well as its Liabilities – such as Debt and Accounts Payable – and Shareholders’ Equity. Assets must equal Liabilities plus Shareholders’ Equity.
How do the 3 statements link together?
To tie the statements together, Net Income from the Income Statement flows into the top line of the Cash Flow Statement and into Shareholders’ Equity on the Balance Sheet, and Changes to Balance Sheet items appear as working capital changes on the Cash Flow Statement, and investing and financing activities affect Balance Sheet items such as PP&E, Debt and Shareholders’ Equity.
The Cash and Shareholders’ Equity items on the Balance Sheet acts as “plugs,” with Cash flowing in from the final line on the Cash Flow Statement.
If I were stranded on a desert island, only had 1 statement and I wanted to
review the overall health of a company – which statement would I use and why?
You would use the Cash Flow Statement because it gives a true picture of how much cash the company is actually generating, independent of all the non‐cash expenses you might have. And that’s the #1 thing you care about when analyzing the overall
financial health of any business – its cash flow.
What is deferred tax?
Deferred tax represents a company’s liability for taxes owed that is postponed to future periods. Deferred tax is primarily the result of tax law that allows firms to write off expenses faster than they are recognized and thus create a deferred tax liability.
A company makes a $100 cash purchase of equipment on Dec. 31. How does this impact the three statements this year and next year?
First Year: Let’s assume that the company’s fiscal year ends Dec. 31. The relevance of the purchase date is that we will assume no depreciation the first year.
Income Statement: A purchase of equipment is considered a capital expenditure which does not impact earnings. Further, since we are assuming no depreciation, there is no
impact to net income, thus no impact to the income statement. Cash Flow Statement:
No change to net income so no change to cash flow from operations. However we’ve
got a $100 increase in CapEx so there is a $100 use of cash in cash flow from investing activities. No change in cash flow from financing (since this is a cash purchase) so the net effect is a use of cash of $100. Balance Sheet: Cash (asset) down $100 and PP&E (asset) up $100 so no net change to the left side of the balance
sheet and no change to the right side. We are balanced.
Second Year: Here let’s assume straight-line depreciation over 5 years and a 40% tax rate.
Income Statement: Just like the previous question: $20 of depreciation, which results in a $12 reduction to net income. Cash Flow Statement: Net income down $12 and depreciation up $20. No change to cash flow from investing or
financing activities. Net effect is cash up $8. Balance Sheet: Cash (asset) up $8 and PP&E (asset) down $20 so left side of balance sheet down $12. Retained earnings (shareholders’ equity) down $12 and again, we are balanced.
What is the difference between enterprise value and equity value?
Enterprise Value represents the value of the operations of a company attributable to all providers of capital. Equity Value is one of the components of Enterprise Value and represents only the proportion of value attributable to shareholders.
What’s the formula for Enterprise Value?
Enterprise Value = Equity Value + Debt + Preferred Stock + Minority Interest ‐ Cash
What is the difference between basic shares and fully diluted shares?
Basic shares represent the number of common shares that are outstanding today (or as of the reporting date). Fully diluted shares equals basic shares plus the potentially dilutive effect from any outstanding stock options, warrants, convertible preferred stock or convertible debt. In calculating a company’s market value of equity (MVE) we always want to use diluted shares.
What are the three main valuation methodologies?
The three main valuation methodologies are (1) comparable company analysis, (2) precedent transaction analysis and (3) discounted cash flow (”DCF”) analysis. (4) LBO
Rank the 3 valuation methodologies from highest to lowest expected value
Trick question – there is no ranking that always holds. In general, Precedent Transactions will be higher than Comparable Companies due to the Control Premium built into acquisitions. Beyond that, a DCF could go either way and it’s best to say that it’s more variable than other methodologies. Often it produces the highest value, but it can produce the lowest value as well depending on your assumptions.
How would you present these Valuation methodologies to a company or its investors?
Usually you use a “football field” chart where you show the valuation range implied by each methodology. You always show a range rather than one specific number
How do you select Comparable Companies / Precedent Transactions?
The 3 main ways to select companies and transactions:
1. Industry classification
2. Financial criteria (Revenue, EBITDA, etc.)
3. Geography
For Precedent Transactions, you often limit the set based on date and only look at transactions within a limited amount of years. The most important factor is industry – that is always used to screen for companies/transactions.
Walk me through a DCF.
“A DCF values a company based on the Present Value of its Cash Flows and the Present
Value of its Terminal Value. First, you project out a company’s financials using
assumptions for revenue growth, expenses and Working Capital; then you get down to Free
Cash Flow for each year, which you then sum up and discount to a Net Present Value,
based on your discount rate – usually the Weighted Average Cost of Capital. Once you
have the present value of the Cash Flows, you determine the company’s Terminal Value,
using either the Multiples Method or the Gordon Growth Method, and then also discount
that back to its Net Present Value using WACC.
Finally, you add the two together to determine the company’s Enterprise Value.”
Walk me through how you get from Revenue to Free Cash Flow in the projections
Subtract COGS and Operating Expenses to get to Operating Income (EBIT). Then, multiply
by (1 – Tax Rate), add back Depreciation and other non‐cash charges, and subtract Capital
Expenditures and the change in Working Capital. Note: This gets you to Unlevered Free
Cash Flow since you went off EBIT rather than EBT. You might want to confirm that this is
what the interviewer is asking for. (Some companies hide D&A in COGS and Operating
Expenses)
How do you calculate WACC?
The formula is: Cost of Equity * (% Equity) + Cost of Debt * (% Debt) * (1 – Tax Rate) +
Cost of Preferred * (% Preferred). In all cases, the percentages refer to how much of the
company’s capital structure is taken up by each component. For Cost of Equity, you can
use the Capital Asset Pricing Model (CAPM – see the next question) and for the others you
usually look at comparable companies/debt issuances and the interest rates and yields
issued by similar companies to get estimates.
