Unit 5 Flashcards
Economic vs Financial structure
The economic is the asset side, tells us of the characteristics of the assets and rights. Whereas the financial structure is the characteristics of the financial sources, in other words the other side of the BS.
Who needs/wants the financial info? (4)
Owners (to make decisions), investors (to decide about investments), institutions (to make actions or define policies) and at last the employees (to plan their relationship with the company).
Balance sheet
The accounting statement summarizing the assets, equity and liabilities in a specific moment (picture) in time. The two sides must balance.
What is on the asset-side and how is it ranked?
We have the FA and the CA, in which the current assets are divided into inventories, receivables and cash. The ranking is done w/r to liquidity. The most liquid assets in the bottom (cash).
Why having international standards setting out the accounting rules?
Comparability! The free movement of capital makes it easy to invest everywhere in the world, and therefore we need comparability of all companies around the world.
The E+L side of the balance sheet?
It contains the equity (owners contribution), the LTD and the STD. which of equity+LTD is called Permanent capital whereas the STD+LTD is the total debt. This side is instead ranked by exigibility, the most exigible in he bottom.
Difference between LTD and STD in time:
The LTD is debt that will be paid back in over 1 year, whereas the STD will be paid back within a year.
Working capital definition:
The part of the permanent capitals that is over after covering the FA and can cover (some of) the CA.
Jag brukar också tänka att det är detta kapitalet som faktiskt arbetar i företaget atm. This is left to work with after covering the FA - helps us operate while waiting for the sold products to be paid. The operating cycle mechanism –> you buy RM, produce, sell, and at last receive cash, but we have to finance ourselves during this period of time.
WC formula:
WC = (CA-CL) = (PC-FA)
Problem with a high level of STD?
Yes, because if the STD is high this means that the WC can be zero or negative (WC=CA-CL), and a lot of money will run out of the company in a short period of time –> not sustainable, cannot operate.
Types of financing, divided into three ways of stating it:
- Duration: permanent capitals or current liabilities.
- Ownership: own resources or outside resources.
- Origin: internal (profits) or external (contributions inc shareholders).
ST-financing: Operating financing (4 types):
- Debt with suppliers
- Delayed salaries
- Periodic taxes
- Any other postponed payments.
ST financing:
Short term bank credits (2)
- Line of credit - where interests are only paid for the credit used.
- Overdraft - if account goes below zero, firms owes the bank (which becomes a type of financing but with really high interest).
ST financing:
Promissory note:
Discount - A bank anticipates clients’ debts. The bank works as an intermediary (but comes with a cost ofc) to pay me directly and then my client can pay the bank at deadline instead.
ST financing:
Factoring
The firm gives the bank all the collection rights while the bank anticipates all the money. This is doing the promissory notes with ALL receivables.
Confirming = same but on the supplier’s side instead. so my company pays the bank at due date.
LT financing:
Medium and long-term loans:
Operating financing that is long term, ex a machinery to pay in 5 years.
LT financing:
Loan:
Dividing a loan into multiple small parts that individuals can buy in exchange of an interest. Useful for big amounts that the bank won’t lend.
LT financing:
Capital increase:
Shareholders contribute with new capital or issued shares. And also reserves from profits can increase the capital.
LT financing:
Leasing:
- Financial leasing: only economic activity (B2B) the renter is a temporal owner until he/she buys it - which is agreed in the contract.
- Operating leasing: can instead be done by individuals also, no final purchase option needed so the ownership remains on the company, the renter is only a renter until you possibly buys it at the end.
Self-financing:
- Maintenance:
Depreciation in the accounting is a cost, but it does not leave the company, only lost value of an asset –> sort of financing for future assets. - Enrichment:
Using profits to invest in FA (capacity) or CA (volume) instead of accumulating them in reserves.
Long term cycle - capital cycle:
From the moment of getting financial resources and buying assets until it will generate income and profits –> including the whole thing. During this time we have to finance ourselves. Called the Average Maturity Period.
Difference between long term cycle and operating cycle:
The operating cycle only includes the CA, not the FA as the long term does. Much shorter cycle.
Short term cycle - operating cycle:
One cycle of production, a loop in the current assets. From rawM to cash. This period of time must be covered by own finances, and it is here the WC concept comes in.
Average maturity period:
The average duration of an operating cycle - time that money takes to be cash again:
OMP = MPstorage + MPproduction + MPselling + MPcollecting.
Average financial maturity period:
The economic period minus the payment to suppliers.
FMP = OMP - MPpayments.
How do you derive each MP?
You take the total amount of the different parts and divide by the average amount –> then you get the number of rotation. The you take 365/n and you will get the MP.
What is the purpose of knowing the operating cycle?
If the company can keep the same level of sales and at the same time reduce the MP, that would mean more efficiency
Financial balance/equilibrium:
We like to think of the FA and CA to be financed by an equal size of permanent capital vs STD, BUT this doesn’t hold… We cannot finance our CA totally by STD. Image when all STD must be paid back but you don’t receive sufficient clients… Therefore the WC must be positive so that the permanent capital also finances CA.
Solvency vs liquidity:
The solvency will measure your assets and receivables but doesn’t mean that you actually have the money atm. Liquidity in contrast, means that you have the cash right now. Ex an invoice will affect the solvency but not he liquidity.
Solvency =
Long-term ratio
Assets/Liabilities (=2)
Current Ratio =
Short-term ratio
Current Assets/Current Liabilities (1.5 to 3). Also called working capital ratio.
Acid Test =
(Current Assets - Inventories) /Current Liabilities (=0.8)
For service companies, this will be close to Current ratio.
Liquidity Ratio =
Cash/Current Liabilities (=0.1 to 0.3). Also called cash ratio.
Indebtness (D/E) =
Debt/Equity (<1 but close), depending too much of the outside can be risky but more expensive with equity.
Debt structure =
=LTD/STD. Firms aim to have this ratio>1 since it means longer time to get cash to pay suppliers.
Asset structure =
= Part of the assets/Total assets.
Coverage ratio =
Net Real Assets /Liabilities. A bit more restrictive than the long term solvency ratio. IN exam only assets as a whole will be used. =same as solvency.
If we cannot cover our debts with our assets, ratio negative –> bankruptcy..
Consistency (firmness) =
= FA /LTD (=2)
How much of the LTD has been used to finance FA? Also tells us about the solvency in the long run.
Economic profit
EBIT = earnings before interests and taxes
Net profit
EBT = earnings before taxes (after reducing/adding interests). The higher debt, the bigger difference from EBIT.
Liquid profit
Earnings after interests and taxes.
Return on assets
ROA = EBIT/Tot Assets = EBIT/Sales*Sales/TotA.
Margin * Rotation.
These two can be very different depending on what type of firm it is - Ullared vs NK.
Return on equity:
ROE = Net profit/Equity. The investors’ most important ratio.
Return to shareholders:
RS = Dividends/Equity. Where dividends are derived as a percentage from the liquid profit.
