Financial Edge Training - Accounting Fundamentals

Question 1

Does EBIT = Operating Profit?

Answer 1

Sometimes yes, but not always.

To ensure we get EBIT correctly from operating profit, we should remove:
- NCI Expenses
- Non-recurring expenses e.g. litigation
- Non-core expenses e.g. selling subsidiary, rent out building and not a property company

Form EBIT, we want to find the profit JUST FROM the core business, how profitabe actually are they? If these aforementioned items are expenses, we should add them back, and if they are revenues we need to remove hem to get to EBIT.

Question 2

Working Capital & Operating Working Capital

Answer 2

Working Capital: Shows whether a firm can pay its bills.
Current A-Current L. If CA is £20 and CL £15, Working Capital = £5 ,’, can pay bills

**Operating WC: ** Exclude cash from CA.
If we now have positive Operating WC, that means we REQUIRE cash to fund that. I.e. Operational liabilities mean I currently HAVE my suppliers cash, but Operation Current Assets mean my debtors have MY cash. Vice versa, negative Operating WC is good as I now have funding and have less Cash tied up in Current Assets than cash i have from Operating CL.

Question 3

Forecasting PP&E

Answer 3

BASE method: Beginning, Additions (CapEx), Subtract (Depreciation, End

Don’t include Impairments, even if there are many in previous PP&E figures. Impairments are UNEXPECTED, so we can’t expect them.

Question 4

Net Debt

Answer 4

Debt - Cash&Cash Equivalents

Cash Equivalents: Highly liquid assets e.g. Short-term deposits, Money market instruments, Short-term investments

Debt: Includes: Preference shares (if treated as debt, Capital/Finance leases, Bank loans, bonds, debentures, overdraft etc.

Question 5

4 Debt Metrics

Answer 5

Net debt: debt - cash&equivalents (shows true debt)

EBITDA Based leverage: Net debt/EBITDA (Tests ability to repay debt)

Asset based leverage: Debt/Equity

Interest cover: EBITDA/Interest expense (tests ability to pay finance costs)

Question 6

Forecasting Retained Earnings

Answer 6

BASE Analysis

Additions: Net income earned in year

Subtractions: Dividends

Question 7

Deferred revenue

Answer 7

Receive cash in advance of delivering service w.g. Subscription services

Defrred revenue is a liability and can be released as income when the service is offered

Question 8

Valuing inventory

Answer 8

All inventory is valued at cost rather than actual sales value.

So if 10,000 inventory is sold, cash increases by 10k but inventory doesn’t decrease by 10k, it decreases by the value of that inventory at cost

Question 9

Calculating EBIT

Answer 9

Start with operating profit

Remove NCI, Non-core, non recurring expenses or revenues

Question 10

Operating working capital calculation

Answer 10

CA: remove cash and short term investments

CL: remove current portion of long term debt and Notes Payable

Essentially we want to remove FINANCIAL operating assets/liabilities. If we would receive or pay interest it is financial

Question 11

Operating working capital calculation

Answer 11

CA: remove cash and short term investments

CL: remove current portion of long term debt and Notes Payable

Essentially we want to remove FINANCIAL operating assets/liabilities. If we would receive or pay interest it is financial

Question 12

Commercial Paper, Net Debt Calculations

Answer 12

Commercial paper is debt if it is a liability on SoFP, and asset if on asset side of SoFP (Invested in another firm’s commercial paper)

Question 13

Effective v Marginal Tax Rate

Answer 13

Effective tax rate = adjusted tax expense/Adjusted profit before tax.
Will differ from marginal as firm operates in multiple companies w different tax rates

Marginal tax rate: Tax rate in country the firm is registered

When modelling we would use the effective tax rate

Question 14

Cash Flow Statement

Answer 14

Cash flows from Operating activity

Cash flow from investing activities

Cash flow from financing activities

Question 15

Creating a CFS from Balance Sheet

Answer 15

Go through SoFP line items, identify if Operating, Financing or Investing

Some items have to be split:
PP&E = O&I, Depreciation is Operating CapEx is Investing
Intangible Assets = O&i, Depreciation is Operating CapEx is Investing
Retained Earnings = O&F, Net Income is Operating, Dividends paid is Financing

Calculate change year on year from x year SoFP to y SoFP.
i=Asset increases we want to be NEGATIVE as bad for cash. Vice versa for liabilities & equity we want positive if decrease

Question 16

Change in Operating Working Capital treatment for CFS

Answer 16

ALWAYS do last year-this year, regardless of positive or negative

Question 17

Ratios:
Gross margin, EBIT Margin, NOPAT

Answer 17

Gross margin = adj. gross profit/revenue
EBIT Margin = EBIT/Revenue
NOPAT = Adj operating profit*(1-effective tax rate)