b/s
'snapshot' of a business' assets, liabilities and equity at a single point in time |
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assets: (resources the company owns and uses) |
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current assets: cash and other assets espected to be turned into cash within next 12 months (short-term) |
→ cash → accounts receivable → prepaid expenses |
non-current: things company needs to run the business (long-term) |
→ tangible (can touch) → intangible (can't touch) |
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liabilities (money owed to others) |
current liabilities: everything expected to be paid within the next 12 months |
→ accounts payable → taxes payable → accrued expenses → deferred revenue |
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non-current liabilities: |
→ long-term loans/debt |
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equity: (difference between assets and liabilities, what is leftover after all assets & paying all obligations) |
→ common stock (capital contributions, money invested in business by owners) |
other comprehensive income (OCI): foreign currency hedge gains and losses, cash flow hedge gains and losses, and unrealised gains and losses for securities that are available for sale. |
retained earnings (accumulated profits held for future use) |
income statement
summary of a business revenues and expenses over a period of time. |
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revenue |
product sales, services rendered |
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expenses |
direct (cost of services, cogs) increase in direct proportion to sales made |
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indirect variable costs (loosely correlate with business' sales however cant be traced back to production of goods or provision of services) |
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advertising, comissions, utilities |
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indirect fixed (overhead expenses) |
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rent, salaries, insurance, admin, legal, accounting, marketing, deprecation, amortisation (bare no correlation to the sales business made) |
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operating profit (EBIT) |
interest and expenses and tax fall below operating profit |
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gross profit margin |
how efficiently the business is producing and selling their products |
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core principles
assets (stuff a business owns) = liabilities (for third parties) + equity (for owners) (stuff that a business owes) |
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adjusted trial balance: bookkeeping worksheet in which the balances of all ledgers are compiled into debit and credit account column totals that are equal. |
important metrics
- fixed assets |
- profit and loss account reserve + security in b/s |
- amount of debt |
- >10% EBITDA margin (10-14% is benchmark) |
trouble
company voluntary agreement (CVA) |
high amount of owners draw |
using mark to market (MTM) for real life assets and static business contracts |
nature of the business sector should be taken into consideration*
big 3
- income Statement (P&L) |
- balance Sheet |
- cash Flow Statement |
- statement of Owners Equity / Statement of Retained Earnings |
boosting cash efficiency
- reducing the cost base |
- divestment |
- outsourcing = contracting tasks to external companies |
- offshoring = relocating business process to another country |
- cost accounting |
- purchasing power parity (PPP) |
- promissory notes |
detecting financial fraud in accounts
- aggressive accounting / creative accounting |
- income smoothing |
- earnings management |
- accounts payable (invoices, ghost companies, round numbers) |
- listing inventory and receivables as one line item (inventory + receivables) |
- multiple restatements are a problem |
- cumulative adjustments instead of restatements |
- use of Non-GAAP measures is bad |
- be wary of EBITDA |
- cooking the books = falsifying accounts |
- off-book accounts |
- round tripping |
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- overstating revenues by recording future expected sales |
- inflating an asset's net worth by knowingly failing to apply an appropriate depreciation schedule |
- concealing obligations and/or liabilities from a company's balance sheet |
- Incorrectly disclosing related-party transactions and structured finance deals |
- accounting anomalies, such as growing revenues without a corresponding growth in cash flows. |
- a significant surge in a company's performance within the final reporting period of a fiscal year. |
- consistent sales growth while competitors are struggling. |
- depreciation methods and estimates of assets' useful life that don't correspond to those of the overall industry. |
- weak internal corporate governance, which increases the likelihood of financial statement fraud occurring unchecked. |
- outsized frequency of complex third-party transactions, many of which do not add tangible value, and can be used to conceal balance sheet debt. |
- the sudden replacement of an auditor resulting in missing paperwork. |
- a disproportionate amount of management compensation derived from bonuses based on short-term targets, which incentivises fraud. |
- using SPEs to conceal debts taken on from other loan providers and leaving it off the balance sheet |
alteration of a companies financial statements to manipulate a company's apparent health or to conceal profits or losses.*
vertical analysis takes every item in the income statement as a percentage of revenue and comparing the year-over-year trends that could be a potential flag cause of concern.*
horizontal analysis represents financial information as a percentage of the base years' figures.*
one must always take into consideration that audits DO NOT find fraud*
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ideals
excellent working capital management |
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negative cash conversion cycle: inventory sold before we have to pay for it. |
normal to low debt ratio |
high liquidity |
Positive NPV > Negative NPV |
things to take into consideration
cash is a liability*
good forma
- The more deals you look at, the better deals you do |
- Risk management is key |
- Interest + Taxes are an expense you get depreciation by laying out money ahead of time (worse kind of expense) due to buying an asset first and get the deduction later |
- Offset with IP and avoidable taxable events |
calculus
EBITDA = Measure of earnings potential of a business |
EBITDA = I + Depreciation + Amortisation (where I = Operating Income) |
EBIT = Operating Profit |
operating Profit/Income = Gross Profit - Operating Expenses |
debt Ratio = If assets where financed debt or own money (if high bad) |
non-current term debt/net income: (2-4 years good) |
models
beneish Model evaluates eight ratios to determine the likelihood of earnings manipulation, including asset quality, depreciation, gross margin, and leverage. After combining the variables into the model, an M-score is calculated. A value greater than -2.22 warrants further investigation, while an M-score less than -2.22 suggests that the company is not a manipulator. |
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benford's Law states "1" tends to occur more frequently as the first digit than other digits, providing a non-uniform distribution pattern. (not strict mathematical rule / limitations - data characteristics and sample size) should be used in conjunction with other models |
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