Financial Statement Analysis and Valuation Midterm Questions and Answers

Financial Statement Analysis and Valuation Midterm Questions and Answers F/S Analysis and Valuation 4-step Process 1. Understanding the business environment and Acct. Information 2. Adjusting and assessing Financial information and accounting info. 3. Forecasting financial information 4. Using information for valuation Demand for Financial Accounting Information 1. Managers and Employees (internal users) 2. Investment Analysts 3. Creditors and Suppliers 4. Stockholders and (board of) directors 5. Customers and Strategic Partners Capital is Composed of 2 Sources: Equity and Debt 1. Equity is more risky than debt (to the investor) - Thus it costs more Benefits of Disclosure All else being equal, more risk lead to higher cost of capital, which lead to lower valuations. - Cost of Capital (as reflected in lower interest rates or higher stock prices). Costs of Disclosures - Preparation and dissemination of financial information (Accountants are expensive) - Competitive Disadvantages (don't want to give up to much info to competitors - Litigation Potential, and - Political costs (make too much money?) SEC's Regulation Fair Disclosure (Reg. FD) Goal is to curb the practice of selective disclosure by public companies Sources of Asset Financing 1. From Stockholders (owner financing) 2. From banks or other creditors (nonowner financing) [a.k.a debt] Accounting Equation Investing (assets) = Nonowner financing (liabilities) + Owner financing (equity) Nonoperating liabilities = Debts Operating Liabilities = - Accounts Payables - Accrued Liabilities Income Statement Reports on a company's performance over a period of time and lists amounts for: - its "top line" revenues (also called sales) and - its expenses Revenues less expenses equals the bottom-line net income amount (also called profit or earnings) Statement of Stockholders' Equity Reports on year-over-year changes in the equity accounts that are reported on the balance sheet: - Contributed Capital (the stockholders' net contributions to the company) - Retained Earnings (net income over the life of the company minus all dividends ever paid) Statement of Cash Flows Reports cash inflows and outflows from operating, investing, and financing activities over a period of time. Competitive Forces within the Business Environment - Industry Competition - Bargaining power of buyers - Bargaining power of suppliers - Threat of substitution - Threat of entry SWOT Analysis - Strengths, weaknesses, opportunities, threats Internal: strengths and weaknesses External: opportunities and threats The worth of a company is: the current value of expected payoffs, and an accurate forecast of future earnings and cash flows is essential. Return on Assets ("ROA") Net Income / Avg Assets Profitability (Profit Margin) x Productivity (Asset Turnover) (NI/Sales) X (Sales/Avg. Assets) Return on Equity ("ROE") Net Income / Avg. Total Equity Assets must possess two characteristics to be reported on the Balance Sheet: 1. It must be owned (or controlled) by the company. 2. It must confer expected future economic benefits that result from a past transaction or event Liabilities represents a company's future economic sacrifices Stockholders' Equity represents capital that has been invested by the stockholders; either: Directly, via the purchase of stock or Indirectly, in the form of retained earnings Net Working Capital (NWC) current assets - current liabilities Retained Earnings beginning R/E + NI (or - Net Loss) - Dividends = End R/E Market Value = # of outstanding common shares x company's stock price Book Value the "value" of the company determined by generally accepted accounting principles (GAAP). Revenue Recognition Principle recognize revenues for goods and services provided to customers at an amount expected to be received. Expense Recognition (Matching) Principle recognize expenses when incurred. - companies recognize an expense when it is incurred, even if no cash is paid Gross Profit Margin = Gross Profit / Sales Margins for Operating Expenses = Operating Expense / Sales