Terms Flashcards
Time-Series Analysis
helps identify trends for a single company or business unit.
Evaluation of Time-Series Analysis. As an analyst, studying a company what would be some areas of interest that would be in sync with this term of evaluation?
- Determining the rate of growth in the companies sales.
- The degree to which its earnings have fluctuated historically with inflation.
- Business cycles
- Foreign currency exchange rate
- Changes in economic growth in domestic and/or foreign markets.
Cross-Sectional Analysis
helps identify the difference similarities and differences across companies or business unit at a single point in time.
Benchmark Comparison
Measures a company’s performance or conditioning against some predetermined standard.
Tangible Net Worth
is usually defined as a total tangible assets minus total liabilities. (Note: Be sure to exclude intangibles such as goodwill, patents, and trademarks.
Common-Size Income Statements
recast each statement item as a percentage of a sale. These statements show how much each sales dollar the company spent on operating expenses and other business costs and how much of each sales dollar hit the bottom line as profit.
Trend Statements
Statements that recast each item as a percentage of a base year number.
Equation: Return on Assets (ROA)
ROA = Net Income / Average Assets = Earnings Before Interest (EBI) [Net Income + Interest Expense x ( 1 - Tax Rate)] / Average Assets
Equation: Disaggregatting ROA into Profit Margin and Asset Turnover
ROA = Earings Before Interest / Average Assets = (EBI /Sales) x (Sales / Average Assets) = Profit Margin x Asset Turnover
Equation: Profit Margin
EBI / Sales = (Sales - COGS - OpEX + Other - Taxes) / Sales
Equation; Asset Turnover
Sales / Average Assets = (Sales / Average Current Assets + Average Long-Term Assets)
Return on Common Equity (ROCE)
Measures a company’s performance in using capital provided by common shareholders to generate earnings.
Equation: Return on Common Equity (ROCE)
(Net Income - Preferred Dividends) / Average Common Shareholder’s Equity
Financial Leverage
Refers to the degree of which the firm finances its operation with debt rather than equity. Debt-to-Capital Ratio
Credit Risk
Refers to the risk of non-payment from the borrower.
Liquidity
Refers to the company’s short-term ability to generate cash for working capital needs and immediate debt repayment needs.
Solvency
Refers to the long-term ability to generate cash internally or form external sources to satisfy plant capacity needs, fuel growth, and repay debt when due.
Equation: Current Ratio
An index of a company’s short-term liquidity. (Current Assets / Current Liabilities)
Equation: Quick Ratio
A more short-term reflection of liquidity. (Cash + Short-term investments + Receivables) / Current Liabilities
Activity Ratios
Tell us how efficiently the company uses its assets. Activity Ratios can highlight efficiencies in asset management - Accounts Receivable, Inventory Levels, and Vendor Payment - and help the company stop areas needing improvement.
Accounts Receivable Turnover Ratio
Is an activity ratio that helps analysis determine whether receivables are excessive when compared to existing levels of credit sales.
Equation: Accounts Receivable Turnover Ratio
Net Credit Sales / Average Accounts Receivable
Equation: Days Accounts Receivable Outstanding
365 Days / Accounts Receivable Turnover
Equation: Inventory Turnover Ratio
Tell us how effectively inventories are managed. Cost of Goods Sold / Average Inventory
Equation: Days Inventory Held (Inventory Turnover Ratio
Tells us how many days it takes for inventory to move from the company to its company. 365 Days / Inventory Turnover
Equation: Accounts Payable Turnover Ratio
Inventory Purchases / Average Accounts Payable
Equation: Days Accounts Payable Outstanding
365 Days / Accounts Payable Turnover
Reference: A companies solvency
This refers to a company’s ability to generate a stream of cash inflows sufficient to maintain its productive capacity and still meet the interest and principal payments on its long-term debt.
Debt Ratios
They provide information about the amount of long-term debt in a company’s financial structure.
Cash Flow From Operations
Refers to the amount of cash that is able to be generated from ongoing business activities.
Cash Flow from Investing
Companies present cash flows related to expansion or contraction of fixed assets, as well as cash flows related to non-operating investments.
Company Default
This is when a company fails to make a required loan payment on time,
Credit Analysis
Intended to help lenders assess a borrower’s default risk or the likelihood of loan default.
Z-Score Model
1.2 X Working capital/Total assets + 1.4 X Retained earnings/Total assets + 3.3 X EBIT/Total assets + 0.6 X Market value of equity/Book value of debt + 1.0 X Sales/Total Assets
A company’s operating cycle
Is determined by how long it takes to sell inventory plus collect cash from customers.
Business Valuation
Involves estimating the worth - or intrinsic value - of a company, one of its operating units, or its ownership shares.
Fundamental Valuation
It is a comprehensive and rigorous approach that uses basic accounting measures (or “fundamentals”) to assess the amount, timing, and uncertainty
of a firm’s future operating cash flows or earnings.
Cash Flow Assessmenr
Lenders and credit analysts use the firm’s financial statements and other information to estimate its future cash flow. Plays a central role in measuring a company’s credit risk.
Forcasting
Future amounts of some financial attribute-What is called a value relevant attribute- that ultimately determine how much a company is worth.
Discounted Present Value
The expected future amounts using a discount rate that reflects the risk or uncertainty from determining the risk (uncertainty) associated with the foretasted future amounts.
Discounted Cash Flow Valuation Approach
Combines the elements in the three steps to express what a stock is worth - its intrinsic value - as the discounted present value of expected future cash flows. There are two ways to implement this approach, and they produce identical results given identical forecast assumptions.
Weighted-Average Cost of Capital
Discount Rate in free cash flow valuation model.
Constant Perpetuity
The present value of the same dollar cash flow each period over an infinite horizon.
Flows of Equity Model
The foretasted cash flow stream to be discounted is after subtracting flows to debt-holders and preferred shareholders.
Price/Earnings Ratio
A measure of the relation between a firm’s current earnings and its intrinsic share value.
The Entry Price
The amount a firm would pay if it bought an identical investment.
Goodwill
When one company buys another company for more than the acquired company’s individual net assets are worth.
Growth Opportunities
The firm’s potential earnings from receiving current earnings in new projects that will eventually earn a rate of return in excess of the cost of equity capital.
Level 1 Permanent Earnings (One of the three distinctly different components of reported earnings.)
Is expected to persist into the future and is therefor valuation-relevant. In theory, the multiple component for this should approach 1/r.
Level 2 Transitory Earnings (One of the three distinctly different components of reported earnings.)
This component is valuation-relevant but is not expected to persist in the future. Because transitory earnings result from one-time events or transactions, the multiple for this component should approach 1.0.
Level 3 Value-Irrelevant Earnings or Noise (One of the three distinctly different components of reported earnings.)
This component is unrelated to future free cash flows or future earnings and, therefore, is not pertinent to assessing current share price. Such earnings components should carry a multiple of zero.
An Earnings Surprise
Occurs when earnings deviate from investor’s expectations.
Conflicts of Interest
Arises when one party to a business relationship can take actions for his or her own benefit that harm other parties in the relationship.
The Principal-Agent Relationship (aka Agent Relationship)
Is an arrangement in which one entity legally appoints another to act on its behalf. In a principal-agent relationship, the agent acts on behalf of the principal and should not have a conflict of interest in carrying out the act.
Agency Cost
The cost that arises from the principle-agent relationship.
Preservation of Repayment Capacity (1 of the 3 Debt Covenants)
Some covenants place limits on new borrowing, prohibit stock repurchases and dividends without prior lender approval or insure that cash generated from both ongoing operations and from asset sales will not be delivered away from servicing debt.
Protection Against Credit-Damaging Events (1 of the 3 Debt Covenants)
All lenders are concerned with the risk of a sudden deterioration in repayment ability that can result from a merger, acquisition, takeover, or recapitalization. Some covenants prevent these adverse events from happening unless the debt is first repaid, the interest rate is adjusted upward, or prior lender approval is obtained.
Signals and Triggers
Signals ensure the steady flow of information from borrower to lender. This information flow can reveal declining sales and profits, diminished operating cash flows, or other facets of the business that signal increased repayment risk.
Affirmative Covenants
Stipulate actions the borrower must take.
Some generalities include:
- Using the loan for the agreed-upon purpose.
- Providing periodic, audited financial statements.
- Complying with financial covenants.
- Complying with laws.
- Allowing the lender to inspect business assets and business contracts.
- Maintaining business records and business properties and carrying insurance on them.
Equation: Fixed-Charge Coverage
A ratio greater than 1.0, [(Net Income + Non-cash Charges) / (Current Maturities + Dividends + Replacement CapEX
The fixed-charge coverage ratio requirement limits the company’s ability to pay dividends.
Negative Covenants
Tend to be more significant and intensely negotiated than affirmative covenants because they restrict the borrower’s actions.
Negative Covenants include
Limits on total indebtedness, investment of funds, capital expenditures, leases, and corporate loans as well as restrictions on the payment in cash dividends, share repurchases, mergers, asset sales, voluntary prepayment of other indebtedness, and new business ventures.
The Events of Default
Is the section of a loan agreement that describes circumstances in which the creditor obtains additional rights.
Restrictions On Total Indebtedness
limit the amount of additional debt the company may incur over the term of the loan.
Net Worth Safety Margin
The dollar amount by which net worth could decline before triggering a covenant violation.
Technical Default (of a covenant)
This is when the borrower violates one or more loan covenants but has made all principle and interest payments.
Discretionary Accounting Accruals
These are non-cash transactions that accrue revenues or expenses.
Covenant-Lite Loans
Loans that contain mineral covenants.
Protection Against Credit-Damaging Events
Covenants that prevent risk related to mergers and acquisitions that could affect loan repayments.
Debt Covenants
Restrictions that help guard against conflicts of interest between creditors and borrowers
Base Salary
Is typically dictated by industry norms, the size of the company, and the executive’s experience and specialized skills.
Annual Incentives
Set yearly financial performance goals that must be achieved if the executive is to earn various bonus awards.
Long-Term Incentives
These motivate and reward executives for the company’s long-term growth and prosperity (typically three to seven years). Long-term incentives are designed to counterbalance the inherently short-term orientation of other incentives.
Stock Options
This gives the holder the right, but not the obligation, to buy company shares at a stated (exercise) price, typically the market price on the option grant date, for a period of years.
Restricted Stock
Typically an award of stock that is nontransferable or subject to forfeiture for a period of years. The most prevalent restriction is one of continued employment, although performance-related conditions are sometimes applied. Dividends can be paid to the executive even when the stock is restricted, and some restricted stock awards carry immediate voting rights. Restricted stock grants provide a set of “golden handcuffs” for retaining executives, at least during the restriction period.
Performance Based Pay-Plans
Require the manager to achieve certain multiyear financial performance goals such as a three-year average return on equity (ROE) of at least 20%. The payout could be either cash or company shares.
Proxy Statement
Information about a company’s executive compensation practices. A notification of the annual shareholders meeting, filed each year with the SEC. Among other disclosures, this document describes both the compensation payments and awards made to the five highest paid executives of the company and any new executive compensation plans.
Compensation Discussion and Analysis (CD&A)
Among other things, the CD&A must describe the specific items of corporate performance that are considered in making compensation decisions, how specific forms of compensation are structured and implemented to reflect performance, the impact of accounting and tax treatments of the particular form of compensation, the results of the most recent say-on-pay vote mandated by Dodd-Frank, and whether and how the vote affected compensation decisions.
Clawback Provision
Bonuses earned due to accounting fraud or other dishonest actions may be required to be paid back.
Regulatory Accounting Principles (RAP)
Financial statements guidelines used by creditors and shareholders will be prepared under GAAP. But Those statements are prepared under Financial Statement preparations for banks, insurance companies, public utilities, and many others provide to the government agencies that regulate them.
Loan Loss Provision
A banks bad debt expense associated with its loan receivables.
Minimum Capital Requirements
Requirements that insure an institution remains financial sound and can met its obligations to depositors.
Capital Adequacy Ratio
RAP investor capital divided by RAP gross assets.
Net realizable value
Accounts receivable generally reflected in the balance sheet.
Uncollectibles
The amount that will not be collected because customers are unable to pay.
Returns and Allowances
The amount that will not be collected because customers return the merchandise for credit or are allowed a reduction in the amount owed.
Fair Value
is “the price that would be received to sell an asset or paid to transfer a liability in an orderly transactions between market participants.
Without recourse
meaning that the factor cannot turn to the company for payment in the event that some customer receivables prove uncollectible.
With recourse
meaning that the company must buy back any bad receivables from the factor
Factor
What a purchaser of a loan is called.
Securitization
occurs when receivables (such as mortgages and automobile loans) are bundled together and sold or transferred to another organization (securitization entity) that issues securities collateralized by the transferred receivables.
Servicing Asset
If the expected fees represent more than adequate compensation, then the proceeds will also include a:
Discounting
is accelerating cash on Notes because the financial institution advances cash to the company based on the discounted present value of the note.
Settlement
which cancels the original loan with a transfer of cash, other assets, or equity interest ( borrower’s stock) to the lender.
Continuation of modification of debt term
canceling the original loan and making a new loan agreement.
Inventories
Assets held for sale.
Merchandise Inventory
An inventory account.
Raw materials inventory
consists of components such as steel that will eventually be used in the completed product.
Work-in-process inventory
contains the aggregate cost of units that have been started but not completed as of the balance sheet date.
Finished goods inventory
represents the total costs incorporated in completed but unsold units.
Perpetual inventory system
keeps a running (or “perpetual”) record of the amount of inventory on hand. Purchases are debited to the Inventory account itself, and the cost of units sold is removed from the Inventory account as sales are made.
Absorption Costing
fixed costs are allocated based on the number of units produced.
Variable costing
the cost can distort cost of goods sold for a specific year if production levels change significantly.
Expected benefit approaches
Assets could be measured at their estimated value in an output market - a market where assets are sold.
Economic sacrifice approaches
Assets could be measured at their estimated cost in an input market - a market where assets are purchased.
Discounted present value
The value of an item of manufacturing equipment is measured by estimating the discounted present value of the stream of future net operating cash inflows it’s expected to generate over operating life.
Net realizable value
the amount that would be received if the assets were sold in the used asset market.
Historical cost
the historical amount spent to buy the asset constitutes the past sacrifice incurred to bring the asset into the firm. Dominant GAAP measurement.
Replacement cost (aka current cost) approach
assets are carried at their current purchase cost- the expenditure (sacrifice) needed today to buy the asset.
Capitalized costs
All costs necessary to acquire the asset and make it ready for use are included in the asset account.
Joint costs
incurred in acquiring more than one asset are apportioned among the acquired assets on a relative fair value basis or some other rational basis.
