Accounting Flashcards
How would a $10 increase in depreciation affect the statements?
Income statement: (40% tax): $10*(1-0.4)=$6 less income
CF statement: inc. red. by $6, depr. incr. by $10, $4 net incr. in cash from ops -> cash increases $4
Balance Sheet: $4 increase in cash, $10 loss in assets (depr.) -> net decrease of $6 -> drop in retained earnings
What are the 3 statements?
- Income Statement: Shows revenue and expenses which yield net income
- Balance Sheet: Shows assets and how company finances them
- Cash Flow Statement: Shows cash-flows since not every revenue or expense is cash-flow
effective
Which statement if only one?
Cash flow statement; positive cash-flows over long-term almost always mean healthy business
Which statement if only two?
Inc. statement and balance sheet because (assuming opening and closing statements available) you can use those to create the cash flow statement
How do the three statements link together?
To link them, make Net Income the top line for the Cash-Flow statement. Adjust the Net Income for any non-cash items such as D&A. Next, reflect changes to operational Balance Sheet items such as Acc. Receivable, which may increase or decrease the cash flow. That gets you to Cash-Flow from Operations. Then reflect investing and financing activities. Link cash on the Balance Sheet to the ending Cash number on the CFS and add Net Income to Retained Earnings within Equity on the Balance Sheet. Link non-cash adjustment to appropriate Asset or Liability (subtract links on asset side and add links on L&E side).
Which types of Cash-Flow are there?
- Cash-Flow from Operations
- Cash-Flow from Investments
- Cash-Flow from Financing
What does the Change in Working Capital mean, intuitively?
Tells you if the company needs to spend in advance of its growth or if it generates more money as a result of its growth
What does Equity Value and EV mean, intuitively?
Equity Value: Value of ALL asset but only to equity investors
EV: Value of core assets but to ALL investors
How/why unlever beta?
To set off debt part and see how equity reacts to market changes, alternatively use comparables if no market data available
A company goes from 20% debt to 30% debt. How does it change cost of equity, cost of debt and WACC?
Cost of debt and cost of equity always increase because risk of bankruptcy becomes higher. As company goes from no debt to some debt WACC decreases first because debt is cheaper than equity but then risk of bankruptcy outweighs lower cost of debt and WACC starts to increase
Could you have negative shareholders’ equity?
Yes, because of eiter
- LBO with dividend recapitalizations
- Company loses money consistently leading to negative retained earnings
What is working capital?
WC (“Umlaufvermögen”) = Current Assets – Current Liabliities
NWC = Acc. Rec. + Inventory – Acc. Payable …short-term assets are compared to short-term liabilities
If positive, then company can pay off its short-term liabilities with its short-term assets. It’s often used to tell if company is healthy.
When should Cash be included in WC?
Usually, cash is not included because WC wants to answer how much cash is tied up in WC. But there are exceptions such as Cash that is not freely available to use (“trapped cash”) such as in a register in a supermarket, that cannot be used for other purposes
Is negative WC bad?
Not necessarily, following situations:
- Subscriptions with high deferred revenue
- Retail companies like Amazon or McDonald’s often have negative WC because customers pay upfront. This can be a sign of business efficiency
- Could also point to financial trouble and possible bankruptcy
How is a cash outflow or cash inflow through WC calculated?
NWC CF = NWC (t0) – NWC (t-1)
When would you receive $100 but don’t recognize it as revenue?
If customer decides to prepay for service that is not yet delivered (in accr. accounting)
When customer cash is received but not yet recognized as revenue, what happens with it?
CF increases; Liabilities from prepayment gets created. Nothing happens on IS until revenue is recognized, liability disappears, while income and therefore retained earnings increase.
A company creates $100 of inventory and Accounts Receivable, while Accounts Payable increase by $50. Is the WC cash outflow necessarily $50 ($100 - $50)?
In most cases yes, but if there is an FX change it could be different (e.g. inventory is valued at $120 while FX reduces value to $100, then WC cash outflow could be $70).
What are the main drivers in NWC development?
- Bargaining power against suppliers: more power means longer payment horizons, more Acc. Payable and therefore less WC
- Bargaining power against buyers: reduces accounts receivables
- Inventory management: efficient inventory management leads to less inventory
- Company growth: two possible effects:
o Every variable in calculation usually gets bigger (already negative NWC companies get even more negative and positive ones get more positive)
o Growth can improve bargaining power and therefore move company from positive to negative NWC
Walk me through a $100 bailout and how it affects the 3 statements?
Confirm which type of bailout (debt, equity, combination of both,…). Usually an equity bailout by govt.
- No change in Income Statement
- CF Statement: CF from Financing +100
- BS: Cash +100; Equity +100
Walk me through a $100 write-down of debt – as in OWED debt. How does it affect the 3 statements?
When liability is written down, it’s recorded as a gain:
- Inc. Statement: +$100 pretax; +$60 NI (assuming 40% tax rate)
- CF: $60 NI - $100 write-down: Net Chg. In Cash is -$40
- BS: Cash -$40; debt -$100, RE +$60
When would company collect cash from customer and not record it as revenue?
- Web-based subscription software
- Cell phone carriers charging annual contracts
- Magazine subscriptions
If cash collected is not recorded as revenue, what happens to it?
Usually deferred revenue under liabilities. Over time it turns into real revenue on the IS
Difference between accounts receivable and deferred revenue?
Acc. Rec. has not been collected and represents how much rev. the company is waiting on. Def. Rev. has been collected but not recorded as revenue yet.
What’s the difference between cash-based an accrual accounting?
Cash-based recognizes revenue and expenses when cash is actually received or paid out. Accrual accounting recognizes revenue when collection is reasonably certain (e.g. after an order happened). Most large companies use accrual accounting because credit cards etc. are very common. Smaller businesses use cash-based acc. as it is simpler.
What would a TV purchase look like in both accounting types?
Cash-based: revenue would not show up until company charges the card, at which point it would show up as revenue on IS and cash on BS. In accrual accounting it would show up as revenue right away but instead of appearing in cash on BS it would go into Accounts Receivable first. It would only turn into cash once cash is actually received.
Under what circumstances would Goodwill increase?
Can increase if company re-assesses its value and finds out it is worth more, but it is very rare. Two types of scenarions:
- Company gets acquired (premium)
- Company buys other company and reflects newly acquired Goodwill in their statements
What impact does Goodwill have on NI?
Usually doesn’t, only during impairment, when NI is decreased.
What is a Goodwill Impairment?
Happens when company doubts actually paid price for investment. In the IS like D&A.
What’s the main difference between Goodwill and other Intangibles?
Other Intangibles usually get depreciated over time will Goodwill only does in case of an Impairment
How are subsidiaries consolidated in financial statements?
- Financial Asset (<20%): As financial asset in BS; value changes in IS (financial gain not operating income)
- Investments in Associates (20%-50%): Not consolidated, recognized with “at equity” method
- JVs (usually two parties hold 50% each): Also valued via “at equity” method
- Majority holdings (>50%): Total consolidation; everything that is not owned by mother is minority interest in equity. It is more important how much mother really controls than the actual percentage (40% could be enough for full consolidation)
How does the At-Equity Method work?
It is used to quantify investments at cost or FMV pro-rata to how big the investment from the mother company is. There is therefore no consolidation happening but a separate investment on the BS. Dividends and financial losses reduce the value of the investment, while profits increase the value. Dividends don’t go through mother IS, while profits and loss does.
A company buys 90% of another. What impact does this have on Equity?
Because company consolidates full financial statements it has to introduce Minority Interest on BS to account for other 10%.
What are Retained Earnings used for?
Cumulates profits and loss (after dividends)
How is GAAP accounting different from tax accounting?
- GAAP is accrual-based but tax is cash-based
- GAAP uses staright-line depreciation or similar whereas tax accounting uses accelerated depreciation
- GAAP is more complex and more accurately tracks assets/liabilities whereas tax accounting is only concerned with revenue/expenses in current period and what income tax you owe
What are deferred tax assets/liabilities and how do they arise?
They arise because of temporary differences between what company can deduct for cash tax purposes vs. what they can deduct for book tax purposes. The most common way they occur is with asset write-ups and write-downs in M&A deals. Asset write-up creates def. tax liab. while asset write-down creases def. tax asset.
Def. tax liab. arise when you have a tax expense on the IS but haven’t actually paid yet. Def. tax assets arise when you pay taxes but haven’t expensed them yet
Other example: Netflix incurs monthly cost for Jan. already in Dec. P&L now has additional cash for tax purposes but not for book purposes and therefore pays more taxes than it needs to acc. to books -> DTA is created
Walk me through how you create a revenue model for a company.
Two ways: bottoms-up build and tops-down build.
- Bottoms-Up: Start with individual products, estimate avg. sale and then growth rate in sales to tie everything together
- Tops-Down: Start with big picture metrics like overall market size, then estimate company’s market share and how it will change over time
Walk me through major items in Shareholders’ Equity.
- Common Stock: Value of however much stock the company has issued
- Retained Earnings: How much NI it has saved up over time
- Additional Paid in Capital: How much stock-based compensation has been issued and how much new stock employees exercising options have created. Also includes how much over par value a company raises in an IPO or other equity offering
- Treasury Stock: The dollar amount of shares that the company has bought back
- Accumulated Other Comprehensive Income: Catch-all that includes otherer items like FX rates changing
What is the Statement of Shareholders’ Equity and why do we use it?
Major items in Shareholders’ Equity as described above and how you achieve them. Can help analyzing companies with unusual stock-based comp.
What are examples of non-recurring charges we need back to EBIT/EBITDA when looking at financial statements?
- Restructuring charges
- Goodwill Impairment
- Asset Write-downs
- Bad Debt Expenses
- Legal Expenses
- Disaster Expenses
- Chg. In Accounting Procedures
How do you project BS items like Acc. Rec. and Accrued Expenses in a 3-statement model?
- Acc. Rec. & Def. Rev.: % of revenue
- Acc. Payable: % of COGS
- Accrued Expenses: % of operating expenses or SG&A
How should you project D&A or Capex?
% of revenue or previous PP&E balance. More complex: create PP&E schedules that splits out different assets by their useful lives, assuming straight-line depr. and assumed Capex based on historical data
