Equity Financing and Accounting Quality

Financial flexibility

Ability of a firm to quickly adapt to financial changes

Short-term liquidity risk

Risk of a firm not meeting short-term financial obligations

Long-term solvency risk

Risk of a firm not being able to meet long-term financial obligations

Credit risk

Risk of loss due to a borrower's failure to repay a loan

Bankruptcy risk

Risk of a firm becoming insolvent and unable to pay debts

Systematic risk

Risk inherent to the entire market or economy

SEC

Securities and Exchange Commission; mandates risk disclosure in 10K filings

Firm-Specific Risks

Unique risks affecting a company's industry, strategy, and profitability

Commodity Prices

Changes in raw material prices impacting a firm's profitability

Foreign Exchange

Impact of currency rate changes on a firm's financials

Interest Rate Risk

Changes in interest rates affect investments' fair values

Interest Rate Swaps

Used to hedge or neutralize interest rate change risks

Risk Management Disclosures

Firms disclose risks based on types they are exposed to

Financial Flexibility

Ability to strategically use debt financing for higher returns

ROCE Disaggregation

Analyzing ROCE components for financial flexibility insights

Net Operating Assets

Operating assets minus financing obligations and equity

Balance Sheet Reformulation

Operating and financing items separated for clarity

Operating Cycle

Firm's ability to meet near-term payment obligations

Current Ratio

Current assets divided by current liabilities

Quick Ratio

Cash and quick assets / current liabilities

Operating Cash Flow Ratio

Cash flow from operations / average current liabilities

AR Turnover

Sales / average accounts receivable

Inventory Turnover

Cost of goods sold / average inventory

AP Turnover

Inventory purchases / average accounts payable

Debt Ratios

Measure the relative amount of liabilities in a firm's capital structure

Liab to Assets

Total liabilities / total assets

Liab to SE

Total liabilities / total equity

LongTerm Debt to Long Term Capital

Long-term debt / (long-term debt + long-term equity)

Interest Coverage Ratios

Indicate how many times a firm's income or cash flows can cover interest charges

Net Income Basis

(Net income + interest and tax expenses) / interest expense

Cash Basis

(Operating cash flow + cash to interest and income taxes) / cash to interest

Operating Cash Flow to Total Liabilities Ratio

Operating cash flow / average total liabilities, measuring a firm's ability to generate cash flow to service debt

Analyzing Credit Risk

Assessing the likelihood of a firm not being able to repay interest and principal borrowed

Collateralized assets

Assets like marketable securities, accounts receivable, inventories, and property used to secure a loan

Capacity for debt

The ability of a firm to take on debt based on its financial situation

Contingencies

Potential uncertainties that can impact a firm's credit standing

Conditions or covenants

Restrictions placed by lenders on a firm to protect their interests, such as specific financial ratio levels

Altmans Z Score

Bankruptcy prediction model with score ranges indicating financial health

Systematic Risk

Risk related to economic factors affecting investment decisions

CAPM Model

Used to determine a firm's risk-based required rate of return

Beta

Measure of a firm's systematic or undiversifiable risk

Accounting Quality

Ensures fair and complete representation of a firm's financial status

Balance Sheet

Summarizes a firm's assets, liabilities, and equity at a specific point in time

Statement of Cash Flows

Summarizes cash flow implications and changes in a firm's financial position over time

Income Statement

Details revenues, costs, expenses, gains, losses, and accruals for a period

GAAP

Generally Accepted Accounting Principles for financial reporting

IFRS

International Financial Reporting Standards for financial reporting

Earnings Quality

Reflects ongoing earnings accurately, aiding in performance evaluation and forecasting

Voluntary Disclosures

Unbiased and accurate information provided by managers, aiding in forecasting

Balance Sheet Quality

Key qualities of financial statements: earnings (IS) and balance sheet

LIFO

Method affecting cogs representation negatively but not inventory valuation

FIFO

Method affecting inventory valuation positively but not cogs representation

Earnings Management

Manipulating financial reports to mislead stakeholders or influence outcomes

Corporate Governance

Strong board of directors ensuring ethical practices and transparency

Liabilities Recognition

Identifying obligations with likely future costs and limited avoidance

Long Term Debts

Involves choosing interest rates for repayment and fair value reporting

Fair Value Reporting

Option to report debt at market value for better risk assessment

Warranty Agreements

Obligations needing estimation for likely future costs like repairs

Deferred Revenue

Payment received for future goods/services, recognized after delivery

Revenue Recognition

Ensuring revenue isn't recognized too early for accurate financials

Starbucks Case

Deferred revenue example where revenue recognized after service delivery

Mutually Unexecuted Contracts

Agreement to exchange resources not yet fulfilled

Executory Contract

Liability or asset realized upon contract fulfillment

Contingent Obligations

Uncertain events like lawsuits requiring future transfers

Accounting Rules for Contingent Obligations

Guidelines determining when to recognize liability

Recognizing Loss for Contingent Obligations

Firms acknowledge loss when probable and reasonably estimated

Off-Balance Sheet Financing Arrangements

Innovative financing methods not meeting debt recognition rules

Liabilities Management

Lowering reported liabilities on the balance sheet through various methods

Asset Recognition

Accurate valuation of assets for liquidity and financial risk assessment

Cash Measurement

Straightforward valuation of cash on the balance sheet

Noncurrent Assets

Assets controlled for future benefits, initially valued at fair value

Inventory Valuation

Recording inventory at lower of cost or market, affected by measurement methods

Management Judgement

Influences earnings quality, subject to GAAP limitations

Peripheral Gains/Losses

Non-core transactions impacting income statements before taxes

Restructuring Charges

Covering expected costs from significant business changes

Discontinued Operations

Significant changes in business leading to separate income statement reporting

OCI

Recording unrealized gains/losses in comprehensive income and equity section

Changes in Accounting

Reporting principle changes retrospectively and estimate changes prospectively

Accounting Classifications

Differences complicate comparisons, affecting reported gross margins

Accrual Accounting

Incorporating deferrals and accruals to track economic activities

Accrual Component

Adjustments converting cash flow to accrual accounting earnings

Accrual Method of Accounting

Calculates earnings regardless of cash flow timing

Net Income

Total earnings after deducting expenses

Operating Cash Flows

Cash generated from core business operations

EBITDA

Earnings before interest, taxes, depreciation, and amortization

Cash Flow from Operations

Cash generated or used in daily business operations

Valuation of Earnings

Assessment of the worth of reported earnings

Financial Fraud Detection Model

Analyzes financial data to identify potential fraudulent activities

Foreign Private Issuer (FPI)

Non-US company trading in US markets subject to SEC regulations

Multi-Jurisdictional Disclosure System (MJDS)

Allows Canadian companies to sell securities in the US using Canadian prospectus

Comparability in Financial Reporting

Ensuring consistency in financial reporting for multinational firms

US SEC

Securities and Exchange Commission regulating US financial markets

Ownership Test

Requirement for FPIs to have over 50% of voting shares owned by US residents

Business Contacts Test

Criteria including US executives, assets, or administration for FPI status

Biovail

Canadian firm trading on NYSE, became a US registrant in 1996

Form 20-F

Filing requirement for foreign private issuers (FPIs) with the SEC

FPI Status

Lost in 2010, impacts reporting requirements and compliance for firms

10-K

Annual report filed with the SEC, includes financial performance and risk factors

FPI Score

Measures a firm's compliance with requirements, reflects changes post status shift

FPI Exemptions

Relate to financial statements, disclosure of insider info, and corporate governance