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AFM 182 > Chapter 6: Income Statement Analysis & Planning > Flashcards

Chapter 6: Income Statement Analysis & Planning Flashcards

1
Q

what is a business model

A

Captures how you create and deliver value to customers (value proposition) through your products/services and also capture value as a company (earning money through revenue streams)

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2
Q

what part of the business model canvas are you mainly looking at and where when analyzing company performance

A

mostly looking at the revenue streams and cost structures on the income statement

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3
Q

what are the 2 types of revenue streams

A
  • transactional
  • recurring
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4
Q

what are transactional revenue streams

A
  • Represents those for which a single sale can be made, without any further customer obligation
  • Company would need customers to keep these transactions if they want to keep making revenue
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5
Q

how do you determine if a revenue stream is transactional

A

if the offer requires you to pay once per product or use

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5
Q

what are examples of transactional revenue streams

A
  • Products (ex. $ per unit sold)
  • Usage (ex. $ per day snowboard rental)
  • Advertising (ex. $ per click on IG)
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6
Q

what are recurring revenue streams

A
  • Represents those where a customer is locked in an obligation to pay a recurring amount based on some set frequency
  • Company wouldn’t need to do anything to keep making revenue once they have customers
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7
Q

what are examples of recurring revenue streams

A
  • Rental (ex. $ per square foot/month)
  • Lease (ex. $ per car leased/month)
  • Subscription (ex. $ per user/month)
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8
Q

how do you determine if a revenue stream is recurring

A

if the offer requires you to pay continuously for the product/service

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9
Q

what are revenue drivers

A

What drives revenue

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10
Q

what are common revenue drivers

A

volume or price

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11
Q

for a transactional revenue stream what would be the volume and price driver

A

the volume driver would be the number of units sold, and the price driver would be the price of each unit

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12
Q

why are revenue drivers important

A
  • used to analyze the performance of a company
  • Helps management make meaningful and informed decisions
  • ex. If revenue decreased, why did it?
    Could be from a decrease in volume when the business decided to increase the prices
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12
Q

why should you distinguish if a company is a merchandiser or a service provider

A
  • because merchandisers have COGS, and service providers don’t
  • COGS for merchandisers is usually the most significant expense on the income statement
  • Because of this, the analysis of costs will differ depending on what the company sells
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13
Q

for a recurring revenue stream what would be the volume and price driver

A

the volume driver would be the number of customers (per month or year), and the price driver would be the price of the average subscription fee (per month or year)

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13
Q

what are examples of expenses

A
  • Salaries & Wages
  • Selling, General, and Administrative Expenses (SG&A)
    • Marketing & Advertising
    • Rent
    • Legal & Professional Fees
    • Utilities
    • Office Supplies
  • Depreciation
  • Other Administrative Expenses
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14
Q

which revenue driver is controllable, which isn’t

A
  • Price is a controllable driver
  • Volume is generally not controllable
  • Management can experiment with different prices, which could change the volume sold
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15
Q

what are cost drivers

A

All inputs that drive costs

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15
Q

what are cost structures

A

Represent all of the expenditures that are incurred to earn revenue

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15
Q

does it matter what kind of revenue structure a company has when determining their cost structure

A
  • no
  • only matters what the company is selling: a product or service (are they a merchandiser or service provider)
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15
Q

what are common cost drivers for COGS

A
  • # of units purchased
  • Cost ($) per unit
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16
Q

what are common cost drivers for salaries & wages

A
  • # of employees (headcount(HC))
  • Average salary/wage per employee
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16
Q

how do you determine what the cost drivers are

A
  • Depends on what type of cost is being analyzed
  • When analyzing performance by examining costs, need to first determine what type of cost you’re looking at to determine what drives it
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17
Q

what are common cost drivers for depreciation

A
  • depends on the type/category of assets owned
  • Depreciation method for each asset type
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17
Q

what is the goal of knowing cost drivers

A
  • to be able to analyze performance
  • Knowing cost drivers helps you know what is causing the expenses to be what they are
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18
Q

what is horizontal/trend analysis

A
  • Involves comparing line items over a span of time; variances in different line items across periods
  • Can be very detailed; analyzing every journal account against a comparative period (how detailed it is depends on who is using the information, and what they need from it)
  • Can be very high level; analyzing only the financial statement line items
  • Magnitude of variances by dollar amount and/or percentage needs to be considered
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18
Q

what are the 2 main types of financial analysis performed on the income statement

A

horizontal and vertical analysis

19
Q

who is the financial analysis done for

A
  • The analysis is done for management (internal) use only
  • Public companies can choose to include some analysis in their external reports, but usually only if it would provide critical information that would be useful to shareholders
  • Ex. To prevent shareholders from selling their shares from negative company performance or to encourage share purchases from favourable trends
20
Q

what are common time horizons used by public companies when performing horizontal analysis

A
  • Monthly analysis: Comparing current month’s results to prior month’s results
  • Quarterly analysis: Comparing current quarter’s results to prior quarter’s results or the same quarter in the previous year
  • Year-over-year (YoY) analysis: Comparing current year’s results to the prior year
21
Q

what is vertical analysis

A

Compares a journal account, grouping, or financial statement line item to a base, representing 100%

22
Q

what is the base used for vertical analysis on the balance sheet

A

Total assets are used as a base for balance sheet accounts and line items

23
Q

what is the base used for vertical analysis on the income statement

A

Total revenue is used as the base for income statement accounts and line items

24
Q

what is done for vertical analysis to be meaningful

A

its compared with previous figures, like prior month, quarter, or years

25
Q

how can you add additional value to the income statement analysis

A

use budget data/make budgets based on them

26
Q

what does budgets allow companies to analyze

A
  • since they are used to compare to actual results, they help analyze:
    1. Whether their expectations of future performance are reasonable
    2. Whether (and why) they performed, or didn’t perform, as expected
27
Q

what do financial analysts also examine to assess performance

A

other metrics and ratios

28
Q

what is ratio analysis

A
  • Examining key financial ratios
  • Truly comprehensive analysis is more than just looking at the ratios
29
Q

what can gross margin/profit % tell us

A
  • can tell us if the COGS is increasing or decreasing based on if it changes over the periods (and assuming prices don’t change)
  • If gross margins stayed the same, can conclude that COGS didn’t change (assuming prices don’t change)
  • Can also conclude that the fluctuations in the total revenues and expenses are caused by the sales volumes instead of other factors like increasing inventory prices
30
Q

what does companies also do when examining gross margin

A
  • Companies can also examine gross margins of their competitors to see if they are effective in securing competitive inventory prices or not pricing their products competitively
  • Helps them determine their performance in the overall marketplace
  • If gross margin of the company is much lower than the competitors, they may reconsider their relationships with current suppliers or attempt to negotiate better prices for its inventory
31
Q

what is operating/EBIT margin

A

Represents % of total revenue left over after all operating expenses have been paid

32
Q

what does a high (strong) operating margin indicate

A
  • indicates that the company’s operations are effective enough at driving the company’s growth
  • Tells us that the company doesn’t really need external financing to be successful in the foreseeable future
33
Q

when is operating/EBIT margin the most useful

A

when looked at across different times (using horizontal analysis) or compared to an industry average or competitors

34
Q

what is benchmarking

A

Analytical process of comparing a company’s metrics to the rest of the industry or competitors

35
Q

what is net profit margin/return on sales

A
  • Indicates what % of total revenue remains after ALL costs are paid
  • Is a %, but can also be interpreted as how many cents of profit the business generates for each dollar of sales made
36
Q

when is net profit margin most useful

A

Most useful when compared across time or when used in benchmarking

37
Q

why is net profit margin a particularly important profitability metric

A
  • it impacts the company’s ability to obtain financing
  • When a company seeks external financing (from more debt or equity), potential capital providers usually ask about net profit margin first
  • Potential lenders are looking to determine if a company will be capable of repaying its debt obligations
  • Potential equity investors will compare it to other companies to determine who would be the best option to invest in
  • Net profit margin also plays a key role in company valuations when it comes to pricing IPOs
38
Q

how do you do horizontal analysis on the income statement

A
  • Take the dollar amount from the most recent period and subtract from the prior period (= variance)
  • Take the variance and divide by the prior year # to get the variance % (Base period is the earlier period)
39
Q

what are you looking at when performing horizontal analysis

A
  • Usually have $ & % threshold
  • Pay attention to the analysis thresholds
  • What $ and % variances are the company looking for?
  • Determine whether the variance is expected
    Ex. COGS should be a certain % of revenue
  • Try to get 80% + “coverage” of the variance
    Ex. variance increased by $x, try to get an explanation for that variance
  • Quantify and explain WHY?
  • Something happened, but why??
40
Q

how do you do vertical analysis on the income statement

A

Take the amount from each of the line item and divide by the amount in the total revenues

41
Q

what are you looking at when performing vertical analysis

A
  • Pay attention to the analysis thresholds
  • What % variances are the company looking for?
  • Determine whether the variance is expected
    Ex. if revenue mix changes, COGS mix should change too
  • Coverage is not relevant the way it is in horizontal analysis
    Ex. variance increased by $x, try to get an explanation for that variance
  • Less focus on quantification, and more focus on WHY?
  • Why did something happen??
42
Q

why is analyzing company performance crucial for its long term success

A
  • can a company determine how well it’s performing and where corrective measures are necessary
  • When a company determines what’s working and what isn’t, they take action
  • Financial analysis has a stronger purpose behind it if they plan for the future through budgeting
43
Q

what is a budget

A
  • An estimate of a company’s financial results for the next fiscal year
  • Set before a fiscal year starts, and once approved and finalized they don’t change
  • Some companies also prepare long-term financial forecasts (usually for the next 3-5 years)
  • The long-term forecasts are a part of a company’s strategic planning
  • used to set internal financial targets for the fiscal year
44
Q

what is strategic planning

A

Lays out the company’s operation and financial plans over the medium to long term

45
Q

what should employees understand from the financial targets

A
  • Where the company is heading in the next fiscal year
  • What targets they are expected to meet
  • How they can contribute to meeting the financial targets
46
Q

what do companies do with their budget throughout the year and what does it help with

A
  • compared it against actual result
  • Helps internal management teams understand how business segments are performing and what decisions to make to improve performance
47
Q

are budgets shared with external stakeholders

A
  • Detailed budgets are usually not shared with any external stakeholders, but sometimes are to inform external stakeholders at a high level
  • Ex. public companies need to keep their shareholders informed, and they often communicate financial targets that the company plans to meet during the period
  • Ex. company informs shareholders about the amount of revenue they expect to achieve in the next fiscal year, or the operating margin % the company is targeting
  • but if a company’s lender (like the bank) requests company budgeted financial statements, the company will need to provide them
48
Q

what is financial planning & analysis (FP&A)

A
  • Teams in larger organizations that are responsible for all functions: financial analysis, budgeting, and forecasting
  • In smaller companies, there may not be a dedicated FP&A team, but certain individuals on the accounting/finance team will do the functions
49
Q

what is the budgeting process like

A
  • requires active participation from every business segment
  • Most companies prepare budgeted financial statements by month for the next fiscal years
  • For those that have a fiscal year that follows the calendar year, the budgeting process usually starts in September to ensure the final version is complete before the start of the next year
  • FP&A team is tasked with preparing the budget, but the process is highly collaborative & somewhat negotiated
  • Executive management, the C-Suite, will usually set some expectations and targets for the coming year
50
Q

what are the expectations executive management sets

A
  • These aren’t necessarily set in stone, unless the budget is a purely top-down budget
  • Expectations are set based on past experience + goals/targets for the future
51
Q

what are top down budgets

A

Those driven by executive management, with little to no input from the lower organizational levels

52
Q

what are bottom-up budgets

A

Those driven by lower-level staff and management, with little to no guidance from senior management

53
Q

what is hybrid budgeting

A
  • Executive expectations and targets are interpreted as guidelines, and there is a degree of flexibility for the FP&A team to manoeuvre within, although straying too far from them is not advisable
  • Senior Management —targets—> hybrid budget <—input— Front-Line Staff & Management
  • the most efficient budgeting process
  • With guidelines in place, lower-level staff and management work to construct bottom-up budgets since they are closest to the end customer
  • They have their own understanding of the business “at a ground level” and use that knowledge to guide the budgeting process
  • FP&A team will work closely with other departments, starting with sales to establish expectations
54
Q

which budgets are made first in the budgeting process

A

Sales budgets is usually the starting point of the budgeting process, since everything else is dependent on the level of sales expected

55
Q

what are stretch targets

A
  • Financial objectives that are meant to be challenging to attain
  • There is an underlying motivation to dampen expectations so that business leaders can achieve targets and be rewarded with bonuses at the end of the year for meeting or exceeding those targets
56
Q

what is the step by step process of budgets

A
  • When initial budgets are done, there are different reviews, modifications, and revisions done
  • Can happen many times in the budget process until senior management is satisfied with the outcome
  • When the approval happens, the budgeting process is still not complete
  • The BOD has to review and approve the budget before it is communicated internally across all departments and business units
57
Q

what does public companies communicate to their external shareholders after the budget is finalized

A
  • communicate select financial targets externally to shareholders/the market
  • The targets are usually still challenging, but more achievable compared to the internal targets so shareholder and potential investors don’t negatively see the company’s capabilities and long-term prospects

AFM 182 (11 decks)

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