Week 4 Flashcards
what are operating assets/liabilities compared to non-operating
Assets/liabilities used in producing goods/services e.g. accounts receivable, accounts payable, land, building
Financial assets/liability e.g.
– Cash and assets used to manage liquidity
– Borrowings from outsiders (banks, bond holders etc) – Financial items are typically interest-bearing
– We report ‘Debt’ separately from other non-operating
assets
Non-Operating Assets / Liabilities (Financing Assets / Liabilities) produce
Financing Revenues and Expenses in our re-cast income statement
Operating Assets / Liablilites produce either:
– Rev / Expense from Core Activities
– Other Income or Expense (e.g. rental income etc)
we will only classify items as non-operating (financing) if
hey are of a financing nature:
– Cash holdings
– All borrowings and interest-bearing liabilities
– All assets that earn a rate of interest, or are held for short-term cash management / financial investment purposes
Analysts rely heavily on
information contained in firms’ published financial reports when generating their forecasts of future performance and valuing firms
the usefulness of financial statements for forecasting / valuation may be improved by
systematically reformatting and adjusting it to enhance comparability and measure on- going earning power more reliably
i.e. Financial statements may be recast to standardise line-item descriptions.
Non-operating Items
Financing items. Items that bear a rate of interest, and produce our net interest expense
• Debt, Borrowings, Lease Liability, Cash
Operating Items
Assets and liabilities used to produce the ‘core’ and ‘other’ revenues and expenses
Classification on Income Statement
– Items from Core Activities: items pertaining to core business and of a non-financial nature
• Sales, COGS, wages exp., SG&A expense, Depreciation on tangible and intangibles etc.
– Other Income: items arising outside core activities
but which are not interest revenues or expenses • Rental revenues, income from investment in associates, etc.
– Financing: items that actually or effectively bear interest:
• Interest expense, interest revenues, finance costs
Operating Cash Flows
– Payments to/from suppliers and customers
– Interest received and paid
– Divs received
– Tax paid
Investing Cash Flows
– Payments to purchase long-term assets
– Proceeds from Disposal of long-term assets
Financing Cash Flows
– Proceeds of Borrowings / Equity Issues
– Repayment of Principal Borrowed / Return of Shareholder Capital
what are type of adjustments
1) Estimation of an ‘Adjusted NPAT’ which is the measure by which the accuracy of prior analyst forecasts will be assessed
2) Adjustments made to the balances in the recast financial statements
Types of accounting adjustments
Estimation of an ‘Adjusted NPAT’ involves
- gives insight to ability to generate distributable cash in the future
- forecast a firm’s earnings (profit) from continuing activities (strongest indicator of future performance)
– Analyst usually does not adjust the account balances in the recast statements, just identifies two levels of profit (Net Profit as Reported, Adjusted Net Profit After Tax).
alternate names for their estimates of ‘earnings from continuing activities’
– Ongoing earnings
– Street Earnings
– Adjusted Earnings…………..
what do analysts typically exclude from adjusted NPAT?
Goodwill impairment expense (Goodwill writedown)
acquisition expense
asset sale gain/loss
litigation charge
realized investment gain
restructuring charge
If they included the one-off impairment of $16.1m in ‘Adjusted NPAT’
this would effectively ‘double-count’ the effect on future profits
• The $16.1m impairment reflects the firms’ belief that future profits will be lower (PV of reduced future profits = $16.1m)
Why is Adjusted NPAT useful
predicts future earnings and the ability to generate free cash flows to equity better than the firm’s Reported Net Profit After Tax
One motivation for firms to provide alternative (non-GAAP) earnings measures is to
influence the set of revenues and expenses that analysts choose to include in their measure of earnings
If managers signal the ‘one-off’ nature of a particular expense by excluding it from the non-GAAP earnings measure, analysts may do the same
If so, analyst-defined earnings will be higher than otherwise, and analyst valuations of the firm will be higher than otherwise.
A good analyst should recognise management incentives when deciding on which items to include / exclude from their ‘Adjusted NPAT’
adjustment of the actual balances in a firm’s recast financial statements to
– Facilitate more valid comparison with competitors
– Improve the usefulness of statements for valuation purposes
- • Reduce effect of accounting distortions on assessment of firm’s profitability / risk
What is the motivation for adjustments to the balance of reported financial statement
information suggesting that particular items are overstated/understated
what items are usually excluded from Adjusted NPAT?
Goodwill impairment expense because it is believed to be less relevant to predict future earnings
Sale of a business segment - unlikely to reoccur
Items from Core Activities:
items pertaining to core business and of a non-financial nature
• Sales, COGS, wages exp., SG&A expense, Depreciation on tangible and intangibles
Other Income:
tems arising outside core activities but which are not interest revenues or expenses
• Rental revenues, income from investment in associates
Recast income statement
Financing:
tems that actually or effectively bear interest:
• Interest expense, interest revenues, finance costs
Operating Items
Assets and liabilities used to produce the ‘core’ and ‘other’ revenues and expenses described on previous page
Non-operating Items
Financing items. Items that bear a rate of interest, and produce our net interest expense
• Debt, Borrowings, Lease Liability, Cash
Analysts typically exclude:
– Restructuring charges are typically write- downs of asset values when a firm re- organises its operations,
– Gains on Sale of Assets (e.g. Buildings etc), or investments (in other coys)
