Finance & Accounting

Liquitity Ratio

Can the company pay its short-term debts?

Solvency Ratio

Is total debt managemenable? Can creditors be paid if the company is liquidated?

Problem with ratios

•      No universal benchmark — ratios vary by industry.

•      Snapshot in time — only reflects the balance sheet date.

•      Window dressing — companies can manipulate ratios (e.g. repaying short-term debt just before year-end to look more solvent).

Reasons for using ratios?

•      Track trends year over year within one company.

•      Compare companies in the same sector.

•      Banks use ratio targets to decide whether to continue lending.

Static Liquidity ?

Based on the balance sheet at one moment in time, do current assets cover short-term debt?

Dynamic Liquidity there are three liquidity ratios.

Based on the cash flow forecast over a period, do cash flow inflows exceed cash outflows?

The three liquidity ratios.

• Net Working Capital (NWC)

• Current ratio

• ACID test ratio

Depth Ratio

Share of assets financed by debt (liabilities ÷ total assets).. Higher = worse

Solvency Ratio

How much equity covers total assets; shows long-term financial stability.

ICR

How many times operating profit covers interest payments.

Current Ratio

Can you pay short-term debts with your short-term assets?

Acid test

Like current ratio but stricter — inventory is excluded.

ROA / ROE

Profit earned per euro of assets (ROA) or per euro of equity (ROE).

ACD

Average days it takes to collect payment from customers. (Higher = worse)

NWC (Net Working Capital)

Current assets minus current liabilities; the buffer to cover short-term obligations.

Financial Levarage

using borrowed money to make more profit for the shareholders.

The idea is simple. If you borrow money at a low interest rate and invest it in something that earns a higher return, the extra profit goes to the shareholders. You used the bank's money to make yourself richer.

DuPont Chart

ROA just tells you "this company earns X% on its assets." DuPont tells you how — is it because they have fat profit margins, or because they're super efficient with their assets?

Profitability

How much is earned on invested capital?

Anual report has three parts

1. Financial statement (balance sheet etc)

2. Management Report (events part year, outlook for future)

3. Auditor’s report (External auditors conslustion on reliability)

Five Financial Reporting Principles

1. Realization Principle (revenue)

2. Matching Principle (Costs)

3. Prudence Principle

4. Continuitity Principle

5. Comparability

Realization Principle

Revenue is recognized when the product or service is sold and delivered — not when payment is received.

Example: Holiday booked in December, trip taken in January → revenue belongs to January (delivery is in January).

Matching Principle

Costs are matched to the period in which they generate revenue. Two types:

•      Product matching — costs accounted for in the period the related revenue is recognized. Example: cost of goods sold matches the revenue from the same sale.

•      Period matching — costs accounted for in the period they belong to, regardless of payment. Example: insurance premium, rent, interest, depreciation.

Prudence Principle

Losses are recognized as soon as they are identified. Profits are only recognized when actually realized.

•      Research expenditure → prudence wins → immediately expensed (future benefit too uncertain).

•      Development expenditure → matching wins → capitalize on balance sheet IF feasibility is proven.

•      Write off a debt when the customer is bankrupt, even before the loss is confirmed.

Continuitity Principle

Assets are valued on the assumption the company will continue to operate. If continuity is at risk, assets must be valued at liquidation value (usually much lower). Publishing liquidation values can be a self-fulfilling prophecy: suppliers stop credit, banks withdraw loans, customers flee.

Comparability

Same accounting policies must be applied from year to year (time comparison). A change in policy requires a restatement. Under IFRS, all listed companies use the same rules across borders (cross-company comparison).

3 Management Reports

1. Events

2. Outlook (forceast)

3. Risk section

4 Auditors Reports

1. Unqualified opinion

2. Qualified opinion

3. Disclaimer of opinion

4. Adverse opinion

What is an asset?

It must meet two conditions:

1. The company controls it.

2. It is expected to generate economic benefit for the company.
   
   
   Else you can leave the expenditure on the income statement

Which of these are on balance sheet: Research expenditure, development expenditure, investment in staff training

• Research expenditure? No.

• Development expansion? Yes.

• Investment in staff training? No.

On-Balance vs Off-Balance for IFRS and Dutch GAAP

You rent a building for 5 years, paying €100,000 per year.

Off-balance (Dutch GAAP):

• Nothing appears on the balance sheet

• Each year just €100,000 cost on the income statement

• Your balance sheet looks clean — low debt, high solvency ratio

• But in reality you are committed to paying €500,000 over 5 years

On-balance (IFRS):

• Day 1: you put the building on the balance sheet as an asset (€500,000) AND a debt of €500,000

• Your total assets go up, your total debt goes up

• Solvency ratio gets worse — but it reflects reality

Impairment

when reality is worse than the book value.

Say that machine is now only worth €40,000 if you sold it today — but your balance sheet still says €70,000. That's a lie. You must write it down to €40,000. The €30,000 difference is a loss on the income statement. That's an impairment.

Realizable value

what is it actually worth in reality? You pick the highest of two options:

• What you'd get if you sold it today (net selling value)

• What it will earn you if you keep using it (value in use)

FIFO

Oldest stock sold first. Inventory valued at most recent prices. Gives higher inventory value when prices rise.

LIFO

Newest stock sold first. NOT allowed for external reporting in the Netherlands (inventory value too low if prices rise).

WAC

After each purchase, recalculate the weighted average price of all units in inventory. Used for each sale.

Think of a company that stores thousands of litres of oil in one big tank. New oil gets pumped in, old oil gets pumped out — it all mixes together. You literally cannot say "this litre was bought on March 3rd at €2.10." So you just take the average price of everything in the tank.

Same with bulk goods like grain, sand, chemicals, coffee beans — they all get mixed together in storage.

When a project spans multiple years, when should profit be recognized?

• If you can make a reliable cost estimate → you must use Percentage of Completion

• If you cannot make a reliable cost estimate → you use Completed Contract

What is net added value

The value a company creates itself — revenue minus what it bought from others, minus depreciation.

Revenue − raw materials − other bought-in costs - depreciation.

Financial Lease

You own it. It is on the balance sheet. You have the risks.

Operational Lease

You're just renting it. You dont have risks.