Accounting Fundamentals--Summer 2000
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Income Statement Classification
• Operating income• Other income and expense• Income from continuing
operations• Income, gains & losses from
discontinued operations• Extraordinary gains and losses• Changes in accounting principles
Accounting Fundamentals--Summer 2000
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Statement of Cash Flows
• FASB 95--1987• Components
•Operating cash: Operations and working capital
• Investing cash: Non-current assets and investments
• Financing cash: L/T debt, equity and dividends
Accounting Fundamentals--Summer 2000
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Roots = Financing Activities
Trunk & Branches = Investing Activities
Fruit = Operating Activities
Businesses are like Fruit Trees
Accounting Fundamentals--Summer 2000
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Net Income vs. Cash Flow
Indirect Method• Net Income• +/- Non-cash Items• +/- Changes in Operating
Working Capital• = Cash Flow from Operations
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Indirect vs. Direct Method
• FASB prefers the direct method• FASB requires net income to cash
from operations reconciliation• Components:
• Cash from customers• Cash from dividends• Cash from interest income• Other operating cash receipts• Cash paid to suppliers• Cash paid to employees• Cash paid for taxes• Cash paid for interest• Other operating cash payments
Accounting Fundamentals--Summer 2000
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Economic Value Added
• Income from Capital- Cost of Capital= E V A
Accounting Fundamentals--Summer 2000
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Sources of Capital
• Debt (interest %)• Equity (interest % + 6%)
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Capital
• Working capital• Net tangible non-current
assets• Capitalized R & D• Capitalized Employee Devel.
Costs
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Adj. Operating Income
• Operating income• Plus:
•R & D• Emp. Devel. Costs
• Minus:•R & D Amort.• Emp. Devel. Cost Amort
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Keys to Success
• Make it a way of life• K I S S• CEO / Management buy-in• Gradual introduction• Thorough training
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Target Your Efforts
•Solvency assurance
•Wealth enhancement
•Performance improvement
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Include the Trifecta: Q-S-T
•Q: Quantitative analysis
•S: Strategic assessment
•T: Tactical feasibility
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Tools for Financial Statement Analysis
•Ratio analysis•Trend analysis•Common-size analysis•Base period analysis•Comparative analysis•Horizontal and vertical
analyses
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A Financial Statement Approach
•Look for key relationships•Focus on spending drivers•Don’t overlook the
Statement of Cash Flows•Remember to measure
trends•Tell a story
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Guidelines for a Presentation
•Clarity•Accuracy•Simplicity•Visually friendly•Limit page content
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Cash Flow Red-Flags
• Receivable and inventory growth rate exceeds sales growth rate
• Payables growth rate exceeds inventory growth rate
• Current liabilities grow faster than sales
• Sustained operating losses (negative net income)
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Cash Flow Red-Flags (cont’d)
• Negative operating cash flow• Capital expenditures exceed
operating cash flow• Sustained capital expenditures
reductions• Sustained sales of marketable
securities in excess of purchases• Substantial shift from long to
short term borrowing• Dividend reduction or elimination
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Cash Sufficiency Ratio
• Cash Flow From Operations + Interest + TaxesPPE + Debt Servicing + Taxes + Dividends
• Should be greater than 1• Can easily disaggregate• Different footprints for
different development stages
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Cash Conversion Cycle
•Cash conversion cycle•Days in payables ≥ DSO + Days in
inventory
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Typical Common Ratios
•Solvency & liquidity•Earnings•Performance
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Ratio Analysis
•General guidelines:•Be consistent•Ascertain contents of
numerator and denominator•Apply common sense…
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Trend Analysis
•Static analysis is virtually useless
•Trend direction is key•Combine with other
approaches
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Common-size Analysis
•Helpful for size discrepancies
•Keyed to sales or total assets
•Helpful for industry comparisons
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Base Period Analysis
•Combines trending and percentage analysis
•Select representative base year and set the index at 100
•Measure subsequent periods in terms of the base year
•Helpful for industry comparisons•Eliminates size bias
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Comparative Analysis Cautions
•Timing variances•GAAP variances•Conservative vs. Aggressive
GAAP•Management attitude…”win at
all cost!”•Size•Geographic venues
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Horizontal and Vertical Analysis
•The most basic…and most powerful analytical tool
•Key element in fraud detection
•Keeps the organization under control
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Horizontal Analysis
•Period versus period changes•Value changes•Percentage changes
•Look for irregularities
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Horizontal Analysis - Example
2009 2008 $ Change % Change
Current Assets $400 $300 $100 33%
Total Assets $2,500 $2,200 $300 14%
Current Liabilities $200 $150 $50 33%
Long-term Debt $1,600 $1,500 $100 7%
Equity $700 $550 $150 27%
Total Liabilities & Equity $2,500 $2,200 $300 14%
ABC CompanyPartial Balance Sheets
2008 and 2009
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Vertical Analysis
•Relationships within the same period:•Numerical relationships•Percentage relationships
•Look for irregularities
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Vertical Analysis - Example
$ % $ %
Current Assets $400 16% $300 14%
Total Assets $2,500 100% $2,200 100%
Current Liabilities $200 8% $150 7%
Long-term Debt $1,600 64% $1,500 68%
Equity $700 28% $550 25%
Total Liabilities & Equity $2,500 100% $2,200 100%
ABC CompanyPartial Balance Sheets
2008 and 2009
2009 2008
Accounting Fundamentals--Summer 2000
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Theory of Constraints
• The Concept• The Process• The Measures
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The Concept• Presented in Eliyahu Goldratt’s
The Goal• The goal of a business is to
make money…consistent with customer satisfaction
• Continuous flow• Avoid the “herbies”• Eliminate the bottlenecks first
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The Process
• Identify the constraints• Exploit the constraints (reduce
the bottlenecks)• Subordinate everything else• Elevate the constraints
(remove the bottlenecks)• Reiterate the process
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