Lecture 5 - Analysis of the Statement of Shareholders' Equity Flashcards
Sound financial statement analysis requires:
- A distinction between operating and financing aspects of the business
- A reformulation of the financial statements into a form that makes this distinction clear
What do each of these stand for in the cash conservation equation?
C - I = d + F
C = Net cash from operations
I = Net cash outflow from investing
C - I = Free cash flow
d = Net dividends F = Net cash outflow to debt holders and debt issuers
(Net dividends = common dividends + share repurchases - share issues)
If C - I - i > d
lend or buy down own debt
If C - I - i < d
borrow or reduce dividends
Simplified Balance Sheet
Assets
- Operating assets
- Financial assets
- Total Assets
Liabilities and Equity
- Operating liabilities
- Financial obligations
- Common stockholders’ equity
- Total
Reformulated Balance Sheet
Operating Assets
- Operating assets
- Operating liabilities
- Net operating assets
Financial Obligations and Owners’ Equity
- Financial liabilities
- Financial assets
- Net financial obligations
- Common equity
- Total NFO and Equity
Operating income =
Operating revenue - operating expense
OR - OE = OI
Reformulated Income Statement
Operating income
- Operating revenue
- Operating expense
Net financial expense
- Financial expense
- Financial income
Comprehensive income
New book value =
Old book value + comprehensive income - dividend
What is the governing accounting relation?
Book value0 + comprehensive income - net payout
= book value at time t
Reformulated statement of common stockholders’ equity
Opening book value of common equity (CSEt-1)
+ Net transactions with common shareholders
+ Capital contributions (share issues)
- Share repurchases
- Common dividends
+ Comprehensive income to common shareholders
+ Net income - non controlling interest income
+ Other comprehensive items
- Preferred dividends
Closing book value of common equity (CSEt)
Step one of reformulation:
- Restate beginning and ending balances for items incorrectly included in or excluded from common equity
- preferred stock
- non controlling interest included in equity
+ dividends payable
Step two of reformulation:
- Calculate net transactions with shareholders
= cash dividends + share repurchase - share issues
Step three of reformulation:
- Calculate comprehensive income
= net income + other comprehensive income
- earnings from accounting changes
- preferred dividends
- non controlling interest in earnings
- hidden dirty-surplus losses
Dividend payout =
Dividends / Comprehensive income
Total payout ratio =
(Dividends + stock repurchases) / Comprehensive income
Dividends to book value =
Dividends / (Book value of CSE + Dividends + Stock repurchases)
Retention ratio =
(Comprehensive income - dividends) / Comprehensive income
= 1 - payout ratio
ROCEt =
Comprehensive earnings / 1/2(CSEt + CSEt-1)
Net investment rate =
Transactions with shareholders / Beginning book value of CSE
Growth rate of CSE =
Change in CSE / Beginning of CSE
= (Comprehensive income + net transactions with shareholders) / Beginning CSE
Hidden dirty surplus:
Shareholders lose when shares are issued at less than the market price
e.g. the exercise of options
This loss however is not recorded as an expense under GAAP and IFRS
Is stock based compensation equity or liability?
Liability - shareholders have a liability to issue stock at less than market price
Yet GAAP and IFRS treat is as equity - both make it look like issuing stock options increases equity
What is option overhang?
The value of the options not yet exercised
What is the market value method vs. the book value method with respect to losses on convertible securities?
- the market value method recognises losses on conversion
- the book value method records the shares at the book value of the convertible securities, with no loss recognised
