Adventis Certification I Multiple Choice Exam Study Guide

What do the the three Financial Statements communicate?

- The financial condition, results of operations, and various other activities of an organization

- They provide a considerable amount of information to various stakeholders that enable them to make decisions

Board of Directors

Hold management accountable and make board-level decisions about corporate strategy

Company Management

Measure performance and make strategic, operating and financial decisions

Creditors

Measure creditworthiness, liquidity, and bankruptcy risk

Investors

Make decisions on buying or selling equity investments

Acquirers

Determine valuation and make investment decisions

Regulators

Determine whether the company is operating according to regulations and the law

Income Statement

- Presents the results of operations over a period of time

- Typically monthly, quarterly, and/or annually

What is the purpose of the Income Statement?

- To show stakeholders whether the company made or lost money during the period being reported

- It indicates how Revenues are transformed into Net Income

- It displays the Revenues recognized for a specific period of time and the Expenses charged against those Revenues

Revenue (Sales)

The amount charged for the delivery of goods and services

Cost of Sales (Cost of Goods Sold)

The direct cost of producing revenue (raw materials, direct wages, etc.)

Gross Profit

- Calculated as Revenue less Cost of Goods Sold

- Indicates how efficiently labor and supplies are used in the production process

Operating Expenses

All other expenses required to run the business

- EX: Management Salaries, Marketing, Travel, etc.

Operating Income

Also known as EBIT

- Calculated as Revenue less COGS and Operating Expenses

- Indicates a company's earning power from ongoing operations

Non-Operating Expenses

Expenses or Income not related to the regular business of the company

- EX: Interest Expense, Restructuring Expenses, etc.

Corporate Taxes

Local and Federal income taxes the company incurs

Net Income

Also called Net Earnings

- Calculated as Revenue less all expenses of the company

- Indicates the increase in Shareholder's Value resulting from operations

Balance Sheet

Shows an organization's financial position at a particular point in time

- It discloses the resources an organization controls (assets) and the claims on those resources (liabilities and equity).

What are assets?

What a company owns

What are liabilities?

What a company owes

Equity

Represents any remaining claims of shareholder's against a company

- The cumulative shareholder investment plus cumulative net income

Cash

Current assets comprising currency equivalents that can be accessed immediately

Accounts Receivable

The amount owed to an organization from the sale of its products or services

Fixed Assets

The value of assets and property that cannot be easily converted to cash and has a useful life of more than 1 year

- EX: Property, Plant, and Equipment

Accounts Payable

The amount owed to an organization's vendors

Debt

The amount of obligations owed to an organization's creditors

Working Capital

A measure of a company's efficiency and its short-term financial health

- Calculated as Non-Cash Current Assets - Non-Debt Current Liabilities

What may happen if a company's Non-Cash Current Assets do no exceed its Non-Debt Current Liabilities?

The company may run into challenges repaying creditors and suppliers in the short-run

What are Non-Cash Current Assets and what accounts are included?

Represents all assets besides cash that are expected to be converted into cash within one year

- These accounts include A/R, Inventory, Prepaid Expenses, and other Assets

What are Non-Debt Current Liabilities and what accounts are included?

Represents all obligations besides short-term debt that are due within one year

- These accounts include A/P, Accrued Liabilities, and other obligations

Is debt less expensive than equity?

Yes, this is because in the case of bankruptcy, debt owners have priority claims on a company's assets

Why is equity considered more risky than debt?

In the case of bankruptcy, equity holders are not guaranteed to get their investment back, making it more expensive

- Therefore, equity holders require a higher rate of return to mitigate their risk

Net Debt

Calculated as Total Debt less Cash

- Resulting amount if cash were used to pay down debt

- Primarily used in credit analysis, as creditors assume the company's cash balance could be applied to debt repayment in the event of a liquidity crunch or bankruptcy

Cash Flow Statement

Shows how much cash is generated or lost during a period of time

- It reconciles (settles) net income to change in cash and shows how changes in the balance sheet accounts and net income affect cash

- It is useful in determining the short-term viability of a company, particularly the ability of a company to pay its bills

- Reflects a company's liquidity

Cash Flow from Operating Activities and what is included?

The amount of cash generated by an organization's normal business operations

- Includes Net Earnings, Depreciation and Amortization, and Change in NWC

Cash Flow from Investing Activities and what is included?

Cash flow related to the acquisition and disposal of an organization's long-term investments, including PP&E and Mergers and Acquisitions

- Includes Capital Expenditures an Acquisitions

Cash Flow from Financing Activities and what is included?

Cash flow between an organization and its owners and creditors

- Includes Debt and Equity Issuances and Repayments, Dividends, and Share Repurchases

Depreciation and Amortization

The method of allocating the cost of an asset over its useful life for both accounting and tax purposes

- This is an expense on the Income Statement, but this amount does not actually represent cash leaving the company because the cash only leaves the company when the asset is initially purchased

- This is a SOURCE of cash on the CF STATEMENT

Capital Expenditures (CapEx)

Funds used by a company to purchase or upgrade physical assets such as PP&E

Change in Working Capital

Consists of the impact to cash resulting from all non-cash current asset accounts and all non-debt current liability accounts

- A decrease in NWC represents a source of cash and is a positive number on the CF Statement

- An increase in NWC represents a use in cash and is a negative number on the CF Statement

Share Repurchases (Treasury Stock)

The reacquisition by an organization of its own stock

- The organization either retires the repurchased shares or keeps them as treasury stock

- When shares are repurchased, the remaining shareholders have a higher ownership percentage

- Because the resulting ownership stake held by remaining shareholders is larger, so is each shareholder's portion of earnings; thus share repurchases are a form of returning capital to shareholders

Dividends

A distribution of cash to current shareholders and are most derived from a dividend per share amount as directed by an organization's board of directors

- Dividends do not affect ownership percentages and represent a pure "check" to shareholders, though dividends are usually reinvested into a business

- Dividends sometimes become "sticky" and expected, so companies who institute dividend programs due to having stable cash flows, could have trouble if the dividend program is downgraded or removed entirely

Change in Debt

Represents any debt issuances or repayments

EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization)

Gives an indication of a business's current operational profitability and is widely used when assessing the performance of a company as it allows for comparison of profitability between companies in a wide range of industries

Free Cash Flows

A way of looking at a company's cash flow to see what is available for distribution to creditors and shareholders

- Most commonly defined as Cash Flow from Operations less Capital Expenditures

Financial Ratios

Useful indicators of a company's performance and financial situation, and past ratios are often the starting point for forecasting into the future

- Can be used to spot trends, analyze the impact of drivers and variables, evaluate performance, and keep companies on the right track

Liquidity Ratios

Indicate a company's ability to meet its short-term financial obligations

- They are of most interest to those extending short-term credit to a company, such as banks and other lending institutions

Current Ratio (Liquidity Ratio)

Indicates whether a company's short-term assets are readily available to pay off its short-term liabilities

= Current Assets/Current Liabilities

- Normal ratio is between 1.50 and 3.00

Cash Ratio (Liquidity Ratio)

Indicates a company's ability to use cash to pay off its current liabilities

= Total Cash/Current Liabilities

- Normal ratio is between 0.20 and 1.00

Efficiency Turnover Ratios

Indicate how effectively a company utilizes its assets

Days Receivable (Efficiency Ratio)

Average number of days an invoice is in accounts receivable before collection

= (Accounts Receivable/Annual Revenue) x 365

Asset Turnover

Amount of revenues generated per dollar of assets; measures the efficiency of a company's use of its assets in generating sales revenue

= Total Revenue/Total Assets

Profitability Ratios

Provide insight into the profits made by a company relative to its assets, equity, or revenue

- They measure a company's ability to generate profit relative to a metric, and evaluation of different metrics can help point to outperformance vs. peers or opportunities for improvement

Gross Margin (Profitability Ratio)

Relative to revenue, indicates how efficiently labor and supplies are used in the production process

= Gross Profit/Revenue

Operating Margin (Profitability Ratio)

Relative to revenue, indicates a company's earning power from ongoing operations

= Operating Income/Revenue

Net Margin (Profitability Ratio)

Relative to revenue, indicates the increase in shareholder's equity from earnings

= Net Income/Revenue

Return on Equity

Measures profits earned for each dollar invested in a company's equity

Net Income/Shareholder's Equity

Credit Ratios

Measure a company's ability to meet its long-term obligations, and benchmark its overall capital structure

- They are used by creditors, ratings agencies, and management to make sure companies are properly capitalized, have the ability to safely pay down debt obligations and evaluate the impact of a possible transaction or change to capital structure

Debt/EBITDA (Total Leverage) (Credit Ratio)

Used to assess the probability on defaulting on debt

= Total Debt/EBITDA

Net Debt/EBITDA (Net Leverage) (Credit Ratio)

Used to assess the probability on defaulting on debt, taking into account a cash balance that could be used to pay down debt

= Net Debt/EBITDA

Debt-to-Equity (Credit Ratio)

Indicates the relative proportion of debt and equity used to finance a company's assets

= Total Debt/Total Equity

EBITDA Interest Coverage Ratio (Credit Ratio)

Indicates how easily a company can pay interest on outstanding debt

= EBITDA/Interest

Market Ratios

Measure investor response to owning a company's stock and help to understand how investors value a company

- They evaluate the market price of a share of common stock and are an indicator of a company's ability to generate profits or build assets

Enterprise Value

Shows the sum of all claims on a company (the entire firm's value) and is independent of capital structure

- Changes in capital structure do not affect EV

= Equity Value + Net Debt

Equity Value (Market Cap, Market Value)

Value of the equity shareholders' portion of the company, or the value of all the shares outstanding

= Enterprise Value - Net Debt or = Share Price x S/O

Price/Earnings (P/E) (Market Ratio)

Shows how much investors are willing to pay per dollar of earnings and is affected by leverage

= Market Value/Net Earnings

Earnings per Share (EPS) (Market Ratio)

Shows the amount of earnings attributable to a share of common stock

= Net Earnings/Shares Outstanding

Dividend Yield (Market Ratio)

Shows the return on a share of common stock

= Dividend per Share/Market Price per Share

Enterprise Value/EBITDA (Market Ratio)

Measures the value of common stock in a way that enables comparison of companies across different industries; EBIT can also be used

= Enterprise Value/EBITDA

Enterprise Value/Revenue (Market Ratio)

Compares the total value of a company to its revenue

= Enterprise Value/Revenue

According to the Adventis Program, what does Financial Modeling mean?

Financial Statement Forecasting

Financial Model

A representation of an organization's financial path forward

- Financial modelers will rely on historical financial statements to help them forecast financial statements

What are the 2 primary objectives of financial modeling?

1. Arm decision makers with reliable information

2. Communicate effectively to stakeholders

What is the impact to financial statements when Net Income is Positive?

Equity increases and Cash increases

What is the impact to financial statements when Debt is paid down?

Debt decreases and Cash decreases

What is the impact to financial statements when an Invoice is submitted to a customer?

Revenue increases and A/R increases

What is the impact to financial statements when a Payment is received from an invoice?

Accounts Receivable decreases and Cash increases

What is the impact to financial statements when a Bill is paid?

Accounts Payable decreases and Cash decreases

What is the impact to the financial statements when Equipment is purchased?

Fixed Assets increases and Cash decreases