Week 4

Question 1

what are operating assets/liabilities compared to non-operating

Answer 1

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

Question 2

Non-Operating Assets / Liabilities (Financing Assets / Liabilities) produce

Answer 2

Financing Revenues and Expenses in our re-cast income statement

Question 3

Operating Assets / Liablilites produce either:

Answer 3

– Rev / Expense from Core Activities

– Other Income or Expense (e.g. rental income etc)

Question 4

we will only classify items as non-operating (financing) if

Answer 4

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

Question 5

Analysts rely heavily on

Answer 5

information contained in firms’ published financial reports when generating their forecasts of future performance and valuing firms

Question 6

the usefulness of financial statements for forecasting / valuation may be improved by

Answer 6

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.

Question 7

Non-operating Items

Answer 7

Financing items. Items that bear a rate of interest, and produce our net interest expense

• Debt, Borrowings, Lease Liability, Cash

Question 8

Operating Items

Answer 8

Assets and liabilities used to produce the ‘core’ and ‘other’ revenues and expenses

Question 9

Classification on Income Statement

Answer 9

– 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

Question 10

Operating Cash Flows

Answer 10

– Payments to/from suppliers and customers

– Interest received and paid
– Divs received
– Tax paid

Question 11

Investing Cash Flows

Answer 11

– Payments to purchase long-term assets
– Proceeds from Disposal of long-term assets

Question 12

Financing Cash Flows

Answer 12

– Proceeds of Borrowings / Equity Issues

– Repayment of Principal Borrowed / Return of Shareholder Capital

Question 13

what are type of adjustments

Answer 13

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

Question 14

Types of accounting adjustments

Estimation of an ‘Adjusted NPAT’ involves

Answer 14

• 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).

Question 15

alternate names for their estimates of ‘earnings from continuing activities’

Answer 15

– Ongoing earnings
– Street Earnings
– Adjusted Earnings…………..

Question 16

what do analysts typically exclude from adjusted NPAT?

Answer 16

Goodwill impairment expense (Goodwill writedown)

acquisition expense

asset sale gain/loss

litigation charge

realized investment gain

restructuring charge

Question 17

If they included the one-off impairment of $16.1m in ‘Adjusted NPAT’

Answer 17

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)

Question 18

Why is Adjusted NPAT useful

Answer 18

predicts future earnings and the ability to generate free cash flows to equity better than the firm’s Reported Net Profit After Tax

Question 19

One motivation for firms to provide alternative (non-GAAP) earnings measures is to

Answer 19

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’

Question 20

adjustment of the actual balances in a firm’s recast financial statements to

Answer 20

– 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

Question 21

What is the motivation for adjustments to the balance of reported financial statement

Answer 21

information suggesting that particular items are overstated/understated

Question 22

what items are usually excluded from Adjusted NPAT?

Answer 22

Goodwill impairment expense because it is believed to be less relevant to predict future earnings

Sale of a business segment - unlikely to reoccur

Question 23

Items from Core Activities:

Answer 23

items pertaining to core business and of a non-financial nature

• Sales, COGS, wages exp., SG&A expense, Depreciation on tangible and intangibles

Question 24

Other Income:

Answer 24

tems arising outside core activities but which are not interest revenues or expenses

• Rental revenues, income from investment in associates

Question 25

Recast income statement

Financing:

Answer 25

tems that actually or effectively bear interest:
• Interest expense, interest revenues, finance costs

Question 26

Operating Items

Answer 26

Assets and liabilities used to produce the ‘core’ and ‘other’ revenues and expenses described on previous page

Question 27

Non-operating Items

Answer 27

Financing items. Items that bear a rate of interest, and produce our net interest expense

• Debt, Borrowings, Lease Liability, Cash

Question 28

Analysts typically exclude:

Answer 28

– 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)