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AFM 212 > Chapter 1 (part 1) > Flashcards

Chapter 1 (part 1) Flashcards

Slideshow 1 (week 1) - Chapter 1 23 slides

1
Q

What is the purpose of a financial statement analysis?

A
  • It allows us to better understand a company’s current and future performance and financial condition.
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2
Q

What is a financial statement analysis

A
  • Its the the process of extracting information from financial statements.
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3
Q

Who are the people who need financial statements?

A

Managers
Investors and analysts
Creditors, lenders and rating agencies
Regulatory agencies

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4
Q

What are the benefits of high quality financial disclosure?

A

Access to capital
Good reputation
Valuation and analysis
Risk assessment
Others

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5
Q

What are the costs of high quality financial disclosure?

A

Compliance and audit costs
Monitoring cost
Proprietary costs
Litigation costs
Others

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6
Q

What are the two primary reports that companies must supply?

A
  • Form 10-K
  • Form 10-Q
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7
Q

What is the form 10-K?

A
  • Its an audited annual report
  • It includes the four financial statements with explanatory notes and the management’s discussion and analysis of financial results.
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8
Q

What is form 10-Q?

A
  • Its the unaudited quarterly report
  • It includes the summary version of the four financial statements
  • And Limited additional disclosures
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9
Q

What does a manager have to consider when supplying accounting information?

A

Managers have to consider the benefits and costs of disclosure when deciding on the quantity and quality of accounting information to supply.

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10
Q

What are some additional sources of information that go beyond traditional financial statements?

A

Financial statement footnotes
Management discussion and analysis
Independent auditor report
Regulatory filings, including proxy statements (DEF 14A) and other SEC filings (8K)
Prospectus (S1)
Analyst Research Reports

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11
Q

What is the goal of the SEC regulation on Fair disclosure?

A

Its goal is to curb the practice of selective disclosure by public companies.

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12
Q

What is selective disclosure?

A
  • Selective disclosure is when a company shares nonpublic material information with certain individuals or groups, such as analysts or institutional investors, without making that information available to the public at the same time.
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12
Q

What does intentional disclosure mean?

A
  • If a public company intentionally discloses any material nonpublic information (important information that could affect the company’s stock price), it must simultaneously disclose this information to the public.
  • This ensures that all investors receive the information at the same time.
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13
Q

What are the two types of disclosure we see under the regulation fair disclosure (reg FD)?

A
  • Intentional disclosure
  • Unintentional disclosure (non-intentional disclosure)
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14
Q

What does unintentional (non-intentional disclosure) mean?

A
  • If a company unintentionally discloses material nonpublic information (accidentally shares it with a select group), it must make the information public promptly after realizing the mistake.
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15
Q

What are the different types of assurance of financial reports?

A

Notice to Reader (complication)
Review Engagement
Audit Engagement

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16
Q

What are all the factors that a ‘Notice to reader’ assurance engagement has?

Discuss:
- Assurance level
- Cost
- Complexity
- Scope
- Use

A

Assurance Level: None - Its assurance level is zero (none) meaning the financial information is simply compiled and without any assurance about its accuracy or validity.

Cost: Its cost is low

Complexity: Simple

Scope: The accountant organises financial data (information) provided by management but does not verify the data.

Usage: Its used for internal use or small companies

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17
Q

What are all the factors that a ‘review engagement’ assurance engagement has?

Discuss:
- Assurance level
- Cost
- Complexity
- Scope
- Use

A

Assurance level: Limited- Its assurance level is limited meaning the financial information do not have a full audit performed and financial statements are materially misstated

Cost: The costs are considered moderate

Complexity: Its complexity is intermediate

Scope: The accountant performs inquiries and some analytical procedures to provide limited assurance.

Usage: Typically used by small companies seeking loans or by private companies that want to provide some assurance to external investors without the full cost of an audit.

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18
Q

What are all the factors that a ‘audit engagement’ assurance engagement has?

Discuss:
- Assurance level
- Cost
- Complexity
- Scope
- Use

A

Assurance Level: Reasonable - The highest level of assurance that the financial statements are free of material misstatements.

Cost: High

Complexity : Complex

Scope: Includes both inquiry and detailed analytical procedures, as well as testing to verify the accuracy of the financial statements.

Usage: Required for public companies or large private companies seeking to issue bonds, obtain significant loans, or meet regulatory requirements.

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19
Q

What is the framework for analysis and valuation?

A
  • Its a step by step process used to perform both financial statement analysis and valuation
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20
Q

What is the financial statement analysis?

A
  • Its the process of extracting information from financial statements to better understand a company’s current and future performance and financial condition.
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21
Q

What is valuation?

A

Its the process of drawing on the results of financial statement analysis to estimate a company’s worth (enterprise value).

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22
Q

What are the five steps for a framework for analysis and valuation?

A

Industry Analysis
Porter’s 5 forces
Economic Cycle

Business Analysis
Business model
Competitive advantage
Business Cycle

Financial statement analysis
Ratio analysis
Common size statement analysis

Forecasting and valuation/Credit analysis
Financial modelling
DCF/Multiple
Collateral

23
Q

What is an industry?

A
  • An industry is a group of companies and organizations that produce similar products or provide similar services.
24
Q

How are industries classified?

A
  • Industries are classified based on the primary business activities of the companies within them.
  • Companies are grouped together based on what they primarily do or produce
25
Q

What is the FF12 Industry?

A

This is an example of a system that categorizes companies into one of 12 broad industry groups based on their primary business activities

26
Q

What are some commonly used industry classification systems?

A
  • NAICS
  • SIC
  • GICS
27
Q

What is the NAICS?

A
  • North American Industry Classification System
  • Its used mainly in the US, Canada, Mexico
  • It classifies businesses by the type of economic activity they engage in.
28
Q

What is the SIC?

A
  • Standard Industrial Classification
  • Its an older system used in some context
  • Usually used for historical data comparison and specific industries
29
Q

What is the GICS?

A
  • Global Industry Classification Standard
  • GICS was developed by MSCI and Standard & Poor’s
  • Mainly to be used by the global financial community specifically for investment research and portfolio management.
30
Q

What is the porter’s five forces?

A
  • These are five forces in the business environment that affect a company’s competitiveness.
31
Q

What are the porter’s five forces?

A
  1. Industry competition (existing competition)
  2. Bargaining power of suppliers
  3. Bargaining power of buyers
  4. Threats of substitution
  5. Barriers to entry (threat of entry)
32
Q

What are barriers to entry (threat of entry)?

A
  • These are unique industry characteristics that make it difficult for new competitors to enter the market overall.
33
Q

What does barriers help maintain? (barriers to entry)

A
  • These barriers help maintain the profitability of companies already operating in the industry by limiting the number of new entrants, which reduces competition.
34
Q

What are some types of barriers to entry?

A
  1. Organizational economies of scale - minimum efficient scale
  2. Patents and proprietary knowledge
  3. Regulatory/Government
  4. Asset Specificity
35
Q

What are some factors that affect the intensity of existing competition within an industry?

(itself + explanation of each factor)

Part 1

A

Number of companies:

  • More companies means companies must compete for some buyers and resources.
  • When companies have similar market shares they tend to fight for market leadership making competition even more intense
  • Herfindahl-Hirschman Index - This is a measure of market concentration and it helps determine how competitive an industry is based on the number and size of companies.

Slow industry growth:

  • Slow industry growth causes companies to fight for increased market share.
  • Slow industry growth causes companies to fight for increased market share.

Low switching cost:

  • If buyers can easily switch to a competitor’s product, competition is high.
36
Q

What are some factors that affect the intensity of existing competition within an industry?

(itself + explanation of each factor)

Part 2

A

High Fixed Costs and/or high storage costs:

  • Industries with high fixed costs (like factories, machinery, or equipment) must maximise production to lower their per-unit cost, leading to a fight for market share to cover these high costs

High exit barrier:

  • Companies may have to stay in competition due to it being expensive or hard to leave the industry.
  • They may be earning little or even negative returns on investment.
37
Q

What are some conditions that make entry easy in an industry?

A

A low scale threshold
Access to distribution channels
Common/Accessible technology
Low switching costs

38
Q

What are some conditions that makes exit easy in an industry?

A

Markable assets
Low exit costs
Independent business

39
Q

What are some conditions that make entry difficult in an industry?

A

High scale threshold
Restriction distributed channels
Patented or proprietary knowledge
High brand switching costs

40
Q

What are some conditions that make exit difficult in an industry?

A

Specialized assets
High exit costs
Interrelated business

41
Q

What does substitute products refer to?

A
  • Substitute products refer to products from other industries that fulfill the same need in a different way.
42
Q

What happens when competition is high?

A
  • Lack of buyer loyalty (If buyers don’t have strong loyalty to a particular brand, or there are no established brands, they are more likely to switch to substitute products.)
  • Cost savings (If switching to a substitute product saves buyers money without sacrificing quality or performance, they are more likely to choose the substitute.)
  • Ease of switching (If it’s simple and inexpensive for consumers to switch to a substitute product, competition from substitutes is higher)
  • Producers of Substitutes Have High Margins (If the producers of substitute products have high profit margins, they can reduce prices to attract more customers, increasing competition)
43
Q

How are buyers powerful (Bargaining power of buyers)?

A

If they purchase large volumes relative to supplier sales

Product is considered standard or undifferentiated

They can produce the product themselves

Supplier have high fixed costs

The product is not of strategic importance to the buyers

44
Q

How are suppliers powerful (Bargaining power of suppliers)?

A

The supply market is dominated by a few companies

The buyers are neither large nor concentrated

They do not have to contend with substitute products

Their products are differentiated or the suppliers have built up switching costs:

They pose a credible threat of forward integration

45
Q

What is the radar chart?

A
  • It shows the intensity of each of Porter’s Five Forces for different industries.
  • Each axis of the radar chart represents one of the porter’s five forces
  • The distance from the center represents the intensity of each force. The further a point is from the center, the stronger that force is in that particular industry.
46
Q

What is an economic cycle?

A

This shows the natural fluctuations of an economy over time.

47
Q

What are the phases of the economic cycle?

A

Expansion
Peak
Recession
Depression
Trough
Recovery

(cycle repeats)

48
Q

What is the Industry, Business and Product Life Cycle?

A

It shows the four stages that a product or business typically goes through:

Introduction
Growth
Maturity
Decline

49
Q

What happens during the introduction?

In your explanation:

explain the

  • sales
  • costs
  • profitability
  • competition
A

Take-off happens for the product

Sales: Low
Costs: High cost per customer
Profitability: Financial losses at this stage
Competition: Few competitors, if any

50
Q

What happens during the growth period?

A

It’s the shake-out stage:

Sales: Increasing sales
Costs: Cost per customer begins to fall
Profitability: Profits rise as the business scales
Competition: Increasing number of competitors

51
Q

What happens during the maturity stage?

A

It’s considered the saturation stage:

Sales: Peak sales
Costs: Cost per customer is lowest
Profitability: Profits are high
Competition: Stable number of competitors

52
Q

What happens during the decline stage?

A

Sales: Falling sales
Costs: Low cost per customer
Profitability: Profits fall
Competition: Number of competitors falls

53
Q

What does it mean when it says the external factors that affect industries?

A

These are factors that are beyond the control of the company and can cause its future results to differ from expectations.

54
Q

What are the five external factors that affect industries? (part 1)

A

Economic environment:
- Examples: Recession , Interest rate , Taxes

International:
- Examples: Local economic and labor conditions , Political instability , Tax laws , Local and national government regulation

Political environment:
Examples: regulations, elections, trade agreements, government policies

55
Q

What are the five external factors that affect industries? (part 2)

A

Social environment:
Customs and conventions
Cultural and fashion trends
Ethics and social issues

Technology:
New processes
New products

AFM 212 (6 decks)

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