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Investment Banking > Financial Accounting > Flashcards

Financial Accounting Flashcards

To learn about the3 financial statements

1
Q

what are the four types of accounting?

A

bookkeeping, financial accounting, managerial accounting and tax accounting.

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2
Q

What is financial accounting?

A

The main output is a set of financial documents that are publically available and allow people outside of the organisation to make an assessment of the financial stability of the company. This is for stakeholders and investors.

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3
Q

What is bookkeeping?

A

bookkeeping is the collection of all of the financial information. Bookkeeping includes all of the information for the transactions, items records and more. It is the corner stone on which all other financial data is calculated and recorded.

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4
Q

What is tax accounting?

A
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4
Q

What is managerial accounting?

A
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5
Q

What are the three main statements?

A

P&L / income statement, the cashflow and the balance sheet.

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6
Q

what is the purpose of the P&L?

A

This allows you to assess the trends in revenue and profit of a company.

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7
Q

what is the purpose of the balance sheet?

A

This assess what the company owns and what the company owes. All balance sheets have two sides.
Assets in the left and liability and equity on the right.

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8
Q

What is the purpose of the cashflow?

A
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9
Q

What are the main items on the income statement?

A
  1. Revenue - Net Sales, the top line of the income statement.
  2. Other Revenue - is revenue from non recurring, non main revenue.
  3. costs - COGS this is the cost of goods sold. The main costs are: COGS, selling, general and administrative expenses, depreciation and amortisation and interest expenses.
  4. gross profit.
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10
Q

what are examples of selling, general and administrative expenses?

A
  • advertizing and promotions
  • managerial
  • office rent
  • utility bills
  • anything that is not directly related to cogs, D&A, taxes or interest
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11
Q

What are the main examples of depreciation and amortisation?

A
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12
Q

What is the revenue recognition principle?

A

Revenue should be recognized when:
- there is evidence of an arrangement between the buyer and the seller
- the product has been delivered or the service has been rendered
- the price is determined or is determinable.
- the seller is reasonably sure of collecting the cash

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13
Q

What are costs of goods sold?

A
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14
Q

What is depreciation?

A

It is a representation of the using up of tangible assets, such as property, equipment, plants and vehicles.

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15
Q

What is amortization?

A

this is the repersentation of the using up of the intangible assets, such as goodwill, licenses, copyrights and other.

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16
Q

what is interest?

A

Costs associated with the lending of money from banks and investors.

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17
Q

What are taxes?

A

After all expenses the taxes are paid.

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18
Q

What is the Expense Recognition Principle?

A

This tends to follow the matching principle.

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19
Q

What is the matching principle?

A

Expenses associated with the revenues should be recognised at the same time.

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20
Q

What is accrual accounting?

A
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21
Q

What is the average tax rate?

A

Income Taxes / EBT

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22
Q

There are two main P&Ls what are they?

A

They are single-step and multi-step income statements. The single step does no intermediate calculations only showing all the revenues, then all of the costs and then the net income. The multi-step will show differences and calculations along the way, such as Gross Profit, EBITDA, EBIT and EBT.

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23
Q

What is seen on the asset side?

A
  • cash
  • accounts receivable
  • WIP
  • finished goods
  • ## property, plant and equipment
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24
Q

What is seen on the liabilities side?

A
  • accounts payable
  • financial liabilities
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25
Q

What is the equity?

A
  • it is the paid in capital that is technically owed to the shareholders.
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26
Q

what is depreciation?

A

It is an expense of a business as a required asset is used up over time. This will effect the asset value in the PP&E section of the balance sheet.

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27
Q

What are the main depreciation methods?

A

Straight line method and activity based method. Straight line considers the salvage value and the original value and the useful lifetime. Activity based we divide by the useful life rather than the years, this depends on the item.

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28
Q

What is amortization?

A

It is an expense of a business as a required asset is used up over time. This will effect the asset value in the PP&E section of the balance sheet. Here the asset is intangible. Not all intangibles are amortized such as brand. Software or patents may be on the otherhand.

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29
Q

Historic cost vs fair value accounting?

A

Companies can choose between the two methods but it must be done consistently.
Fair value is the current value of the item at market price. Historic value is the value when the item was purchased. Fair value cannot be used for all items but can be for items such as: Real Estate, Brand Value, Trademarks, Other fixed and intangibles, Debts and Pensions.

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30
Q

What are the different types of inventories?

A
  • Materials and supplies
  • work in process
  • finished goods
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31
Q

What is a prepaid expense on a balance sheet and why is it an asset?

A

An example of this is paying the rent upfront for a whole year, this is considered an asset as you have not yet used up the asset in the form of the years usage of the real estate.

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32
Q

What does PPE breakdown into?

A
  • buildings
  • land
  • machinery and equipment
  • construction in progress
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33
Q

What are the types of liabilities?

A

Current and Non current liabilities. Current is within the next year.

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34
Q

What is the difference between current and deferred income taxes?

A
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35
Q

What are some of the current liabilities?

A
  • accounts payable
  • accrued and other liabilities
    -debt due within one year
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36
Q

What are some of the non current liabilities?

A
  • Long term debt
  • deferred income taxes
  • pensions
  • retiree benefit
  • tax payable
  • uncertain tax positioons
  • long term operating leases
  • other
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37
Q

What is the shareholders equity?

A

There are ownership claims, capital that the company owes to the shareholders.

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38
Q

Some examples of shareholder equity

A

Paid in capital - the firms starting capital and any additional money used to icnrease the capital of the business.
Retained earnings - accumulated earnings, profits that have not been distributed as dividends.
Net Income - the profit we have made this year.

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39
Q

What are the shares outstanding?

A

This is the amount of stock that has been sold to investors and not purchased back by the company. This included preferred stock and common stock. This figure uses the stocks at their par value.

40
Q

What is additional paid in capital?

A

This only occurs when an investor buys shares directly from a company. It represents the additional amount an investor pays for a companys shares over the face value of the shares during a company’s IPO.

41
Q

What is Treasury Stock?

A

The final item on the shareholders’ equity is the treasury stock. There are the number of shares that were bought back by the company. It might sell the stock at a later date to raise capital for the company. This reduces the total shareholders’ equity as it represents a smaller number of shares that are available to investors.

42
Q

What is the accounting equation?

A

Assets = Liabilities + Equity. This must balance for all businesses.

43
Q

What is a general ledger?

A

This helps us organise all information for the company. This does the recording on a higher level.

44
Q

What are T accounts

A

On the top is the account type, on the left and right side are the increases and decreases you then get the balance at the end of the account. Debits are found on the left side of the T account and credits are found on the right side of the T account. Assets increase in the debit side and decrease on the credit side.

45
Q

What is the layout of a balance sheet T account?

A

Title at the top for the balance sheet.
Assets on the left and shareholders equity and liabilities on the right side. When assets increase this is written in the debit and decreases in the credit. When liabilities of equity increase in value this is written on the credit side with decreases on the debit side.

46
Q

What is the main connection between the income statement and the balance sheet?

A

Revenue - Costs = Profits, the profits are recognised as retained earnings on the balance sheet in the shareholders’ equity.

47
Q

What is the difference between debit and credit?

A

Debit is an entry representing an increase in assets or decrease in a liability. Credit is an entry representing a decrease in assets or increase in a liability. Debit increases account balance and credit decreases account balance.
Debit is also used to record expenses, assets and losses. Credit is used to record incomes, gains and liabilities.

48
Q

What is the layout of an income statement T account?

A
49
Q

When revenue is realised but cash is not yet given, where does the corresponding asset value go?

A

Trade receivables or accounts receivables.

50
Q

What happens when cash is received before revenue is realised?

A

the cash is debited and the prepaid revenue is credited. This is a liability.

51
Q

What is accrual accounting?

A

Revenues and expenses are incurred when services are rendered even if the cash has not yet been received or been paid.

52
Q

What are the 4 categories of accruals?

A

Unearned Revenue: A payment has been received prior to services being rendered. When the service is rendered the unearned revenue will be recorded as revenue.
Accrued Revenue: A payment has not been received for products/services that have been rendered.
Prepaid Expenses: expenses are paid before the goods required by the company are rendered
Accrued Expenses: a good has been given before the company has paid for the goods.

53
Q

What does the cashflow statement tell you about a business?

A
  • do regular operations generate enough cash to sustain the business.
  • does the business have sufficient cash to service existing debt and pay interest expenses.
  • how much cash is being invested
  • does the firm make enough money to take advantage of new opportunities.
54
Q

what are the components of net cashflow?

A

Operating cashflow: cash transactions affecting the net income of the firm.
Investing cashflow: cash relating to long term investments in fixed assets and other assets.
Financing cashflow: cash that affects a company’s capital structure (both debt and equity).

55
Q

What is the equation for the net cashflow?

A

ending cashflow - previous period cashflow.

56
Q

What are the two ways to present the cashflow statements?

A

The direct and indirect methods. Both of these record the investing and financing cashflows in the same way so the differences generated from them is on in the operating activities cashflow.

57
Q

What is the direct method for cashflow?

A

This is based on the actual cash flows from accounts without considering accrual and deferred items. This shows all cash transactions during a given period. This is also called cash accounting.

58
Q

What is the layout of the direct method cashflow statement?

A

cash received from customers
cash paid to suppliers
cash paid for interest expenses
cash paid for taxes

capital expenditure

payments of long term debt

59
Q

Why do most companies use the indirect accounting method for their cashflow?

A

It seamlessly integrates into their existing financial reporting. This reduces the need for additional documentation. This is compatible with the accrual accounting principle. This makes it suitable for large organisations with complex operations and accounting structure.

60
Q

What is the indirect method of cashflow accounting?

A

This starts by using the EBITDA or Net Income and then making adjustments for non cash items. Eliminating Non cash expenses, changes in balance sheet from accrual accounting.

61
Q

How do you run an indirect cashflow?

A

Start with EBITDA:
- less cash interest payments
- less cash taxes paid
+/- change in Accounts Receivable
+/- Change in Inventory
+/- change in Accounts Payable
+/- Change in Other Assets
+/- Change in Other Liabilities

62
Q

How do you calculate cashflow from investing activities?

A
  • money made from investments in fanancial markets etc
  • ## investments in long term assets such as PPE.
63
Q

How do you calculate cashflow from financing activities?

A
  • cash received from issuing stock or debt
  • cash repayment for debt
  • cash payment of dividends.
64
Q

What is the cashflow golden rule?

A

Net Cash Flow = cash (at end) - cash (at beginning)

65
Q

What are the rules for calculating cash changes?

A

Assets up Cash down - pay money to buy assets.
Assets down Cash up - money from selling assets.
Liability up Cash up - debt or financing money comes in.
Liability down Cash down - repaid debt or other payables then spend money.

66
Q

What other statements may be required for larger companies along with the first 3 financial statements?

A

Management Discussion and Analysis then also Footnotes. listed firms require financial statements every 3 months.

67
Q

Who overseas companies and audits financial statements?

A

The auditors. These are people who independently evaluate the financial information of a company.

68
Q

What are the 5 dimensions of financial analysis?

A
  • operating efficiency
  • profitability
  • liquidity
  • solvency
  • valuation
69
Q

What are the main types of analysis that can be performed on the financial statements?

A

There is horizontal and vertical analysis. Vertical involves looking and comparing the numbers in the same accounting period. While horizontal involves comparing numbers in different accounting periods.

70
Q

What are the days working capital ratios?

A

Days Payable Outstanding - The company’s average payable period, the number of days it takes a company to pay its suppliers.
Days of Sales Outstanding - The average number of days the company takes to collect revenue.
Days of Inventory Outstanding - This is a measure of operating efficiency, converting inventory to sales

71
Q

How is DSO calculated?

A

(Trade Receivables / Revenue) x 360

72
Q

How is DPO calculated?

A

(Trade Payables / CoGs) x 360

73
Q

How is DIO calculated?

A

(Inventory / CoGs) x 360

74
Q

What is liquidity?

A

This is the ability for a company to pay off its short term liabilities.

75
Q

What is solvency?

A

This is the ability for a company to meet its long term obligations.

76
Q

What is profitability?

A

The ability to generate profits from the available asset base.

77
Q

What is efficiency?

A

The ability for a company to effectively employ resources into business operations. This includes: utilising assets, managing working capital and inventory and paying suppliers.

78
Q

What are valuation ratios?

A

This measures the intrinsic value of the company.

79
Q

What are the common liquidity ratios?

A

Current ratio, quick ratio and Net trading cycle.

80
Q

What is the Current Ratio?

A

Current Assets / Current Liabilities, the ability for a company to pay off its short term liabilities. Ratio greater than 2 is desireable.

81
Q

what is the Quick Ratio?

A

(Current assets - Inventory) / Current Liabilities.

82
Q

What is the net trading ratio?

A

DSO + DIO - DPO

83
Q

What are the common solvency ratios?

A

debt ratio and interest coverage ratio.

84
Q

What is the debt ratio?

A

The portion of the firms assets that is financed with debt. Total Liabilities / Total Asset. < 0.67.

85
Q

What is the interest coverage ratio?

A

EBIT / Interest payment, this is because as debt increases interest expenses definitely increase.

86
Q

What are the most common profitability ratios?

A

net profit margin, return on assets, return on equity.

87
Q

What is the net profit margin?

A

Net Income / Revenue, a percentage ratio, only a certain fraction of total revenue turns into profit. you can also use:
Gross profit margin = Gross Profit / Revenue
EBIT Margin = EBIT / Revenue
EBT Margin = EBT / Revenue

88
Q

What is the return on Assets?

A

Net Income / Total Assets, an indicator of the company’s profitability without considering the way in which its activities are financed.

89
Q

What is the return on equity?

A

Net Income / Shareholders’ Equity, the profit that a company has generated with the invested equity capital.
ROE can be decomposed into three components:
net income / revenue * revenue / total assets * total assets / shareholders’ equity.
These components are net profit margin, asset turnover and financial leverage ratio.

90
Q

What are the most common ratios for efficiency?

A

net trading cycle, DIO, DSO, DPO

91
Q

What is the net trading cycle?

A

how many days it takes a company to convert its resources into cash.

92
Q

What are the most common valuation ratios?

A

Earnings per share, diluted earnings per share, P/E, dividend yield.

93
Q

What is earnings per share?

A

Net income - preferred dividends / weighted average number of common shares outstanding.

94
Q

What is diluted earnings per share?

A

adjusted income available for common shares / weighted average common and potential common shares outstanding.

95
Q

What is the P/E ratio?

A

share price / EPS

96
Q

what is dividend yield?

A

Dividend per share / Current Share price.

97
Q

What does the value and sign of the net trading cycle indicate?

A

It indicates if the company uses other peoples money to finance operations (<0). Or if it uses its own cash to finance operations (>0).

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