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The IS links the BS at the beginning of the period to the BS at the end of the period through
NI, which gets added to RE (minus dividends paid out).
Current assets include
cash and assets that a firm expects to turn into cash, sell or consume within approximately one year from the date of the BS.
Examples of current assets are
cash, marketable securities held for the short term, A/R, notes receivable (due within year), inventories of merchandise (retailer), raw materials, work in process and finished goods (for manufacturer), and prepaid operating expenses, such as prepaid insurance and prepaid rent.
Examples of noncurrent assets include
land, buildings, equipment, patents and long-term investments in securities.
A second section of the BS, labeled “Investments” or “Investments in Securities”, includes
long-term (noncurrent) investments in securities of other firms.
A company's financial statements are generally consolidated when
the corporation owns more than 50% of the shares of the other corporation.
The securities in the Investments section of the BS represent
investments in firms whose assets and liabilities the firm has not consolidated with its own.
Marketable securities are
securities that the firm plans to hold for a relatively short period of time.
PP&E includes
land, buildings, machinery, automobiles, furniture, fixtures, computers and other equipment.
BS lists PP&E items at
acquisition cost reduced by accumulated depreciation - except land. Frequently, only the net balance, or book value, appears on the BS. Land usually appears at acquisition cost.
Are intangible assets recognized as assets?
Intangible assets, such as patents, trademarks, franchises and goodwill are not recognized as assets if they are produced in house, only those that firms acquire are recognized.
Monetary assets appear on BS at ___.
NPV. Cash is amount of cash. A/R is amount of cash firm expects to collect in the future. If the time period of collection is expected to be greater than one year (unlikely), the firm will discount it to PV. Since this is unlikely, accounting generally ignores NPV of A/R because of lack of materiality.
Nonmonetary assets generally appear on BS at
Nonmonetary assets, such as merchandise inventory, land, buildings and equipment, generally appear at acquisition cost, in some cases adjusted downward for depreciation. Some nonmonetary, financial assets, such as holdings of marketable securities, appear on the BS at current market value.
Marketable securities, appear on the BS at
current market value
Asset values on BS do not take into account
estimated future earnings to be derived from those assets.
Accumulated depreciation is a
contra account – gets subtracted from the value of an asset.
SG&A includes
marketing, advertising, research & development (R&D), corporate overhead and Amortization.
Gross profit =
revenue - cogs
Do service companies have COGS?
Operating profit =
EBIT margin =
What is a deferred tax expense?
Companies keep a separate set of books for tax purposes that typically differs from the accounting records. This is because generally accepted accounting principles call for different methods of recognizing revenue and expenses than the IRS. For example, when a company Depreciates $1,000 of PP&E, it may recognize $100 per year of Depreciation on its P&L each year for 10 years. Meanwhile, the IRS offers an accelerated depreciation schedule that enables companies to recognize a higher proportion of the expense in the early years. For the first few years, this reduces the taxable income on the IRS books relative to the company’s P&L. So the company pays less tax in cash than it shows on its P&L as an income tax expense. The difference needs to be accounted for and is shown as a deferred tax expense.
Depreciation is often embedded in _____.
Amortization is often embedded in ______.
EBITDA can be calculated by either
Starting with Revenue and subtracting only the "cash" expenses (i.e. everything except D&A) [$118.0 - $86.0 - $9.3 = $22.7] or
Starting with EBIT and adding back the non-cash expenses
What does it mean to say that a firm has high operating leverage?
High percentage of COGS is fixed costs (as opposed to variable). Thus, an increase in revenue can have a greater impact on bottom line (and vice versa).
Said differently if a firm’s cost structure is primarily fixed, then as Sales increase, COGS as a % of Sales will decrease (because the numerator, COGS, stayed constant while the denominator, Sales, increased).
What is SG&A?
SG&A stands for Selling, General and Administrative expenses and, in general, it consists of operating expenses that are not directly related to manufacturing a product.
A variable component of SG&A is:
sales commissions. Also worth remembering - SG&A often gets labeled as the "fat" in the company, but the selling expense component shouldn’t fall into that category.
SG&A should be broken out:
It’s often worth breaking SG&A into two key components. You may wish to break out "S" from "G&A" and use different drivers for each. This is especially helpful in a more complicated model. For example, selling expense should have a component tied to revenue. G&A, on the other hand, should probably be based primarily on a growth rate (e.g. inflation).
Amortization of intangibles gets classified within
Amortization of intangibles gets classified within SG&A, but behaves totally independently, based on an amortization schedule. You should always forecast this line item separately.
Is capex a fixed or variable cost?
Capex is, in fact, primarily a fixed expenditure that rarely needs to increase in line with revenue. Some degree of operating leverage is typically evident, resulting in a declining Capex percent of sales as revenue grows. However, it is probably not realistic for a Company to grow 10% per year without increasing its Capex budget.
Net PP&E is
Gross PP&E less accumulated depreciation
Walk through a typical income statement
- Cost of Goods Sold
= Gross Profit

- SG&A

= Operating Profit

- Interest Expense (net)
= Pretax Income

- Income Taxes

= Net Income
Operating expenses is a synonym for
SG&A (represents all operating expenses after COGS)
Receivable turnover =
revenue/average A/R
2 measures of a company's credit policies
1. receivable turnover
2. average days' sales uncollected
average days' sales uncollected =
365/receivable turnover. It is the number of days it takes to collect on receivables
Cash equivalents are
securities (e.g. T bills) that have a term of less than or equal to 90 days
Short-term investments (a.k.a. ______) are:
marketable securities.
investments intended to be held for less than one year
Investments in securities held to maturity are reported
at original cost
Trading investments are always ______, and are reported on balance sheet at
current assets.
Any unrealized holding gains or losses must be listed as a gain or loss on the income statement
Available-for-sale securities are reported on balance sheet at _____.
Gains are losses are _____
Gains and losses are listed as an adjustment to SE, and NOT on income statement
Inventory turnover =
This represents the number of times inventory flows into and out of the firm within the accounting period
An income tax liability is
created periodically to reflect expected taxes to be paid.
How is an operating lease accounted for?
An operating lease is treated as an executory contract. No obligation or receivable appears on the BS.
How is a capital lease accounted for?
Treated as if purchase of property:
Assets and related long-term obligations are recorded at PV of future minimum lease payments

Value of the asset is amortized as an expense in the income statement, on a straight-line basis, over the term of the lease. The depreciation period depends on whether the lease transfers ownership or has a bargain purchase option.

Each rental payment is treated as part interest expense and part payment of principal.
What are the 4 criteria, any one of which makes a lease a capital lease?
1. lease transfers ownership of property by end of lease.

2. Lease contains bargain purchase option.

3. Lease term is 75% or more of estimated economic life of the property.

4. PV of minimum lease payments at beginning of lease equals or exceeds 90% of FMV of property.
Contributed capital consists of what 3 things?
1. par value of preferred stock

2. par value of common stock

3. paid-in-capital in excess of par value
A stock dividend is an intra-SE event that transfers an amount from ___ to ____.
RE to contributed paid-in-capital
Are future earnings forecasts required in MD&A?
An unqualified opinion indicates that the auditor is
unaware of any material misstatements
As a general rule, revenue is recognized when
the firm has provided virtually all of the goods or services and the expected cost of providing the service must be measurable. Firm must also be able to reasonably estimate the probability of payment.
The basic reason for the broad use of EBITDA is
to improve the comparability among firms. Unlike P/E, EBITDA removes the influence of historical capital investment and capital structure.
What is the rationale behind adding back ITDA to Earnings?
For D&A it is that (i) they are non-cash charges and (ii) the are based on historical cost of assets, which is relevant to current value of the firm.
A deferred tax asset is added when
there is a significant likelihood of fuure earnings and the magnitude and timing of the "tax savings" from NOL carryforwards can be reasonably estimated.
EBITDA fails to reflect changes in
working capital. Thus, if during the period the company consumes cash by building either inventory or A/R or paying down previously stretched A/P, actual cash generated will be lower.
Most important adjustment to EBITDA is
subtracting out CAPX. According to Joel, you only subtract out maintenance CAPX because growth CAPX is not reflected in current income.
EBITDA should also be adjusted for
one-time charges.

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