CFAI 4- Financial Reporting and Analysis Flashcards
The ability to meet short-term obligations is generally referred to as …..,
and the ability to meet long-term obligations is generally referred to as ……..
The ability to meet short-term obligations is generally referred to as liquidity, and the ability to meet long-term obligations is generally referred to as solvency. Cash flow in any given period is not, however, a complete measure of performance for that period because, as shown in Example 1, a company may be obligated to make future cash payments as a result of a transaction that generates positive cash flow in the current period.
basic and diluted earnings per share on the face of the income statement.
Basic earnings per share is calculated using the weighted-average number of common (ordinary) shares that were actually outstanding during the period and the profit or loss attributable to the common shareowners.
Diluted earnings per share uses diluted shares—the number of shares that would hypothetically be outstanding if potentially dilutive claims on common shares (e.g., stock options or convertible bonds) were exercised or converted by their holders—and an appropriately adjusted profit or loss attributable to the common shareowners.
Financial Reporting Documents
Balance Sheet,
Statement of Comprehensive Income
(Income Statment; Other Compreensive Income)
The statement of changes in equity, variously called the “statement of changes in owners’ equity” or “statement of changes in shareholders’ equity,” primarily serves to report changes in the owners’ investment in the business over time.
Cash Flow Statment
Financial flexibility
is the ability of the company to react and adapt to financial adversities and opportunities.
Porque é que as Financial Notes são importantes?
IMPORTANTE PARA EXAME E VIDA BROW!
Porque nos dão uma ideia de como são calculados os financial statments. Para compararmos duas empresas os financial statments devem ter seguido as mesmas normas.
Overall, flexibility in accounting choices is necessary because, ideally, a company will select those policies, methods, and estimates that are allowable and most relevant and that fairly reflect the unique economic environment of the company’s business and industry. Flexibility can, however, create challenges for the analyst because the use of different policies, methods, and estimates reduces comparability across different companies’ financial statements. Comparability occurs when different companies’ information is measured and reported in a similar manner over time. Comparability helps the analyst identify and analyze the real economic differences across companies, rather than differences that arise solely from different accounting choices. Because comparability of financial statements is a critical requirement for objective financial analysis, an analyst should be aware of the potential for differences in accounting choices even when comparing two companies that use the same set of accounting standards.
.
MD&A como é que pode auxiliar um analista na hora de investir?
The management commentary or MD&A is a good starting place for understanding information in the financial statements. In particular, the forward-looking disclosures in an MD&A, such as those about planned capital expenditures, new store openings, or divestitures, can be useful in projecting a company’s future performance. However, the commentary is only one input for the analyst seeking an objective and independent perspective on a company’s performance and prospects.
Under international standards for auditing (ISAs), the objectives of an auditor in conducting an audit of financial statements are
- To obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement, whether due to fraud or error, thereby enabling the auditor to express an opinion on whether the financial statements are prepared, in all material respects, in accordance with an applicable financial reporting framework; and
- To report on the financial statements, and communicate as required by the ISAs, in accordance with the auditor’s findings.8
Quando são feitas auditorias às empresas a empresa que faz a auditoria emite uma opinião relativa ao conteúdo nos financial statment.
Os financial statment são classificados segundo 3 categorias….
An unqualified audit opinion states that the financial statements give a “true and fair view” (international) or are “fairly presented” (international and US) in accordance with applicable accounting standards. This is often referred to as a “clean” opinion and is the one that analysts would like to see in a financial report. There are several other types of opinions.
A qualified audit opinion is one in which there is some scope limitation or exception to accounting standards. Exceptions are described in the audit report with additional explanatory paragraphs so that the analyst can determine the importance of the exception.
An adverse audit opinion is issued when an auditor determines that the financial statements materially depart from accounting standards and are not fairly presented. An adverse opinion makes analysis of the financial statements easy: Do not bother analyzing these statements, because the company’s financial statements cannot be relied on.
“contra account.”
The estimated uncollectible amount is recorded in an account called allowance for bad debts. Because the effect of the allowance for bad debts account is to reduce the balance of the company’s accounts receivable, it is known as a “contra asset account.”
Any account that is offset or deducted from another account is called a “contra account.”
Endingretainedearnings
Endingretainedearnings
Assets
Equation (4a)
Endingretainedearnings=Beginningretainedearnings+ Netincome−Dividends
Or, substituting Equation 3 for Net income, equivalently:
Equation (4b)
Endingretainedearnings=Beginningretainedearnings+Revenues− Expenses−Dividends
This becomes the expanded accounting equation:
Equation (5a)
Assets = Liabilities + Contributed capital + Ending retained earnings
Or equivalently, substituting Equation 4b into Equation 5a, we can write:
Equation (5b)
Assets=Liabilities+Contributedcapital+Beginningretainedearnings+ Revenue−Expenses−Dividends
Accrual accounting
Accrual accounting requires that revenue be recorded when earned and that expenses be recorded when incurred, irrespective of when the related cash movements occur. The purpose of accrual entries is to report revenue and expense in the proper accounting period.
Accounting system:
Journal
Ledger
Trial Balance
Financial Statments
A journal is a document or computer file in which business transactions are recorded in the order in which they occur (chronological order). The general journal is the collection of all business transactions in an accounting system sorted by date. All accounting systems have a general journal to record all transactions. Some accounting systems also include special journals. For example, there may be one journal for recording sales transactions and another for recording inventory purchases.
A ledger is a document or computer file that shows all business transactions by account. Note that the general ledger, the core of every accounting system, contains all of the same entries as that posted to the general journal—the only difference is that the data are sorted by date in a journal and by account in the ledger. The general ledger is useful for reviewing all of the activity related to a single account. T-accounts, explained in Appendix 23, are representations of ledger accounts and are frequently used to describe or analyze accounting transactions.
A trial balance is a document that lists account balances at a particular point in time. Trial balances are typically prepared at the end of an accounting period as a first step in producing financial statements. A key difference between a trial balance and a ledger is that the trial balance shows only total ending balances. An initial trial balance assists in the identification of any adjusting entries that may be required. Once these adjusting entries are made, an adjusted trial balance can be prepared.
The financial statements, a final product of the accounting system, are prepared based on the account totals from an adjusted trial balance.
When, at the end of an accounting period, cash has not been paid with respect to an expense that has been incurred, the business should then record:
A.an accrued expense, an asset.
B.a prepaid expense, an asset.
C.an accrued expense, a liability.
- B is correct. Payment of expenses in advance is called a prepaid expense which is classified as an asset.
- C is correct. When an expense is incurred and no cash has been paid, expenses are increased and a liability (“accrued expense”) is established for the same amount.
When, at the end of an accounting period, cash has been paid with respect to an expense, the business should then record:
A.an accrued expense, an asset.
B.a prepaid expense, an asset.
C.an accrued expense, a liability.
•C is correct. When an expense is incurred and no cash has been paid, expenses are increased and a liability (“accrued expense”) is established for the same amount.
Long Term Contracts can be divided in accounting by
Under the percentage-of-completion method, in each accounting period, the company estimates what percentage of the contract is complete and then reports that percentage of the total
p.e: 50% of the cost on the first year means 50% of the revenue
Under the completed contract method, the company does not report any income until the contract is substantially finished (the remaining costs and potential risks are insignificant in amount), although provision should be made for expected losses. Billings and costs are accumulated on the balance sheet rather than flowing through the income statement.
UNDER IFRS and GAAP
Year 1. Under IFRS, Kolenda would recognize $3 million cost of construction, $3 million revenue, and thus $0 income. Under US GAAP, Kolenda would recognize $0 cost of construction, $0 revenue, and thus $0 income. The $3 million expenditure would be reported as an increase in the inventory account “construction in progress” and a decrease in cash.
Year 2. Under IFRS, Kolenda would recognize $2.4 million cost of construction, $2.4 million revenue, and thus $0 income. Under US GAAP, Kolenda would recognize $0 cost of construction, $0 revenue, and thus $0 income. The $2.4 million expenditures would be reported as an increase in the inventory account “construction in progress” and a decrease in cash.
Year 3. Under IFRS, Kolenda would recognize the $0.6 million cost of construction incurred in the period. Because the contract has been completed and the outcome is now measurable, the company would recognize the remaining $4.6 million revenue on the contract, and thus $4 million income. Under US GAAP, because the contract has been completed, Kolenda would recognize the total contract revenue (i.e., $10 million). Kolenda would recognize $6 million cost of construction and thus $4 million income. The inventory account “construction in progress” would be eliminated.
Installment Sales
sales in which proceeds are to be paid in installments over an extended period. For installment sales, IFRS separate the installments into the sale price, which is the discounted present value of the installment payments, and an interest component. Revenue attributable to the sale price is recognized at the date of sale, and revenue attributable to the interest component is recognized over time.
Under US GAAP, when the seller has completed the significant activities in the earnings process and is either assured of collecting the selling price or able to estimate amounts that will not be collected, a sale of real estate is reported at the time of sale using the normal revenue recognition conditions.22 When those two conditions are not fully met, under US GAAP some of the profit is deferred. Two of the methods may be appropriate in these limited circumstances and relate to the amount of profit to be recognized each year from the transaction: the installment method and the cost recovery method. Under the installment method, the portion of the total profit of the sale that is recognized in each period is determined by the percentage of the total sales price for which the seller has received cash. Under the cost recovery method, the seller does not report any profit until the cash amounts paid by the buyer—including principal and interest on any financing from the seller—are greater than all the seller’s costs of the property. Note that the cost recovery method is similar to the revenue recognition method under international standards, described above, when the outcome of a contract cannot be measured reliably (although the term cost recovery method is not used in the international standard).
Expense Recognition
2 methods
Matching principle- as despesas que se podem relacionar diretamente com as vendas são declaradas no mesmo período que os revenue. p.e. Cost of goods
Period Costs- as despesas que não se podem relacionar diretamente com as vendas feitas são declaradas no período em que incorrem. (p.e. admistrative expenses)
Under US GAAP what can u consider an operating activitie?
Under US GAAP, operating activities generally involve producing and delivering goods and providing services and include all transactions and other events that are not defined as investing or financing activities
Specifically, under IFRS, interest and dividends received can be shown either as operating or as investing on the statement of cash flows, while under US GAAP interest and dividends received are shown as operating cash flows. Under IFRS, interest and dividends paid can be shown either as operating or as financing on the statement of cash flows, while under US GAAP, interest paid is shown as operating and dividends paid are shown as financing.)
Complex capital structure vs simple capital structure?
When a company has issued any financial instruments that are potentially convertible into common stock, it is said to have a complex capital structure. Examples of financial instruments that are potentially convertible into common stock include convertible bonds, convertible preferred stock, employee stock options, and warrants.48 If a company’s capital structure does not include such potentially convertible financial instruments, it is said to have a simple capital structure.
Diluted EPS vs Basic EPS
The distinction between simple versus complex capital structure is relevant to the calculation of EPS because financial instruments that are potentially convertible into common stock could, as a result of conversion or exercise, potentially dilute (i.e., decrease) EPS. Information about such a potential dilution is valuable to a company’s current and potential shareholders; therefore, accounting standards require companies to disclose what their EPS would be if all dilutive financial instruments were converted into common stock. The EPS that would result if all dilutive financial instruments were converted is called diluted EPS. In contrast, basic EPS is calculated using the reported earnings available to common shareholders of the parent company and the weighted average number of shares outstanding.
BasicEPS=
Netincome−PreferreddividendsWeightedaveragenumberofsharesoutstanding
The weighted average number of shares outstanding is a time weighting of common shares outstanding. For example, assume a company began the year with 2,000,000 common shares outstanding and repurchased 100,000 common shares on 1 July. The weighted average number of common shares outstanding would be the sum of 2,000,000 shares × 1/2 year + 1,900,000 shares × 1/2 year, or 1,950,000 shares. So the company would use 1,950,000 shares as the weighted average number of shares in calculating its basic EPS.
It is possible that some potentially convertible securities could be antidilutive
what is that?
By antidilutive means that basic EPS could be lower than diluted EPS.
Analysis of the income statment methods
Common Size analysis:
Neste método de análise colocamos os income statment lado a lado e calculamos os rácios para apreender de onde poderão vir as discrepâncias. Mais usado para comparar empresas do mesmo sector.
Income Statment ratios:
Profit Margin : net income/revenue,
gross profit margin….
Comparar indicadores e o porque dos indicadores subirem de ano para ano ou descerem.. mais profit? menos revenue? sustentável? etc…
Standard Setting Bodies Vs Regulatory Authorities
Standard Setting Bodies definem as regras que as regulatory authorities por sua vez vão legislar.
Objectives of securities Regulation
Protecting Investors
Ensuring that markets are fair, efficient and transparent
Reducing systemic risk
Neutrality of information in the financial statements most closely contributes to which qualitative characteristic?
A.Relevance.
B.Understandability.
C.Faithful representation.
C is correct. The fundamental qualitative characteristic of faithful representation is contributed to by completeness, neutrality, and freedom from error.
Standard Setting approach
Multi step format
Single step format
Multi step presents gross profit it is most common in manufacturing and merchandise companies.
Single step não representa o gross profit.
Qualitative Characteristics of financial reporting
RELEVANT FAITHFUL are the most important 2 comparability verifiability timeliness understandability
Financial statments assumptions
Accrued accounting
Going concern
Frameworks to be effective must be:
Transparent
Consistent
Comprehensive
6.2. Barriers to a Single Coherent Framework
- Valuation: As discussed, various bases for measuring the value of assets and liabilities exist, such as historical cost, current cost, fair value, realizable value, and present value. Historical cost valuation, under which an asset’s value is its initial cost, requires minimal judgment. In contrast, other valuation approaches, such as fair value, require considerable judgment but can provide more relevant information.
- Standard-Setting Approach: Financial reporting standards can be established based on 1) principles, 2) rules, or 3) a combination of principles and rules (sometimes referred to as “objectives oriented”). A principles-based approach provides a broad financial reporting framework with little specific guidance on how to report a particular element or transaction. Such principles-based approaches require the preparers of financial reports and auditors to exercise considerable judgment in financial reporting. In contrast, a rules-based approach establishes specific rules for each element or transaction. Rules-based approaches are characterized by a list of yes-or-no rules, specific numerical tests for classifying certain transactions (known as “bright line tests”), exceptions, and alternative treatments. Some suggest that rules are created in response to preparers’ needs for specific guidance in implementing principles, so even standards that begin purely as principles evolve into a combination of principles and rules. The third alternative, an objectives-oriented approach, combines the other two approaches by including both a framework of principles and appropriate levels of implementation guidance. The common conceptual framework is likely to be more objectives oriented.
- Measurement: The balance sheet presents elements at a point in time, whereas the income statement reflects changes during a period of time. Because these statements are related, standards regarding one of the statements have an effect on the other statement. Financial reporting standards can be established taking an “asset/liability” approach, which gives preference to proper valuation of the balance sheet, or a “revenue/expense” approach that focuses more on the income statement. This conflict can result in one statement being reported in a theoretically sound manner, but the other statement reflecting less relevant information. In recent years, standard setters have predominantly used an asset/liability approach.
During 2009, Argo Company sold 10 acres of prime commercial zoned land to a builder for $5,000,000. The builder gave Argo a $1,000,000 down payment and will pay the remaining balance of $4,000,000 to Argo in 2010. Argo purchased the land in 2002 for $2,000,000. Using the installment method, how much profit will Argo report for 2009?
A.$600,000.
B.$1,000,000.
C.$3,000,000.
A is correct. The installment method apportions the cash receipt between cost recovered and profit using the ratio of profit to sales value (i.e., $3,000,000 ÷ $5,000,000 = 60 percent). Argo will, therefore, recognize $600,000 in profit for 2009 ($1,000,000 cash received × 60 percent).
Fairplay had the following information related to the sale of its products during 2009, which was its first year of business:
Revenue$1,000,000Returns of goods sold$100,000Cash collected$800,000Cost of goods sold$700,000
Under the accrual basis of accounting, how much net revenue would be reported on Fairplay’s 2009 income statement?
A.$200,000.
B.$900,000.
C.$1,000,000.
B is correct. Net revenue is revenue for goods sold during the period less any returns and allowances, or $1,000,000 minus $100,000 = $900,000.
•For 2009, Flamingo Products had net income of $1,000,000. At 1 January 2009, there were 1,000,000 shares outstanding. On 1 July 2009, the company issued 100,000 new shares for $20 per share. The company paid $200,000 in dividends to common shareholders. What is Flamingo’s basic earnings per share for 2009?
A.$0.80.
B.$0.91.
C.$0.95.
•C is correct. The weighted average number of shares outstanding for 2009 is 1,050,000. Basic earnings per share would be $1,000,000 divided by 1,050,000, or $0.95.
•Cell Services Inc. (CSI) had 1,000,000 average shares outstanding during all of 2009. During 2009, CSI also had 10,000 options outstanding with exercise prices of $10 each. The average stock price of CSI during 2009 was $15. For purposes of computing diluted earnings per share, how many shares would be used in the denominator?
A.1,003,333.
B.1,006,667.
C.1,010,000.
•A is correct. With stock options, the treasury stock method must be used. Under that method, the company would receive $100,000 (10,000 × $10) and would repurchase 6,667 shares ($100,000/$15). The shares for the denominator would be:
Shares outstanding1,000,000Options exercises10,000Treasury shares purchased(6,667)Denominator1,003,333
working capital
The excess of current assets over current liabilities.
The level of working capital tells analysts something about the ability of an entity to meet liabilities as they fall due. Although adequate working capital is essential, working capital should not be too large because funds may be tied up that could be used more productively elsewhere.
Current Assets
Among the current assets’ required line items are cash and cash equivalents, trade and other receivables, inventories, and financial assets (with short maturities).
2 methods to price inventories
- Standard cost, which should take into account the normal levels of materials, labor, and actual capacity. The standard cost should be reviewed regularly to ensure that it approximates actual costs.
- The retail method in which the sales value is reduced by the gross margin to calculate cost. An average gross margin percentage should be used for each homogeneous group of items. In addition, the impact of marked-down prices should be taken into consideration.
deferred income/revenue
liability
arises when a company receives payment in advance of delivery of the goods and services associated with the payment. The company has an obligation either to provide the goods or services or to return the cash received.
.
Recoverable amount:
The higher of an asset’s fair value less cost to sell, and its value in use.
- Fair value less cost to sell: The amount obtainable in a sale of the asset in an arms-length transaction between knowledgeable willing parties, less the costs of the sale.
- Value in use: The present value of the future cash flows expected to be derived from the asset.
Models to price property in accounting
Cost Model Historical cost - depreciation
Fair value The amount obtainable in a sale of the asset in an arms-length transaction between knowledgeable willing parties, less the costs of the sale.
Why companies get bought for more than the fair value and there is goodwill?
Economic Goodwill vs Accounting Goodwill
First, as noted, certain items not recognized in a company’s own financial statements (e.g., its reputation, established distribution system, trained employees) have value.
Second, a target company’s expenditures in research and development may not have resulted in a separately identifiable asset that meets the criteria for recognition but nonetheless may have created some value.
Third, part of the value of an acquisition may arise from strategic positioning versus a competitor or from perceived synergies.
Analysts should distinguish between accounting goodwill and economic goodwill. Economic goodwill is based on the economic performance of the entity, whereas accounting goodwill is based on accounting standards and is reported only in the case of acquisitions. Economic goodwill is important to analysts and investors, and it is not necessarily reflected on the balance sheet. Instead, economic goodwill is reflected in the stock price (at least in theory). Some financial statement users believe that goodwill should not be listed on the balance sheet, because it cannot be sold separately from the entity. These financial statement users believe that only assets that can be separately identified and sold should be reflected on the balance sheet. Other financial statement users analyze goodwill and any subsequent impairment charges to assess management’s performance on prior acquisitions.
Financial Assets na contabilidade das empresas são medidos pelo
justo valor na maioria dos casos,
só são medidos pelo custo quando são held to maturity , titulos não cotados em que não se consegue estimar fair value e empréstimos a outras empresas.
Treasury shares
Shares in the company that have been repurchased by the company and are held as treasury shares, rather than being cancelled. The company is able to sell (reissue) these shares. A company may repurchase its shares when management considers the shares undervalued, needs shares to fulfill employees’ stock options, or wants to limit the effects of dilution from various employee stock compensation plans. A purchase of treasury shares reduces shareholders’ equity by the amount of the acquisition cost and reduces the number of total shares outstanding. If treasury shares are subsequently reissued, a company does not recognize any gain or loss from the reissuance on the income statement. Treasury shares are non-voting and do not receive any dividends declared by the company.
Money received from customers for products to be delivered in the future is recorded as:
A.revenue and an asset.
B.an asset and a liability.
C.revenue and a liability.
B is correct. The cash received from customers represents an asset. The obligation to provide a product in the future is a liability called “unearned income” or “unearned revenue.” As the product is delivered, revenue will be recognized and the liability will be reduced.
Differences between IFRS and GAAP on CF
IFRS is more flexible.
Classification of cash flows:
◾Interest receivedOperating or investingOperating
◾Interest paidOperating or financingOperating
◾Dividends receivedOperating or investingOperating
◾Dividends paidOperating or financingFinancing
◾Bank overdraftsConsidered part of cash equivalentsNot considered part of cash and cash equivalents and classified as financing
◾Taxes paidGenerally operating, but a portion can be allocated to investing or financing if it can be specifically identified with these categories OperatingFormat of statementDirect or indirect; direct is encouragedDirect or indirect; direct is encouraged. A reconciliation of net income to cash flow from operating activities must be provided regardless of method used
Direct and Indirect Methods for Reporting Cash Flow from Operating Activities
The direct method shows the specific cash inflows and outflows that result in reported cash flow from operating activities. It shows each cash inflow and outflow related to a company’s cash receipts and disbursements. In other words, the direct method eliminates any impact of accruals and shows only cash receipts and cash payments. The primary argument in favor of the direct method is that it provides information on the specific sources of operating cash receipts and payments. This is in contrast to the indirect method, which shows only the net result of these receipts and payments. Just as information on the specific sources of revenues and expenses is more useful than knowing only the net result—net income—the analyst gets additional information from a direct-format cash flow statement. The additional information is useful in understanding historical performance and in predicting future operating cash flows.
The indirect method shows how cash flow from operations can be obtained from reported net income as the result of a series of adjustments. The indirect format begins with net income. To reconcile net income with operating cash flow, adjustments are made for non-cash items, for non-operating items, and for the net changes in operating accruals. The main argument for the indirect approach is that it shows the reasons for differences between net income and operating cash flows. (However, the differences between net income and operating cash flows are equally visible on an indirect-format cash flow statement and in the supplementary reconciliation required under US GAAP if the company uses the direct method.) Another argument for the indirect method is that it mirrors a forecasting approach that begins by forecasting future income and then derives cash flows by adjusting for changes in balance sheet accounts that occur because of the timing differences between accrual and cash accounting.
Como conciliar Balance Sheet com income statment para calcular CF statment?
p.e.
Initial Account Receivables (Balanc 0)+ Revenues (Inc Stat)- Cash collected from customers (CF)= Ending Acc receiv (Balanc 1)
Blue Bayou, a fictitious advertising company, reported revenues of $50 million, total expenses of $35 million, and net income of $15 million in the most recent year. If accounts receivable decreased by $12 million, how much cash did the company receive from customers?
A.$38 million.
B.$50 million.
C.$62 million.
C is correct. Revenues of $50 million plus the decrease in accounts receivable of $12 million equals $62 million cash received from customers. The decrease in accounts receivable means that the company received more in cash than the amount of revenue it reported.
Orange Beverages Plc., a fictitious manufacturer of tropical drinks, reported cost of goods sold for the year of $100 million. Total assets increased by $55 million, but inventory declined by $6 million. Total liabilities increased by $45 million, but accounts payable decreased by $2 million. How much cash did the company pay to its suppliers during the year?
A.$96 million.
B.$104 million.
C.$108 million.
A is correct. Cost of goods sold of $100 million less the decrease in inventory of $6 million equals purchases from suppliers of $94 million. The decrease in accounts payable of $2 million means that the company paid $96 million in cash ($94 million plus $2 million).
Black Ice, a fictitious sportswear manufacturer, reported other operating expenses of $30 million. Prepaid insurance expense increased by $4 million, and accrued utilities payable decreased by $7 million. Insurance and utilities are the only two components of other operating expenses. How much cash did the company pay in other operating expenses?
A.$19 million.
B.$33 million.
C.$41 million.
C is correct. Other operating expenses of $30 million plus the increase in prepaid insurance expense of $4 million plus the decrease in accrued utilities payable of $7 million equals $41 million.
Copper, Inc., a fictitious brewery and restaurant chain, reported a gain on the sale of equipment of $12 million. In addition, the company’s income statement shows depreciation expense of $8 million and the cash flow statement shows capital expenditure of $15 million, all of which was for the purchase of new equipment.
Balance sheet item
12/31/2009
12/31/2010
Change
Equipment$100 million$109 million$9 millionAccumulated depreciation—equipment$30 million$36 million$6 million
Using the above information from the comparative balance sheets, how much cash did the company receive from the equipment sale?
A.$12 million.
B.$16 million.
C.$18 million.
Solution:
B is correct. Selling price (cash inflow) minus book value equals gain or loss on sale; therefore, gain or loss on sale plus book value equals selling price (cash inflow). The amount of gain is given, $12 million. To calculate the book value of the equipment sold, find the historical cost of the equipment and the accumulated depreciation on the equipment.
◾Beginning balance of equipment of $100 million plus equipment purchased of $15 million minus ending balance of equipment of $109 million equals historical cost of equipment sold, or $6 million.
◾Beginning accumulated depreciation on equipment of $30 million plus depreciation expense for the year of $8 million minus ending balance of accumulated depreciation of $36 million equals accumulated depreciation on the equipment sold, or $2 million.
◾Therefore, the book value of the equipment sold was $6 million minus $2 million, or $4 million.
◾Because the gain on the sale of equipment was $12 million, the amount of cash received must have been $16 million.
Net income vs Operating CF
Operating CF what to consider
Turning to the operating section, the analysts should examine the most significant determinants of operating cash flow. Companies need cash for use in operations (for example, to hold receivables and inventory and to pay employees and suppliers) and receive cash from operating activities (for example, payments from customers). Under the indirect method, the increases and decreases in receivables, inventory, payables, and so on can be examined to determine whether the company is using or generating cash in operations and why. It is also useful to compare operating cash flow with net income. For a mature company, because net income includes non-cash expenses (depreciation and amortisation), it is expected and desirable that operating cash flow exceeds net income. The relationship between net income and operating cash flow is also an indicator of earnings quality. If a company has large net income but poor operating cash flow, it may be a sign of poor earnings quality. The company may be making aggressive accounting choices to increase net income but not be generating cash for its business. You should also examine the variability of both earnings and cash flow and consider the impact of this variability on the company’s risk as well as the ability to forecast future cash flows for valuation purposes. In summary:
◾What are the major determinants of operating cash flow?
◾Is operating cash flow higher or lower than net income? Why?
◾How consistent are operating cash flows?
Investing CF
What you should see on it?
Within the investing section, you should evaluate each line item. Each line item represents either a source or use of cash. This enables you to understand where the cash is being spent (or received). This section will tell you how much cash is being invested for the future in property, plant, and equipment; how much is used to acquire entire companies; and how much is put aside in liquid investments, such as stocks and bonds. It will also tell you how much cash is being raised by selling these types of assets. If the company is making major capital investments, you should consider where the cash is coming from to cover these investments (e.g., is the cash coming from excess operating cash flow or from the financing activities described in Step 4). If assets are being sold, it is important to determine why and to assess the effects on the company.
Financing CF
What you should see on it?
Within the financing section, you should examine each line item to understand whether the company is raising capital or repaying capital and what the nature of its capital sources are. If the company is borrowing each year, you should consider when repayment may be required. This section will also present dividend payments and repurchases of stock that are alternative means of returning capital to owners. It is important to assess why capital is being raised or repaid.
We now provide an example of a cash flow statement evaluation.
Common Size analysis units expressed
Common size analysis is usefull in CF analysis:
This method is also useful to the analyst in forecasting future cash flows because individual items in the common-size statement (e.g., depreciation, fixed capital expenditures, debt borrowing, and repayment) are expressed as a percentage of net revenue. Thus, once the analyst has forecast revenue, the common-size statement provides a basis for forecasting cash flows for those items with an expected relation to net revenue.
In common-size analysis of a company’s income statement, each income and expense line item is expressed as a percentage of net revenues (net sales). For the common-size balance sheet, each asset, liability, and equity line item is expressed as a percentage of total assets. For the common-size cash flow statement, there are two alternative approaches. The first approach is to express each line item of cash inflow (outflow) as a percentage of total inflows (outflows) of cash, and the second approach is to express each line item as a percentage of net revenue.
An analyst gathered the following information from a company’s 2010 financial statements (in $ millions):
Balances as of Year Ended 31 December
2009
2010
Retained earnings120145Accounts receivable3843Inventory4548Accounts payable3629
In 2010, the company declared and paid cash dividends of $10 million and recorded depreciation expense in the amount of $25 million. The company considers dividends paid a financing activity. The company’s 2010 cash flow from operations (in $ millions) was closest to
A.25.
B.45.
C.75.
B is correct. All dollar amounts are in millions. Net income (NI) for 2010 is $35. This amount is the increase in retained earnings, $25, plus the dividends paid, $10. Depreciation of $25 is added back to net income, and the increases in accounts receivable, $5, and in inventory, $3, are subtracted from net income because they are uses of cash. The decrease in accounts payable is also a use of cash and, therefore, a subtraction from net income. Thus, cash flow from operations is $25 + $10 + $25 – $5 – $3 – $7 = $45.
Cash flows from taxes on income must be separately disclosed under:
A.IFRS only.
B.US GAAP only.
C.both IFRS and US GAAP.
C is correct. Taxes on income are required to be separately disclosed under IFRS and US GAAP. The disclosure may be in the cash flow statement or elsewhere.
Green Glory Corp., a garden supply wholesaler, reported cost of goods sold for the year of $80 million. Total assets increased by $55 million, including an increase of $5 million in inventory. Total liabilities increased by $45 million, including an increase of $2 million in accounts payable. The cash paid by the company to its suppliers is most likely closest to:
A.$73 million.
B.$77 million.
C.$83 million.
C is correct. Cost of goods sold of $80 million plus the increase in inventory of $5 million equals purchases from suppliers of $85 million. The increase in accounts payable of $2 million means that the company paid $83 million in cash ($85 million minus $2 million) to its suppliers.
An analyst gathered the following information from a company’s 2010 financial statements (in $ millions):
Balances as of Year Ended 31 December
2009
2010 Retained earnings 120 145 Accounts receivable 38 43 Inventory 45 48 Accounts payable 36 29
In 2010, the company declared and paid cash dividends of $10 million and recorded depreciation expense in the amount of $25 million. The company considers dividends paid a financing activity. The company’s 2010 cash flow from operations (in $ millions) was closest to
A.25.
B.45.
C.75.
B is correct. All dollar amounts are in millions. Net income (NI) for 2010 is $35. This amount is the increase in retained earnings, $25, plus the dividends paid, $10. Depreciation of $25 is added back to net income, and the increases in accounts receivable, $5, and in inventory, $3, are subtracted from net income because they are uses of cash. The decrease in accounts payable is also a use of cash and, therefore, a subtraction from net income. Thus, cash flow from operations is $25 + $10 + $25 – $5 – $3 – $7 = $45.
Silverago Incorporated, an international metals company, reported a loss on the sale of equipment of $2 million in 2010. In addition, the company’s income statement shows depreciation expense of $8 million and the cash flow statement shows capital expenditure of $10 million, all of which was for the purchase of new equipment. Using the following information from the comparative balance sheets, how much cash did the company receive from the equipment sale?
Balance Sheet Item
12/31/2009
12/31/2010
Change
Equipment $100 M $105M $5M
Acc Depreciat$40M $46M $6 M
A.$1 million.
B.$2 million.
C.$3 million.
A is correct. Selling price (cash inflow) minus book value equals gain or loss on sale; therefore, gain or loss on sale plus book value equals selling price (cash inflow). The amount of loss is given—$2 million. To calculate the book value of the equipment sold, find the historical cost of the equipment and the accumulated depreciation on the equipment.
◾Beginning balance of equipment of $100 million plus equipment purchased of $10 million minus ending balance of equipment of $105 million equals the historical cost of equipment sold, or $5 million.
◾Beginning accumulated depreciation of $40 million plus depreciation expense for the year of $8 million minus ending balance of accumulated depreciation of $46 million equals accumulated depreciation on the equipment sold, or $2 million.
◾Therefore, the book value of the equipment sold was $5 million minus $2 million, or $3 million.
◾Because the loss on the sale of equipment was $2 million, the amount of cash received must have been $1 million.
Equity analysis vs Credit Analysis
In this 2 types of analysis what is the main focus on each one?
Equity analysis usually places a greater emphasis on growth, whereas credit analysis usually places a greater emphasis on risks
Financial Statement Analysis Framework
Quais são as 6 fases para o processo de análise?
1- Articulate the purpose and context of the analysis
2- collect input data
3- process data
4- analyze/interpret the processed data
5- Develop and communicate conclusions and recommendations
6- follow up
A vertical5 common-size balance sheet
e horizontal common size balance sheet?
A vertical só tem um período enquanto que a horizontal tem mais períodos para comparar.
Trend Analysis
o que é?
When looking at financial statements and ratios, trends in the data, whether they are improving or deteriorating, are as important as the current absolute or relative levels. Trend analysis provides important information regarding historical performance and growth and, given a sufficiently long history of accurate seasonal information, can be of great assistance as a planning and forecasting tool for management and analysts
As another example, consider the following year-over-year percentage changes for a hypothetical company:
Revenue+20%
Net income+25%
Operating cash flow–10%
Total assets+30%
o que podemos à partida analisar desta empresa?
Net income is growing faster than revenue, which indicates increasing profitability. However, the analyst would need to determine whether the faster growth in net income resulted from continuing operations or from non-operating, non-recurring items. In addition, the 10 percent decline in operating cash flow despite increasing revenue and net income clearly warrants further investigation because it could indicate a problem with earnings quality (perhaps aggressive reporting of revenue). Lastly, the fact that assets have grown faster than revenue indicates the company’s efficiency may be declining. The analyst should examine the composition of the increase in assets and the reasons for the changes.
