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Outline of main topics covered

1. FSA basics

• Data processing vs. Analysiso Example: Apple vs. Dell

• Common-size financial statementso Horizontal / trend analysiso Vertical / cross-sectional analysis

• Ratio analysis• Complications

o e.g., difference in FYE, averaging or not

2. Activity ratios

• (Total) asset TO = Revenue / Total assets•

Fixed TO = Revenue / Fixed assets• Working capital TO = Revenue / Working capital

o Working capital = CA - CL• Receivables TO = Revenue / Receivables

o Days of receivables outstanding (DRO)= Days in period / Receivables TO

o also, Days of sales [in receivables] outstanding (DSO)• Inventory TO = Cost of sales / Inventory

o Days of inventory on hand (DOH)= Days in period / Inventory TO

• Payables TO = Purchases / Payableso Days of payables outstanding (DPO)

= Days in period / Payables TO• Examples of applications

3. Liquidity ratios

• Current ratio = Current assets / Current liabilities• Cash ratio = (Cash + Cash equivalents) / Current liabilities

o Cash equivalents = Short-term investment securities that have high creditquality and are highly liquid

• Quick ratio = Quick assets / Current liabilitieso Quick assets = (Cash + Cash equivalents) + Receivables

• Defensive interval ratio = Quick assets / Daily cash expenditureso Daily cash expenditures = Average per day of all expenses less non-cash

expenses and tax expenses• Cash conversion cycle (CCC) = Days inventory on hand (DOH) + Days receivables

outstanding (DRO) - Days payables outstanding (DPO)• Examples of applications

4. Solvency ratios

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• Debt-to-assets ratio = Total debt / Total assets• Debt-to-capital ratio = Total debt / (Total debt + Total equity)• Debt-to-equity ratio = Total debt / Total equity• (Financial) leverage ratio = Total assets / Total equity• Interest coverage = EBIT / Interest expenses

o Cash interest coverage = OCF / Interest payments• Fixed charge coverage

= (EBIT + Lease expenses) / (Interest expenses + Lease expenses)• Examples of applications

5. Profitability ratios

• Profit margin (ROS)o Gross profit margin = Gross profit / Revenueo Operating profit margin = Operating profit / Revenueo Pretax margin = EBT / Revenueo Net profit margin = Net profit / Revenue

• ROIo Return on assets (ROA) = Net profit / Total assetso Operating ROA = Operating profit / Total assetso Return on total capital

= Operating profit / (Total debt + total equity)o Return on equity (ROE) = Net profit / Total equityo Return on common equity

= (Net profit to shareholders of parent - Preferred dividend)/ Common equity

• DuPont analysiso three-way decompositiono five-way decomposition

• Examples of applications

6. Earnings quality

• Concept of financial reporting quality• Types of financial misstatements (errors, fraud, accounting manipulation)• Conceptual definition of total accruals as a measure of earnings quality• CF and BS approaches to estimating total accruals

o TAcc = NI - [(CFO + CFI)]o TAcc = ΔNOA

• Cash-flow-based accruals ratioo = [ NI - (CFO + CFI) ] / avg NOA

• Balance-sheet-based accruals ratioo = ΔNOA / avg NOA

• Accruals ratio (CF and BS based)o Example: Siemens vs. GE

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7. Earnings management and Fraud

• Motivations for accounting manipulationo Meeting earnings benchmarkso Stabilizing earnings performanceo Window dressing during a critical phase, e.g., IPOo Debt covenants and credit ratingso Executive compensation and turnovero Other incentives, such as tax minimization

• Big bath accounting• Discretionary current accruals (DCA)

o Non-discretionary current accruals (NDCA)• Techniques to manage accounting numbers

o Accounting method choice, accounting estimates, real transactions• Common fraud schemes

o Revenue-related, inventory-relatedo Repurchase agreement (repo) as a fraud technique

8. Intangible assets

• Concept of goodwill - e.g., InBev's acquistion of Anheuser-Busch• Accounting for intangible assets

o Purchased vs. Internally developed: Capitalizing vs. Expensing• Exceptions for internal R&D expenditures

o IFRS - at the development phase under certain conditionso US GAAP - only software development costs under conditions like IFRS's

• Rationales for and against expensing• Impacts on financial statements and ratios

o Examples of adjustments for comparability adjusted to expensing vs. adjusted to capitalizing

9. Pensions

• Pension vs. non-pension post-employment benefits• Defined-contribution vs. defined-benefit plans• Accounting for DC plans• Uncertainty factors affecting DB plans• Elementary accounting for DB plans: an individual employee

o various new terms and concepts such as projected vs. defined benefit obligation entitled pension annuity service cost, interest cost, net benefit expense, etc remeasurements: actual vs. expected return on plan assets,

actuarial gains or losses funded status, over- vs. under-funded, net defined-benefit liability,

etc• Where in financial statements to present pension items• Examples of adjustments from an economic perspective

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10. Leases

• Adjusting leases for comparability by capitalizing operating leases as thoughthey were finance leases

o assumptions discount rate for capitalization - How? distribution of payments in a timing group (e.g., 2015 and

thereafter ) - How? • Effects on FS

o recognition of lease assets and liabilities (B/S) depreciation of lease assets (I/S) interest from lease liabilities (I/S)

o reclassifying the excess of the operating lease payments over the interestfrom lease liabilities as

repayment of lease liabilities (CFS, B/S)• Impacts on financial ratios (e.g., debt-to-assets, interest coverage)• The M&S case

o asset-backed contributions (ABC) through SLPo integrating the topics of accounting manipulation, pensions, and leases

11. Reformulation of financial statements

• Operating vs.financial activities under reformulation• Sections in reformulated B/S

o NOA = OA - OLo NFO = FO - FA (incl. preferred equity)o CSE

• Separating operating vs. financial parts of an accounting itemo Working vs. excess casho Non-interest-bearing vs. interest-bearing A/R or A/Po strategic vs. non-strategic AFT equity investmentso derivatives for hedging operating vs. financial risks

vs.non-hedging derivatives• Group discussion question: Morrisons B/S, footnotes, and accounting policies