Professional Documents
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LEARNING GOALS
HFA- Why?
HFA- How?
LEARNING GOALS
AGGRESSIVE ACCOUNTING
A forceful and intentional choice and application of accounting principles done in an
effort to achieve desired results, typically higher current earnings, whether the
practices followed are in accordance with GAAP or not
EARNINGS MANAGEMENT
The active manipulation of earnings toward a predetermined target, which may be set by
management, a forecast made by analysts, or an amount that is consistent with a
smoother, more sustainable earnings stream
LEARNING GOALS
INCOME SMOOTHING
A form of earnings management designed to remove peaks and valleys from a normal
earnings series, including steps to reduce and store profits during good years for
use during slower years.
LEARNING GOALS
CREATIVE ACCOUNTING
Any and all steps used to play the financial numbers game, including the aggressive
choice and application of accounting principles, fraudulent financial reporting, and any
steps taken toward earnings management or income smoothing
FINANCIAL SHENANIGAN
Actions or omissions designed to hide or distort the real financial performance or
financial condition of a company
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Component Processes of
Business Analysis
Business
Environment &
Strategy Analysis
Industry
Analysis
Strategy
Analysis
Financial
Analysis
Accounting
Analysis
Profitability
Analysis
Analysis
of cash
flows
Risk
Analysis
Prospective
Analysis
Intrinsic Value
Business Analysis
Evaluate Prospects
Evaluate Risks
Business Decision Makers
Equity investors
Creditors
Managers
Merger and Acquisition Analysts
External Auditors
Directors
Regulators
Employees & Unions
Lawyers
Financial Statements
Qualitative
Chairpersons Letter
Industry Statistics
Press Releases
Economic Indicators
Financial press
Regulatory filings
Vision/Mission Statement
Trade reports
Web sites
Credit Analysis
Equity Analysis
Management &
Control
Regulation
Financial
Management
Labour Negotiations
Types of
Business
Analysis
Director Oversight
External Auditing
Mergers, Acquisitions
& Divestitures
CREDIT ANALYSIS
Non-trade
Creditors
Trade Creditors
Provide goods
or services
Bear risk of
default
Provide major
financing
Bear risk of
default
Most shortterm
Usually implicit
interest
Most longterm
Usually explicit
interest
CREDIT ANALYSIS
Solvency
Ability to meet long-term
obligations
Focus:
Long-term profitability
Capital structure
EQUITY ANALYSIS
Technical analysis /
Charting
Patterns in price or
volume history of a stock
Predict future price
movements
Fundamental Analysis
Determine Intrinsic value
without reference to price
Analyze and interpret key
factors
Economy
Industry
Company
ACCOUNTING ANALYSIS
Earnings management
Accounting Standards
Accounting
Risk
FINANCIAL ANALYSIS
Common tools
Ratio
analysis
Cash
flow
analysis
PROSPECTIVE ANALYSIS
Financial Analysis
Value
Step- II
HFA
Control
Adjustments
Segregating Operating
& Non- Operating
Assets
Comparative
Analysis
Commonsizing
Trend
Analysis
Ratio Analysis
Unusual Items
Non recurring items
Discontinued segment
Extraordinary items
Prior period items
Changes in accounting policies
Personal expenses
Related party transactions
Off- balance sheet transactions and entities
unrecorded liabilities
Segment disclosures
Discontinued operations
Gain or loss on sale of assets
DTA or DTL
Accounting for financial derivatives and convertibles
Assess accounting flexibility
DISCONTINUED OPERATIONS
ACCOUNTING CHANGES
RCOM 2008-09
Excess of Rs. 16,428.48 crore arising on such transfer of assets and liabilities, before making the
adjustments, in accordance with the Scheme, for cancellation of investments of Rs. 2,096.43
crore (including Equity Shares of Rs. 977.00 crore acquired on conversion of loan) in RGNL and
net effect on fair valuation of assets and liabilities of the Company identified by the Board as
prescribed to be fair valued, based on market approach/ depreciated replacement cost basis by
an independent valuer, for this purpose (Identified Assets) of Rs. 12,698.81 crore has been
credited to General Reserve, to be dealt with in accordance with the Scheme.
Had the Scheme not prescribed this treatment, Rs. 14,332.05 crore would have been credited to
Capital Reserve as required by the Purchase Method prescribed by Accounting Standard (AS)
14 on Accounting for Amalgamation and General Reserve would have been lower by Rs.
12,698.81 crore.
EARNINGS MANAGEMENT
MOTIVATIONS
o
Incoming Shifting:
Accelerate or delay recognition of revenues or
expenses to shift income from one period to another
Classificatory Earnings Management:
Selectively classify revenues Earnings and expenses in
certain parts Management of the income statement to
affect analysis inferences regarding the recurring nature
of these items
Comparative Analysis
With
Company Data
Over Time
Common Size
Statement
Industry Average
Ratio Analysis
Benchmark
Companies
CAGR
- Performance Ratios
- Leverage Ratios
- Liquidity Ratio
- Altman Z- Factor
Yr1
Yr2
Yr3
Output:
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3.
Operating performance
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5.
Operating efficiency
Operating profitability
Risk analysis
Business risk
Financial risk
Growth analysis
Equity
Net Sales
Equity
Sales
Sales
Total Assets
=
Net Income
=
Common Equity
Net Income
Sales
Total Assets
=
Sales
Total Assets Common Equity
Profit
Margin
Total Asset
x Turnover
Financial
xLeverage
EBIT
Sales
EBIT
=
Sales Total Assets Total Assets
EBIT
Sales
EBIT
=
Sales Total Assets Total Assets
EBIT
Interest Expense Net Before Tax
=
Total Assets
Total Assets
Total Assets
EBIT
Sales
EBIT
=
Sales Total Assets Total Assets
EBIT
Interest Expense Net Before Tax
=
Total Assets
Total Assets
Total Assets
Net Before Tax (NBT)
Total Assets
Net Before Tax (NBT)
=
Total Assets
Common Equity
Common Equity
This indicates the pretax return on equity. To arrive at ROE
we must consider the tax rate effect.
EBIT
Sales
EBIT
=
Sales Total Assets Total Assets
EBIT
Interest Expense Net Before Tax
=
Total Assets
Total Assets
Total Assets
Net Before Tax (NBT)
Total Assets
Net Before Tax (NBT)
=
Total Assets
Common Equity
Common Equity
Net Before Tax
Income Taxes
Net Income
100%
=
Common Equity
Net Before Tax Common Equity
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RISK ANALYSIS
BUSINESS RISK
BUSINESS RISK
Two primary determinants of business risk
Sales variability
The main determinant of earnings variability
Cost Variability and Operating leverage
Production has fixed and variable costs
Greater fixed production costs cause greater profit
volatility with changes in sales
Fixed costs represent operating leverage
Greater operating leverage is good when sales are
high and increasing, but bad when sales fall
FINANCIAL RISK
Interest payments are deducted before we get to net income
These are fixed obligations
Similar to fixed production costs, these lead to larger earnings
during good times, and lower earnings during a business
decline
Fixed financing costs are called financial leverage
The use of debt financing increases financial risk and
possibility of default while increasing profitability when sales
are high
FINANCIAL RISK
FINANCIAL RISK
Proportion of debt (balance sheet) ratios
Long-term debt can be related to:
Equity (LTD/Equity)
How much debt does the firm employ in relation to
its use of equity?
Total Capital [LTD/(LTD +Equity)]
How much debt does the firm employ in relation to
all long-term sources of funds?
Total debt can be related to:
Total Capital [Total Debt/(TLNIBL)]
Assessment of overall debt load, including shortterm
FINANCIAL RISK
FINANCIAL RISK
Interest Coverage or Times Interest Earned Ratio
Measures the number of times Interest payments are
covered by EBIT
Interest Coverage = EBIT/Interest Expense
May also want to calculated coverage ratios that reflect
other fixed charges
Lease obligations (Fixed charge coverage)
FINANCIAL RISK
Market Liquidity is the ability to buy or sell an asset quickly with little
price change from a prior transaction assuming no new information
DETERMINANTS OF GROWTH
DETERMINANTS OF GROWTH
ROE is a function of
Net profit margin
Total asset turnover
Financial leverage (total assets/equity)
BASICS OF COMMITMENTS
Commitments -- potential claims against a companys resources due to future
performance under contract
Analyzing Commitments
Sources of useful information:
Notes and MD&A and regulatory Filings
Useful analyses:
Scrutinize management communications and press releases
Analyze notes regarding commitments, including
Description of commitment and its degree of risk
Amount at risk and how treated in assessing risk exposure
Contractual conditions and timing
Recognize a bias to not disclose commitments
Review regulatory filings for details of commitments
OFF-BALANCE-SHEET FINANCING
either
GAAP
ANALYZING RECEIVABLES
Assessment of earnings quality is often affected by an analysis of receivables and their
collectibility
Analysis must be alert to changes in the allowancecomputed relative to sales,
receivables, or industry and market conditions.
Two special analysis questions:
(1) Collection Risk
Review allowance for uncollectibles in light of industry conditions
Apply special tools for analyzing collectibility:
Determining competitors receivables as a percent of salesvis--vis the
company under analysis
Examining customer concentrationrisk increases when receivables are
concentrated in one or a few customers
Investigating the age pattern of receivablesoverdue and for how long
Determining portion of receivables that is a renewal of prior receivables
Analyzing adequacy of allowances for discounts, returns, and other credits
(2) Authenticity of Receivables
Review credit policy for changes
Review return policies for changes
Review any contingencies on receivables
REVENUE RECOGNITION
Analysis
Revenue is important for
Company valuation
Accounting-based contractual agreements
Management pressure to achieve income expectations
Management compensation linked to income
Valuation of stock options
Analysis must assess whether revenue reflects business reality
Assess risk of transactions
Assess risk of collectibility
Circumstances fueling questions about revenue recognition include
Sale of assets or operations not producing cash flows to fund interest
or dividends
Existence of contingent liabilities
DERIVATIVE SECURITIES
Analysis of Derivatives