Accounting and DCF Valuation Concepts

Vocabulary practice flashcards generated from key financial accounting, 3-statement modeling, and DCF valuation study notes.

Income Statement (P&L) Purpose

Measures a company's financial performance (revenue, expenses, and net profitability) over a specific accounting period (e.g., quarter or year).

Income Statement Core Formula

$$\text{Revenue} - \text{Expenses} = \text{Net Income}$$

Gross Profit Formula

$$\text{Revenue} - \text{Cost of Goods Sold (COGS)}$$

Operating Income (EBIT) Formula

$$\text{Gross Profit} - \text{Operating Expenses (SG\&A, R\&D, D\&A)}$$

EBITDA Formula

$$\text{EBIT (Operating Income)} + \text{Depreciation} + \text{Amortization}$$

Net Income Formula

$$\text{EBIT} - \text{Net Interest Expense} - \text{Income Taxes}$$

Non-Cash Expenses on Income Statement

Depreciation and Amortization (D&A), Stock-Based Compensation (SBC), and Asset Impairments. They reduce accounting profit but do not directly reduce cash in that period.

Balance Sheet Purpose

Shows a snapshot of a company's financial position at a single point in time, listing assets owned and how they are funded (liabilities + equity).

Balance Sheet Core Formula (Accounting Equation)

$$\text{Assets} = \text{Liabilities} + \text{Shareholders' Equity}$$

Current Assets vs Non-Current Assets

Current Assets are expected to convert to cash within 12 months (Cash, A/R, Inventory, Prepaid Expenses). Non-Current Assets are long-term (PP&E, Intangibles, Goodwill).

Current Liabilities vs Long-Term Liabilities

Current Liabilities are due within 12 months (A/P, Accrued Expenses, Short-Term Debt). Long-Term Liabilities are due beyond 12 months (Long-Term Debt, Deferred Tax Liabilities).

Working Capital (Gross)

Current Assets (measure of short-term operational liquidity).

Net Working Capital (NWC) Formula

$\text{Current Assets (excluding Cash)} - \text{Current Liabilities (excluding Short-Term Debt)}$. Measures operational cash efficiency.

Impact of NWC Increase on Cash Flow

Cash OUTFLOW. More operational cash is tied up in uncollected invoices (A/R) or unsold inventory, reducing available cash.

Impact of NWC Decrease on Cash Flow

Cash INFLOW. Cash is freed up from operations (e.g., collecting A/R faster or delaying supplier payments via A/P).

Shareholders' Equity Components

Common Stock, Additional Paid-in Capital (APIC), Retained Earnings, Treasury Stock (negative), and Accumulated Other Comprehensive Income (AOCI).

Retained Earnings Formula

$$\text{Beginning Retained Earnings} + \text{Net Income} - \text{Dividends Paid} = \text{Ending Retained Earnings}$$

Cash Flow Statement (CFS) Purpose

Tracks the actual cash coming into and leaving the company over a period, reconciling Net Income to ending cash balance.

Three Sections of the Cash Flow Statement

1. Cash Flow from Operating Activities (CFO), 2. Cash Flow from Investing Activities (CFI), 3. Cash Flow from Financing Activities (CFF).

Cash Flow from Operations (CFO) Calculation

$$\text{Net Income} + \text{Non-Cash Expenses (D\&A, SBC)} -/+ \text{Changes in Working Capital (Change in Operating Assets \& Liabilities)}$$

Cash Flow from Investing (CFI) Calculation

Capital Expenditures (CapEx, cash outflow) + Acquisitions - Asset Sales / Proceeds from Investments.

Cash Flow from Financing (CFF) Calculation

Debt Issued - Debt Repaid + Equity Issued - Share Buybacks - Dividends Paid.

3 Statements Link: Net Income

Net Income flows from the bottom of the Income Statement to the top line of Cash Flow from Operations and into Retained Earnings on the Balance Sheet.

3 Statements Link: D&A (Depreciation & Amortization)

D&A is an expense on the Income Statement, gets added back in CFO (non-cash), and reduces net PP&E/Intangibles on the Balance Sheet.

3 Statements Link: CapEx (Capital Expenditures)

CapEx appears as a cash outflow in CFI and increases gross PP&E on the Balance Sheet.

3 Statements Link: Ending Cash

The net change in cash across CFO, CFI, and CFF determines the Ending Cash balance on the Balance Sheet.

3-Statement Walkthrough: $10 Depreciation Increase (40% Tax Rate)

1. IS: Pre-tax income down $10, Net Income down $6. 2. CFS: Net Income down $6, add back $10 D&A -> CFO up $4. 3. BS: Cash up $4, PP&E down $10 -> Assets down $6. Retained Earnings down $6 -> Balanced.

3-Statement Walkthrough: $100 CapEx Purchase (All Cash)

1. IS: No immediate impact. 2. CFS: CFI drops by $100 -> Cash drops by $100. 3. BS: Cash down $100, PP&E up $100 -> Total Assets unchanged, Liabilities & Equity unchanged -> Balanced.

3-Statement Walkthrough: $100 Inventory Purchase (50% Cash, 50% Accounts Payable)

1. IS: No impact until sold. 2. CFS: CFO drops by $50 (Inventory +$100 outflow offset by A/P +$50 inflow). 3. BS: Cash down $50, Inventory up $100 (Total Assets +$50); A/P up $50 (Total Liab +$50) -> Balanced.

Discounted Cash Flow (DCF) Model Definition

An intrinsic valuation method that values a business today by discounting its projected future Unlevered Free Cash Flows and Terminal Value by its Weighted Average Cost of Capital (WACC).

Enterprise Value (EV) in a DCF

The total value of the operating core of a business, calculated as the Net Present Value (NPV) of all future Unlevered Free Cash Flows plus the NPV of the Terminal Value.

Equity Value Formula from Enterprise Value (Bridge)

$$\text{Equity Value} = \text{Enterprise Value} + \text{Cash \& Cash Equivalents} - \text{Total Debt} - \text{Minority Interest} - \text{Preferred Stock}$$

Intrinsic Share Price Formula in a DCF

$$\frac{\text{Equity Value}}{\text{Total Diluted Shares Outstanding}}$$

Unlevered Free Cash Flow (UFCF / FCFF) Definition

The cash generated by core operations available to ALL capital providers (both Debt and Equity holders) after operating costs, taxes, CapEx, and working capital needs.

UFCF Calculation Formula (from EBIT)

$$\text{EBIT} \times (1 - \text{Tax Rate}) + \text{D\&A} - \text{Capital Expenditures (CapEx)} - \text{Change in Net Working Capital } (\Delta\text{NWC})$$

UFCF Calculation Formula (from CFO)

$$\text{Cash Flow from Operations (CFO)} + \text{Net Interest Expense} \times (1 - \text{Tax Rate}) - \text{Capital Expenditures (CapEx)}$$

NOPAT (Net Operating Profit After Taxes) Formula

$\text{EBIT} \times (1 - \text{Tax Rate})$. Represents unlevered after-tax operating earnings.

Why Use UFCF Instead of Net Income in a DCF?

Net Income includes non-cash items and depends on capital structure (interest payments), whereas UFCF represents real cash generated by core operations independent of how the company is financed.

Why Cash Flows are Discounted (Time Value of Money)

A dollar received today is worth more than a dollar in the future due to inflation, opportunity cost of capital, and investment risk.

Weighted Average Cost of Capital (WACC) Definition

The blended required rate of return expected by all providers of capital (debt, equity, preferred), used as the discount rate for UFCF.

WACC Formula

$$(\text{Cost of Equity} \times \%\text{ Equity}) + (\text{Cost of Debt} \times (1 - \text{Tax Rate}) \times \%\text{ Debt}) + (\text{Cost of Preferred} \times \%\text{ Preferred})$$

Cost of Debt (Kd) in WACC

The effective yield/interest rate a company pays on its borrowings, adjusted for tax deduction: $\text{After-tax Cost of Debt} = \text{Pre-tax Cost of Debt} \times (1 - \text{Tax Rate})$

Cost of Equity (Ke) Formula (CAPM)

$$\text{Risk-Free Rate } (R_f) + \text{Beta } (\beta) \times \text{Equity Risk Premium (ERP)}$$

Risk-Free Rate (Rf) in CAPM

The theoretical yield on a default-free government bond matching the currency and horizon of the model (typically 10-Year or 20-Year US Treasury).

Beta (̢) in CAPM

A measure of an asset's systematic risk/volatility relative to the broader market. $\beta > 1$ means higher volatility than the market; $\beta < 1$ means lower volatility.

Unlevered Beta (Asset Beta) Formula

$\text{Unlevered Beta} = \frac{\text{Levered Beta}}{1 + \left((1 - \text{Tax Rate}) \times \frac{\text{Total Debt}}{\text{Equity}}\right)}$. Removes the risk effect of financial leverage to isolate business risk.

Re-levered Beta (Equity Beta) Formula

$\text{Re-levered Beta} = \text{Unlevered Beta} \times \left[1 + \left((1 - \text{Tax Rate}) \times \frac{\text{Total Debt}}{\text{Equity}}\right)\right]$. Re-applies the target company's capital structure risk to the industry asset beta.

Equity Risk Premium (ERP)

The excess return investors demand above the risk-free rate for investing in equities rather than riskless government bonds (Historical average ~4.5% - 6.5%).

Terminal Value (TV) Definition

The estimated value of all cash flows beyond the discrete projection period (usually beyond Year 5 or 10), typically representing 50% to 80% of total DCF value.

Perpetual Growth (Gordon Growth) TV Formula

$\text{Terminal Value} = \frac{\text{Final Year UFCF} \times (1 + g)}{\text{WACC} - g}$, where $g$ is the perpetual long-term growth rate.

Perpetual Growth Rate (g) Constraint

The long-term growth rate ($g$) should NEVER exceed the expected long-term GDP growth rate of the country (~2% - 3.5%), otherwise the company eventually becomes larger than the economy.

Exit Multiple TV Formula

$$\text{Final Year Financial Metric (typically Year 5 EBITDA)} \times \text{Target EV/EBITDA Multiple derived from peer comps}$$

Discounting Terminal Value to Present Value

$\text{PV of TV} = \frac{\text{Terminal Value}}{(1 + \text{WACC})^n}$, where $n$ is the number of years in the discrete forecast period.

Mid-Year Convention in a DCF

An adjustment assuming cash flows are received evenly throughout the year (at month 6) rather than all on the final day of the year (December 31), discounting cash flows by $(t - 0.5)$ instead of $t$.

Stub Period in a DCF

A partial initial projection period used when building a valuation model mid-year (e.g., October to December = 0.25 years).

Excel Formula: NPV vs XNPV

=NPV(rate, values) assumes strictly uniform periodic payments at period-ends. =XNPV(rate, values, dates) accounts for exact dates, stub periods, and uneven intervals.

Excel Formula: IRR vs XIRR

=IRR(values) calculates the discount rate where NPV equals zero for equal time periods. =XIRR(values, dates) calculates the exact annualized internal rate of return for specific calendar dates.

Sensitivity Analysis in a DCF

A modeling table (Excel Data Table) evaluating how Enterprise Value / Share Price changes when core assumptions shift (most commonly WACC vs. Perpetual Growth Rate or WACC vs. Exit Multiple).

Growth-Based vs Driver-Based Revenue Forecasting

Growth-Based uses top-down percentage growth rates (best for mature firms). Driver-Based builds up revenue via operational metrics like units sold \times average price (best for granular models).

Levered Free Cash Flow (FCFE) vs Unlevered (FCFF)

UFCF (FCFF) is available to all capital providers and discounted at WACC to get Enterprise Value. Levered FCF (FCFE) is cash left after debt service/interest, available strictly to equity holders, discounted at Cost of Equity to get Equity Value directly.