week 24 Flashcards
what are the four categories of accounting ratios
measures of performance
measures of working capital
measures of solvency and liquidity
measures of return on investment and risk
what are measures of performance
measures how the company is performing financially
profits generated
what are measures of working capital
indicates the ability of the company to manage elements of working capital effectively
what are measures of solvency and liquidity
indicates the ability of the company to pay its liabilities as they fall due
what are measures of return on investment and risk
indicates the ability of the company to generate returns for shareholders and the level of company risk
what are the limitations of ratio analysis
no true comparator peer company
many companies operate in more than one industry
different accounting policies/estimates
data limitations
historical data
missing data
non-financial info not considered
ratios identify where you need to find additional info
meaningful interpretation requires understand of circumstance
how do you compare financial statements
express each line item as a percentage
common size income statement expressed as % of revenue
common size B/S expressed as % of total assets
useful for identifying major changes
how can you identify a company using financial ratios
consider characteristics of company/industry
does it have high levels of inventory?
is it capital intensive? (large non-current assets, alternatively labour intensive)
if the industry associated with high profit margins?
when identifying companies from tables, what ratios do you focus on
profit margin %
inventory turnover times - how quickly you sell inventory
receivables turnover times - how many times a year receive payment from customers
current ratio and quick ratio - difference is the value of inventory
what is a company’s financial reporting process
transactions and events
selection of accounting policies
application of accounting policies
estimates and judgements involved
disclosures about transactions, events, policies estimates and judgements
what is creative accounting
accounting practices that follow the rules but make the most of loopholes in accounting standards to falsely portray a better financial image of the company
does it matter that firms engage in creative accounting
yes - want a level playing field for all investors and investors and other market participants rely on the reported accounting numbers
no - if earnings management is observable at low cost to market participants, published information enables investors to adjust for earnings management
what are the motives for creative accounting
to get around restrictions
to avoid gov action
to hide poor management decisions
to achieve sales or profit target
to attract new share capital or loan capital
to satisfy demands of major investors
to cover up fraud
what are the methods of creative accounting
depreciation
inventory and COGS
provisions
capitalisation of costs
intangible non-current assets
front end revenue recognition
how is depreciation used in creative accounting
choice of method
adjust expected economic lives, scrap values etc to achieve the depreciation charge desired
how is inventory and COGS used in creative accounting
change between FIFO/weighted average to affect COGS figure as desired
remember changes of policies must be disclosed
how are provisions used in creative accounting
estimate a lower or higher figure for warranties etc
overestimate provisions for reorganisation
underestimate provisions for bad debts
how is capitalisation of costs used in creative accounting
rather than treating certain debits as expenses, treat them as assets eg research and development
how are intangible non-current assets used in creative accounting
balance sheet not healthy looking enough
capitalise your brand name
goodwill on acquisition of one company by another
how is front-end revenue recognition used in creative accounting
company’s revenues derive from sales of software plus three years worth of updates
when should income be recognised
why not recognise all the revenue when the software is sold, rather than over the three year period
how can you use accruals and prepayments for creative accounting
move profits from one period to another
understate accruals and overstate prepayments - increase this years profit, decrease next years profit
understate prepayments and overstate accruals - decrease this years profit, increase next years profit
what is real earnings management
practice of structuring transactions to meet financial reporting targets
decrease profits by - accelerating research and development and delaying sales
increase profits by - postponing research and development and accelerating sales
what is fraudulent accounting
clear violations of GAAP with an intent to mislead users
includes: recording sales before they are realisable, recording fictitious sales, backdating sales invoices, overstating inventory by recording fictitious inventory
what are health checks on financial statements
compare reported profits and operating cash flows
look at tax charge in relation to reported profits
check notes for changes in accounting policies and estimates
audit report
