Multiple Choice section of Adventis Certification level 1

What are the three financial statements, and what do they do

income statement, balance sheet, cf statement

they communicate the finanical conditions, results of operations, and other activties of an organization. The three finanical statements provide info to various stakeholders.

How does the board of directors use finanical statements?

to hold mgmt acountable, make board-level decisions about corporate strategy

company mgmt-- how do they use fina statements?

to measure performance and make strategic, operating and financial decisions

Creditors- how do they use fina statements

to measure credit worthiness, liqudity, and bankruptcy risk

investors-- how do they use fina statements?

to make decisions on buying or selling equity investments

acquirers-- how do they use fina statements?

to determine valuation and make investment decisions

regulators

they use fina statements to determine whether the company is operating according to regulations and the law

The income statement does what

what is its purpose

the income statement presents the results of operations (profitability) over a period of time.

The purpose of the income statement is to show stakeholders whether the company made or lost money during the period reported.

THE INCOME STATEMENT

Revenue(sales) is ________.

the amount charged for the delivery of goods or services.

cogs is

the direct cost of producing revenue. (RM, wages, etc.)

Gross profit is ___.

revenue- cogs

it indicates how efficiently lbaor and supplies are used in the production process.

operating expenses are

all other expenses required to run the business (marketing, travel, mgmt salaries)

Operating income, aka ___, is _____.

EBIT

revenue- cogs-operating expenses

it indicates a companies earning power from ongoing operations

Non-operating expenses are

expenses not related to the regular business of the company. (interest expense, restructuring expense, etc.)

Net income//net earnings are

Net earnings indicates the

revenue- all exepsens of the company

increase in shareholder value resulting from operations

THE BALANCE SHEET

it shows______ at a particular _____.

the basic set up is _____.

it must balance lol

the balance sheet shows an organization's finanical position at a PARTICULAR POINT IN TIME!

it shows the resources an organization controls (assets), and the claims on those resources (liability and equity).

the balance sheet measures the performance of a company regardless of when cash transactions occur.

Accounts recievable is

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

Fixed assets are

the value of assets and property that cannot easily be converted to cash and has a useful life of greater than 1 year. Ex. Plants, property, equipment

Debt is

Equity is ___

debt is the amount of obligations owed to creditors

equity is cumulative shareholder investment plus cumulative net income.

Working capital is not on the balance sheet, but it can be derived from balance sheet accounts.

Working capital is a measure of a firm's _____.

Its calculated as _____.

efficiency & short-term financial health.

non-cash current assets - non-debt current liabilties

Non-cash current assets ________

represent all assets (besides cash) that are expected to be converted into cash within one year. ex. a/r, inventory, prepaid expenses, other assets

Non-debt current liabilities _______.

represent all obligations (besides short term debt) that are due within one year. ex. a/p, accrued liablities, etc.

So, if a company's non-cash current assets do not exceed non-debt current liabilties, then it may run into challenges _____.

repaying creditors and suppliers in the short run.

Having a negative or positive working capital isnt necessarily a bad thing, but it does determine whether working capital is a source of cash.

The differences between debt and equity

cheap or expenseive, claims? rates of return?

Debt is a less expensive form of capital because it is less risky. Debt owners typically have priority claims on a company's assets if the firm goes bankrupt.

Equity is more expensive and more risky, so investors require a higher rate of return to mitigate their risk. Equity holders are not guaranteed to get their investment back if the company goes bankrupt--risky!

Net Debt -- not on balance sheet explicitly

calculation:

Net debt is primarily used in ___ anaylsis, ____

Total debt - cash.

If cash were used to pay down debt, net debt would be the resulting amount.

primarily used in credit analysis, as creditors assume the firm's cash balance could be applied to debt repayment in the event of a liqudity crunch of bankruptcy.

CF Statement shows _____.

It reconciles _____.

it breaks down cash into three categories

The CF statement is useful in determining the short-term ___.

how much cash is generated or lost during a period of time. It shows how changes in balance sheet accounts and net income affect cash and breaks down cash into operating, investing, and financing activities.

It reconciles net income to change in cash.

viability of a company and the ability of a firm to pay its bills.--the company's liqudity

Cash from operating activities

made up of 3 components!

is the amount of cash generated from a firm's normal business operations.

-net earnings

-depreciation & ammoritization

-change in working capital

Cash from investing activities

most common components

is cash flow related to the acquistion and disposal of an organization's long-term investments, including property, plant and equipment and M&As.

-Capital Expenditures

-Acquistion

Cash from financing activities

most common line items

is cash flow between the firm and its owners and creditors.

-debt & equity issuance and repayments

-dividends

-share repurchases

Change in Cash is

the sum of the cash from operating, investing, and financing activities.

Why is depreciation & amortization a source of cash on the CF statement?

D &A is the method of allocating cost of an asset over its useful life. While its an expense on the income statement, it does not actually represent cash leaving the company ecause cash only leaves the company for the asset's intial purchase (in CAPEx), so D & A is added back

Capital Expenditures are

funds used by the firm to purchase or upgrade physical assets such as plants, property, and equipment.

Change in working capital consists of

a decrease represents

an increase represents

the impact to cash results from all non-cash current assets and non-debt current liability accounts.

A decrease represents a source of cash and is positive on the CF statement.

An increase in working capital represents a use of cash and would be negative on the CF statement.

working capital is a ______ that _____ cash.

a sponge that absorbs cash.

squeeze sponge--> decrease working cap--> more money for the business

so incr working cap, decr cash

airlines are a negative working capital business. they recieve cash long before the service.

Share repurchases helps shareholders because

when shares are repurchased, the remaining shareholders have a higher ownership percentage. thus each shareholder has a higher portion of earnings.

So, share repurchases are a form of returning capital to shareholders

Dividends are

a distribution of cash to current shareholders. they represent a pure "check" to shareholders. companies with stable CFs usually have a dividend program. Downgrading or removing dividend programs can signal trouble for a company.

Change in debt represents

any debt issuances or repayments.

EBITDA is

it gives an indication of a firms

earnings before interest, tax, D&A.

current profitability. WHY IS IT USED? because it allows for a COMPARISON of profitability between companies in a wide range of industries. It excludes the effects from different forms of finacning, different political and tax jurisidctions, and different rules around D&A.

Free Cash Flow

a way of looking at a company's cash flow to see what is available for distribution to creditors and shareholders. CASh flow from operations -- Capital expenditures.

FCFF is one of the most important metrics to value a company.

financial ratios can be used to

spot trends

analyze the impact of drivers and variables

evaluate performance

forecasting

comparison to other firms

they can be expressed as a decimal, a percent, or a multiple.

there are 5 types of financial ratios...

Liquidity Ratios

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

Efficency Ratios

indicate how effectively a company utilizes its assets

Profitability ratios

provide insight into the profits made relative to assets, equity, or revenue

cREDIT ratios

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

used by creditors

Market Ratios

measure investor response to owning a company's stock

Two Types of Liquidity ratios:

>Current Ratio

>Cash Ratio

these are of interest to those extending short-term credit to a company, like banks.

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

formula: current assets/ current liabilities

1.5-3 is a normal current ratio

>Cash Ratio : Indicates a firms ability to use cash to pay off its current liabilities.

total cash/current liabilities

normal is between .2-1.0

Efficiency Ratios

>Days receivable

>Asset Turnover

>Days Recievable: average number of days an invoice is in accounts receivable before collection

(a/r / annual revenue) * 365

>Asset Turnover: amount of revenues generated per dollar of assets; measures the efficieny of a company's use of its assets in generating sales revenue.

Total Revenue/ Total Assets

2.5 means that for every dollar of assets a company generates 2.5 dollars in revenue.

Profitability Ratios

evaluation of different metrics can help point to outperformance vs. peers or improvement opportunities. All profit (rev or net income) relative to a metric.

>Gross Margin

>Operating Margin

>net margin

>return on equity

>Gross Margin: gross profit/ revenue

indicates how efficiently labor and supplies are used in the production process

>Operating Margin: operating income/revenue

indicates a company's earning power from ongoing operations

>Net Margin: net income/ revenue

indicates the increase in shareholders' equity from earnings

>Return on Equity: net income/ shareholders' equity

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

a ROE of 17% means that for every $1, 17 cents of net income is produced

Credit Ratios (long term obligations)

>Debt / EBITDA (total leverage)

> Net Debt/ EBITDA (Net leverage)

> Debt to Equity

>EBITDA interest coverage ratio

>Debt/EBITDA - used to asses the probability on defaulting on debt

a ratio of 2.5 means that it will take 2.5 years to pay off debt

>Net Debt/EBITDA - used to asses the probability of defaulting on debt, taking into account the cash balance

A net debt/ebitda ratio of 2.5x means that it will take 2.5 years to pay off the debt

>Debt to Equity: total debt/total equity

indicates the relative proportion of debt and equity used to finance a company's assets. A debt to equity ratio of 25% means that for every $1 owned by shareholders, 25cents is owed to creditors.

>EBITDA interest coverage ratio: EBITDA/ Interest

indicates how easily a company can pay interest on outstanding debt

2.0x means that the firm is producing two times the cash needed to satisfy interest expense requirements.

Market ratios cont.

>Earnings per Share (EPS)

>EPS-- shows the amount of earnings attributable to a share of common stock.

Net Earnings/ shares outstanding

An EPS of $2.45 means that $2.45 was earned for every share of stock outstanding

>Dividend Yield

shows the return on a share of common stock.

Dividend per share/ Market price per share

- a dividend yield of 20% means that for every $1 in stock price value, 20 cents was distributed to shareholders as dividends.

Market Ratios

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

>Enterprise Value (firm value or EV)

>Equity Value (Market value, Market Capitalization)

>Price/ Earnings (P/E)

>Earnings per Share (EPS)

>Dividend Yield

> Enterprise value/ EBITDA

>EV / revenue

> Enterprise Value--shows the sum of all claims on a company (the entire firms value) and is INDEPENDENT of capital structure; capital structure changes do not affect EV

EV= Equity value +Net Debt

>Equity Value--value of all the shares outstanding, or the value of the equity shareholders' portion of the company. Eq V= EV-Net Debt

or share price * shares outstanding

>Price to earnings, P/E

>Price to Earnings

Market Value/ Net Earnings

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

- A p/e ratio of 15.0x means that investors are willing to pay $15 for every $1 of net income.

Dividend Yield

>Dividend Yield

shows the return on a share of common stock.

Dividend per share/ Market price per share

- a dividend yield of 20% means that for every $1 in stock price value, 20 cents was distributed to shareholders as dividends.

EV/ EBITDA

measures the value of common stock in a way that enables comparisons across different industires. EBIT can also be used.

EV/EBITDA multiple of 4.5x means that for every $1 of EBITDA the company is worth 4.50 dollars.

EV/ Revenue

compares the total value of a company to its revenue

an EV/ REV multiple of 1.5x means that for every $1 of revenue the company is worth $1.50

Financial Modeling Overview

-A financial model is a representation of a firm's _______ path forward.

financial path fwd.

The two primary objectives of financial modeling are

1. to arm decision makers with reliable info

2. to communicate effectively to stakeholders

transaction: positive net income

cash increases

equity increases

pay down debt

debt decreases

cash decreases

submit an invoice to a customer

revenue increases

a/r increases

receive payment for an invoice

a/r decreases

cash increases

pay a bill

cash decreases

a/p decreases

purchase equipment

cash decreases

fixed assets increase

what happens when a/r increases by $10? what happens when depreciation goes up by 10?