Basic Questions Flashcards
4 Main Financial Statements? Give their equations
• Income Statement
o (Rev - COGS – Exp = Net Income)
• Balance Sheet
o (Assets = Liabilities + Shareholder’s Equity)
• Cash Flow
o (Start Cash + CFf Operations + CFf Investing + CFf Financing = End Cash)
• Statement of Stockholder’s Equity ( Shareholder’s or Owner’s Equity)
o (= Assets - Liabilities)
How are 3 Main Financial Statements Connected?
• Net Income from Income Statement to Cash Flow
o As CF from Operations or Operating Activities
• Net Income from Income Statement to Balance Sheet
o In calculation of Dividends
• Beginning Cash from Balance Sheet to Cash Flow
o Cash from Balance Sheet is used in Cash Flow Statement as Beginning and Ending Cash
What is the Income Statement and its stages?
First: Revenues or Sales Cost of Goods Sold is subtracted o Gives: Gross Profit OPEX are subtracted o Gives: EBITDA Depreciation / Amortisation subtracted o Gives: EBIT Interest Expense and Taxes subtracted o Gives: Net Income
If you can choose 1, which Financial Statement you choose to evaluate a company? What do other 2 not show?
Cash Flow
o Shows liquidity of company
o How much cash is generated / used
• Balance Sheet: does not show performance
• Income Statement: non-cash expenses unrelated to performance shown
What would your company’s budgeting process look like? What are its 5 specifications?
has feed-in from all departments in the company
realistic - yet strives for achievement
risk-adjusted for margin of error
is tied to the company’s overall strategic plan
should be easy to follow by everyone in the company
What makes a financial model good? Give 5 points?
Inputs separated from outputs
Interconnected variables amongst the model
Error checks at multiple stages
Contain detail in relation to the use: not too much not too few
Lean dashboards for input variables and key outputs
What happens to income statement if inventory goes up?
Nothing
o Only Balance Sheet and CF reflect inventory
What does negative working capital mean? Give example?
For a grocery store, customers pay upfront, inventory moves relatively quickly, but suppliers often give 30 days credit. This means that the company receives cash from customers before it needs the cash to pay suppliers.
Negative working capital is a sign of efficiency in businesses with low inventory and accounts receivable.
In other situations, negative working capital may signal a company is facing financial trouble if it doesn’t have enough cash to pay its current liabilities.
When do you capitalise rather than expensing a purchase?
If will be used more than a year, capitalised and depreciated
Why consider issuing Debt instead of Equity?
To optimise capital structure
o If its income is taxable, then debt can help benefit with tax
o If it has steady cash flows and able to make interest payments, then issuing debt lowers WACC
How does an inventory write down affect the 3 Financial Statements?
Balance Sheet: Asset account of Inventory reduced by writedown amount
Income Statement: Expense in COGS reducing net income
CF: writedown added back to CFf Operating Activities
Why would 2 companies merge?
- Cost savings
- Enter new markets
- Gain new tech
- Eliminate competitor
- Advantage in financial metrics
If you were CFO of your company, what keeps you at night? Reasons per statement and outside of statments?
Income Statement o Growth Rates o Margins o Profitability Balance Sheet o Liquidity o ROA o ROE CF o Short-Term & Long-Term cash profile o Need to raise money? o Returning capital to shareholders? Other than statements o Company structure and mission o Government regulation o Condition in the market as a whole
Difference of Debt vs Equity?
Debt involves borrowing money to be repaid, plus interest
Equity involves raising money by selling interests in the company
Which is cheaper, Debt or Equity? Why is it cheaper?
Debt is cheaper
o It is paid before equity and has collateral backing it
What is Cost of Debt? How does if reflect? What does it reflect? Where is it used?
Is the return provided to debtholders and creditos
o Usually calculated through interest rates
o Reflects default risk
o Used in calculating WACC
What is Cost of Equity?
What is it used for?
How can it be calculated?
Rate of return paid to equity investors.
o Used to assess attractiveness of investments
o Can be calculated using CAPM
EBITDA? What does it show? What can that be used for?
Earnings Before Interest, Taxes, Depreciation and Amortisation
Shows Profitability and Free Cash Flow
o Which then can be used to determine how much cash is available from operations to pay interest, capex, etc
o Can be used to determine EV/EBITDA
Enterprise Value EV? What does it mean? Give equation
Value of an entire Firm = Debt + Equity
Price to be paid for the acquisition of company
EV = Market Value of Equity + Debt + Preferred Stock + Minority Interest – Cash
Can company have Negative Book Equity Value? How? Give 2 reasons
Yes
o If has large cash dividends
o If operating at a loss for a long time
Ways to Value a Company? Give 6 ways
- Comparable Companies Analysis (Benchmarking)
- Market Cap or Market Valuation
- Precedent Transactions
- Liquidation Valuation
- DCF: Discounted Cash Flow
- LBO: Leveraged Buyout Model
What is LBO? What is its ratios? How can it be used aggresively?
Acquisition of another company using a significant amount of borrowed money (for the cost of acquisition).
90% debt to 10% Equity
Assets of the company bought (its success) are often used as collateral for the loans/debt, along with the acquirer company’s assets
Acquirer uses the bought company’s cash flow to pay off debt over time
What is Beta? What does it show?
Measure of volatility
o (or systematic risk) of a portfolio compared to the market as a whole
What is CAPM?
What does it describe?
How does it relate to ROA?
Capital Asset Pricing Model
o Describes relationship between Systemaic Risk (Beta) and Expected ROA
o Expected Return of Investment = Risk-free rate of return + Beta of asset * (Expected Market Return - Risk-free rate of return)
Risk free rate of return can be set to 10-year treasury note in USA
What is WACC?
What does it reflect?
Whats the equation?
When does it increase?
What does increase mean?
Weighted Average Cost of Capital: calculation of firm’s cost of capital in which each category of capital is proportionally weighted
o Reflects the cost raising new capital
o Reflects riskiness of a company
Take % of Debt to Total Capital * required ROE
o WACC of firm increases as
Beta & ROE increases
o WACC increase means:
Decrease in valuation
Increase in risk
What is FCF?
What is it a measure of?
Free cash flow: cash a company generates after cash outflows to support operations and maintain capital assets.
o Unlike earnings or net income, FCF is a measure of profitability that excludes the non-cash expenses of the income statement and includes spending on equipment and assets as well as changes in working capital from the balance sheet.
FCF is the cash flow available for the company to repay creditors or pay dividends and interest to investors
FCF = EBIT * (1 - T%) + D&A + CapEx + Change in NWC
What is DCF?
Discounted Cash Flow is a valuation method
o Estimate the value of an investment based on its expected future cash flows
o Value of an investment today, based on projections of how much money it will generate in the future
What is ROA? What does it indicate? What happens when its high? What about debt?
• Return on Assets
o Indicator of how profitable a company is relative to Total Assets
o How efficient a company’s management is at using its assets to generate earnings
o It is a percentage = higher the better
o ROA doesn’t count debt, ROE does. IF company has no debt then ROE=ROA
What is ROE? How is it calculated?
• Return on Equity
o Measures profitability in relation to Stockholder’s Equity
o Net Income / Shareholder’s Equity(=Assets-Debts so I t is Return on net Assets)
o Long Term Avg of S&P is 14%, around that acceptable, anything lower then 10% is poor
