afp_treasury4_session chp 18 amd 19

8/11/2019 AFP_Treasury4_Session Chp 18 Amd 19

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Financial Management

Session 10, Module Five:


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Chapter 18:

Financial Accountingand Reporting

Chapter 19:Financial

Planning andAnalysis

Session 10, Module Five:Financial Management

v4.0 2013 Association for Financial Professionals. All rights reserved. Session 10: Module 5, Overview - 2


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Outl ine:

Introduction Accounting Concepts and Standards

Financial Reporting Statements

Accounting for Derivatives, Hedges and FXTranslation

Accounting for U.S. Governmental and Not-For-Profit Organizations

Chapter 18: Financial Accounting andReporting

v4.0 2013 Association for Financial Professionals. All rights reserved. Session 10: Module 5, Chapter 18 - 3


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Audi t object ives

Generally acceptedauditing standards

Scope

Relevance

Completeness

Accuracy Not financial fitness,

but fair reflection

Process

Study business

Internal controls forreliability Reconcile accounting

entries with evidence

Sampling

Materiality Accounting methods Proper and complete

Audit Process



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Auditor Opinions Standard unqualified

Unqualified with

explanatoryparagraph ormodified unqualified

Qualified

Adverse

Disclaimed



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Balance Sheet Financial condition

at point in time

Assets = Liabilities +Shareholders Equity

Assets: Current assets Fixed assets (depreciable

fixed assets) Intangible assets

Liabilities: Current liabilities Long-term liabilities

Equity



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Discussion QuestionHow are liabilities and debt different?

a) Debt refers to an amount that is owed, regardless ofthe form.

b) Accounts payable is a liability but not a debt.

c) Liability refers only to obligations thatrequire interest payments and isconsidered a subset of liabilities.

d) Notes payable is a liability but not adebt.

Answer: b (a and c have labels reversed;notes payable is both a liability and a debt.)

(p.5-15)v4.0 2013 Association for Financial Professionals. All rights reserved. Session 10: Module 5, Chapter 18 - 7


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Income Statement Revenues earned

Expenses incurred

Gains and losses fromconversions of assetsand liabilities overaccounting period

Measured over a spanof time

Costs andearnings

COGS EBITDA EBIT



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Discussion Question

Answer: c (p.5-18)

Net income adjusted for the following gains and lossesnot reported on the income statement is called what?

Unrealized gains, losses,

from OTTI investments(Topics 320 and 325)

Minimum pension liabilityadjustments (Topic 715)

Foreign currency translationadjustments (Topic 830)

Changes in market values offutures contracts qualifyingas hedges (Topic 815)

a) Operating incomeb) Other income andexpenses

c) Comprehensiveincome

d) Retained earnings



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Discussion QuestionIdentify whether changes in each of the balance sheetaccounts is a source or use of funds on the statementof cash flows.


Increase in an asset

Decrease in an asset

Increase in a liability

Decrease in a liability

Answers: (p. 5-19)

Source of funds

Use of funds

Source of funds

Use of funds


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Indirect method Start: net income from the income statement

Adjust by changes in balance sheet accounts fromprior period

Direct method Source of cash inflows and outflows without relying

on adjustments to net income

Total cash flow for each activity computed

Accrual accounts converted to cash amount

Preparing the Statement of Cash Flows



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Statement of Cash Flows Sources and uses

of funds

Sections: Operating

Investing Financing

Cash fromoperations: addback non-cashcharges (e.g.,

depreciation) Cash, not

earnings, repaysdebt



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Discussion QuestionHow are gains and losses arising from changes ina derivatives fair value accounted for in ASCTopics 815, 820 and 825?

a) If not hedge instrumentsreport in current income.b) Fair value hedgeshedge specific asset or

liability on balance sheetrecognize as income but omithedged item offsetting gains/losses.

c) Cash flow hedges are reported in current

income.d) FX transaction hedges are reported incurrent income.

Answer: a (b recognizes offsetting gains and losses;c and d are reported in comprehensive income)

(p.5-24)v4.0 2013 Association for Financial Professionals. All rights reserved. Session 10: Module 5, Chapter 18 - 13


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IAS 21/ASC Topic 830:

Determine functional currency

Is subsidiarys functional currency also its homecurrency?

Yes Current method Translate all assets and liabilities at current spot rate (date of

translation).

Translate retained earnings at weighted average rate. Translate other equity at transaction date spot rates.

No Temporal method Remeasure nonmonetary balance sheet accounts and related

income statement accounts at historical exchange rates.

FX Translation Accounting



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Outl ine:

Cost Behavior

Decision Evaluation Developing and Operating Financial Budgets

Financial Statement Analysis

Performance Measurement Financial Analysis and Rating Agencies

Chapter 19: Financial Planning and Analysis



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Cost Behavior



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High fixed costsand low variable

costs

Profits will expand rapidly aftercompany earns enough to coverfixed costs.

Low fixed costsand high

variable costs

Volume need not be as great tocover fixed costs.

Added volume will not causeprofits to rise as rapidly due tohigh variable costs.

Operating Leverage



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Discussion QuestionWhich factor should be considered relevantdata for decision evaluation? (pick two)

a) Sunk costsb) Costs that affect future cash flows

c) Revenues that will be earned with either alternative

d) Costs that will be incurred with one alternative butnot the other

Answer: b and d (p.5-44)



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Break-even point: Level of activity foroperation at which costs = benefits

Break-Even Analysis


Fixed CostsUnit Break-Even Point =

Selling Price Per Unit Variable Cost Per Unit

$10,000=

$10 $6

= 2,500 Units


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Capital Budgeting Strategic plans for

proposed large-dollarinvestments

Examples: New/replacement

equipment

New product line

Acquire firm ordivision

C/B analysis usingmodels:

Payback period

Net present value

Profitability index

Internal rate of return



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Evaluates the PV of all inflows and outflows ofa project using WACC as a discount rate

Net Present Value (NPV)


Where: C = net cash flow; i = discount rate; n = number ofperiods; subscript indicates time period (1, 2, etc.); exponentindicates compounding

If the only cash outflow is in the present:

NPV = PV of Cash Inflows PV of Cash Outflows

31 2 n

1 2 3 n

NPV = PV of Cash Inflows Cash Cost

CC C C= + + + ... + Cost

(1+ i) (1+ i) (1+ i) (1+ i)


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A 1 2 3 4 5

B 1 2 3 4 5

$300 $300 $400 $100 $100NPV = + + + + $1,000 = $ 48.43

(1 + .10) (1 + .10) (1 + .10) (1 + .10) (1 + .10)

$1,000 $1,000$300 $300 $400NPV = + + + + $1,00

(1 + .10) (1 + .10) (1 + .10) (1 + .10) (1 + .10)0 = $1,124.98

Net Present Value (NPV)


If WACC = 10%, two projects NPVs are:


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Ratio of PV gained to cost to obtain that value;value gained per dollar of investment:

If only cash outflow is in present (period 0):

Profitability Index (PI)


Present Value of Cash InflowsProfitability Index =Present Value of Cash Outflows

A

B

$951.57PI = = 0.952$1,000.00

$2,124.98PI = = 2.125

$1,000.00


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Discount rate (i) that makes NPV = 0

PV of cash inflows = PV of cash outflows

Internal Rate of Return (IRR)


=

A 1 2 3 4 5

B 1 2 3 4

NPV = PV of Cash Inflow Cost = 0

$300 $300 $400 $100 $100NPV = + + + + $1,000 0 i = 7.7%

(1 + i) (1 + i) (1 + i) (1 + i) (1 + i)

$1,000 $1$300 $300 $400NPV = + + + +

(1 + i) (1 + i) (1 + i) (1 + i) =

5

,000$1,000 0 i = 38.1%

(1 + i)


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Method

AcceptanceCriterion Project A Project B

NPV NPV > 0 $48.43 $1.124.98

PI PI > 1 0.952 2.2125

IRR IRR > WACC* 7.7% 38.1%

Capital Expenditure Analysis Summary


* WACC = 10% in the example


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Risk analysis

Sensitivity analysis

How do changes insingle variable influenceNPV?

Scenario analysis What-if analysis of best

and worst cases (NPV)

Monte Carlo simulation

RADR

High-risk endeavors:higher rate of return tojustify investment

Risk adjustment factor,e.g., 2% if WACC is10%

Low-risk: 8% Medium-risk: 10% High-risk: 12%

Investment Risk Analysis and RADR



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Risk -Adjus ted Return

on Capital (RAROC)

Originally for FI

project evaluation Uses risk estimate to

adjust return oncapital calculations

Comparable

Expected loss (EL)

Nonf inancial issues

Market ready?

Technology ready?

Regulatory mandate?

Other Cost/Benefit Analyses



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Discussion QuestionHow do treasurys plan assessments affectprojected cash flow streams in budgeting?

a) Calculates adequate funds and liquidityb) Determines impact on debt covenants and creditratings

c) Manages financing of long-term assets throughdebt and equity issues

d) Treasury is not directly or indirectlyresponsible for budgeting

Answer: b (p.5-58)



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Budgets Pro Forma Financial Statements



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Suppliers: Sales on credit?

Trading partners: Can counterparty meet

contractual obligations? Lenders: Initiate/maintain credit relationships?

Rating agencies: Credit risks?

Investors: Purchase/sell corporate debt andequity?

Financial Statement Analysis



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Financial Statement Analysis Ratios Liquidity or working

capital ratios

Efficiency or assetmanagement ratios

Debt managementratios

Performance ratios



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Discussion QuestionHow do common-size statements enable directfinancial comparisons of different size firms?

a) Expenses as % of profit reveal who has the bestexpense controls

b) Asset categories as a % of revenues can becompared

c) Liability categories as a % of total assets can

be comparedd) Cash flow elements as a % of net income

can be compared

Answer: c (p.5-63)



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How efficiently fixed assets, or property, plantand equipment, are used.

Example: Firm generated $2 revenue for each$1 invested in fixed assets.

Fixed Asset Turnover


RevenuesFixed Asset Turnover =

Net Property, Plant, Equipment

$15,000= = 2.0 Times

$7,500


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How many times firm turned over stock ofmost liquid assets with flow of revenue.

Example: Firm generated $1.88 of revenue per$1 in current asset accounts.

Current Asset Turnover


RevenuesCurrent Asset Turnover =

Current Assets

$15,000= = 1.88 Times

$8,500


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Efficiency with which company converts salesinto cash.

Example: $0.037 of cash was carved out ofeach revenue dollar.

Cash Conversion Efficiency


Cash ConversionCash Flow from Operations

Efficiency =

Revenues$550=

$15,000

= 0.037 or 3.7%


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Discussion QuestionWhich threeratios help determine the extent towhich a company was leveraged?

a) Total liabilities to total assets

b) Times interest earned ratio

c) Long-term debt to capital

d) Debt to tangible net worth

e) Fixed charge coverage ratio

Answer: a, c, d. Degree of indebtednessratios: The higher the ratio, the greater therelative indebtedness. (p.5-68)



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Percentage of all liabilities to total investmentsor total assets.

Example: Some form of debt supplies $0.471 ofeach $1 of assets.

Total Liabilities to Total Assets


Total LiabilitiesTotal Liabilities to Total Assets =

Total Assets

$7,300= = 0.471 or 47.1%

$15,500


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What percentage of capitalization is providedby long-term debt.

Example: Long-term (L/T) debt supplied 32.2%of total capital.

Long-Term Debt to Capital


-

-

Long Term DebtL/T Debt to Capital =

Long Term Debt +Equity

$3,900= = 0.322 or 32.2%

$3,900 + $8,200


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Ability to service debt via interest payments.

Example: Firm has 5.33 times more funds

available to pay interest than interest that waspaid.

Times Interest Earned (TIE) Ratio


Operating Profit EBITTIE = =

Interest Expense Interest Expense

$1,600= = 5.33 Times

$300


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Net income relative to level of total assets.

Example: Every $1 in total assets generates

$0.055 in net income.

Return on Total Assets (ROTA)


Net IncomeReturn on Total Assets =

Total Assets

$850=$15,500

= 0.055 or 5.5%


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Earnings available to common shareholdersexpressed as a percentage of common equity.

Example: Firm earned $0.104 of accounting net

profit for each $1 of common equityinvestment.

Return on Common Equity


Earnings Available to Common ShareholdersReturn on Common Equity =

Common Equity

Net Income Preferred Dividends=Total Equity Preferred Stock

$850 $0= = 0.104 or 10.4%

$8,200 $0


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Return on total assets as product of return onsales and total asset turnover.

Integrated Ratio Analysis: DuPont Equation


Return on Total Assets = Return on Sales Total Asset Turnover

Net Income Total Revenues=

Total Revenues Total Assets

= 0.057 0.968 = 0.055 or 5.5%


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Discussion QuestionWhy do service industry ratios differ frommanufacturing industry ratios?

a) Balance sheets have higher current assets,especially A/R

b) Service firms have higher debt

c) Supply costs are always low

d) Asset turnover is more

important than profit margin

Answer: a (p.5-74)



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Advantages:

Easily computed andwidely used

Information easily obtained

Easy comparison betweencompanies

Disadvantages: Historical data at fixed points,

not intra-period

No future performancepromise

Not best in isolation(comparative or trend)

Accounting information noteconomic value

Not qualitative value(strategies, talent)

Accounting methods mayreduce comparison validity

Strengths and Limitations of Ratio Analysis



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Return on investment (ROI) Partial period may be misleading.

Does not include cost of capital.

Positive NPV project rejected if it lowers firms ROI?

Performance Measurement


Net Income Net Income

ROI = =Invested Capital Long-Term Debt + Equity


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Residual income (RI) Assigns charge to the invested capital.

If profit exceeds charge for capital, then RI is a

profit.

Free cash flow (FCF)

Performance Measurement


FCF = Net Income Depreciation and Amortization

Change in Non-Cash Working Capital Capital Expenditures

RI = Net Income Invested Capital Cost of Capital


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Value created only if firm earns a rate of returnthat exceeds its WACC

Example: EVA of a company with:

Long-term debt of $3,900, equity of $8,200 Marginal tax rate of $450/$1,300 WACC of 10% Operating income (EBIT) of $1,600

Economic Value Added (EVA)


EVA = EBIT (1 Tax Rate) (WACC)(Long-term Debt + Equity)

= $1,600 (1 0.34615) (.10)($3,900 + $8,200)

= $1,600 (0.65385) (.10)($12,100)

= $1,046 $1,210 = -$164


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Discussion QuestionWhat possible scenario could increase EVA?

a) Rating agencies re-evaluate creditworthiness of anissue.

b) Improve operating efficiency so less EBIT isgenerated on the existing asset base.

c) Invest additional capital in assets that earn a rate ofreturn less than the cost of capital.

d) Eliminate assets that earn a rate of returnless than the cost of capital.

Answer: d (p.5-80)



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End of Session 10Assignment:

Complete the following tasksfor Module Five, Chapter 20:

Review the chapter. Complete the test-your-understanding questions at

the end of the chapter. Review the module flashcards. Complete the online calculations. Complete the online module-specific test. Complete the Exam Practice (Describe and

Differentiate) questions (located at the end of th emodule textboo k).

afp_treasury4_session chp 18 amd 19

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