What characteristics would you like to know?

THE POINT IS TO MAKE IT COMPREHENSIVE

Calculation Interpretation

Ratios
1. Leverage (Risk)
2. Asset Utilization (Efficiency)
3. Liquidity
4. Profitability
5. Market (Valuation)

Leverage
TIE = EBIT / Interest
Time Interest Earned
High the better

Leverage = D/E

Asset Utilization (Efficiency)

Specially for a mature industry
Asset Turnover = Sales / Assets average

F/A turnover = sales / fixed asset average

i.e. revenue/ track miles (Train n shit)

COGS/INVENTORY
Days turnover = inventory/COGS * 365

Days turnover
= inventory avrg / COGS * 365
Turnover = how long it takes to restock

GAP = 3.5 vs 4

Higher the inventory turnover ratio means lower storage cost (less obsoletes
stocks)

Liquidity
Ability to pay bills, (default risk) (enough cash, if too much cash =
unproductive)
Current ratio = Current assets / current liabilities
Current ratio = 2 (usually)
However, for fashion industry (too dynamic as fuck)
So current ratio must be high as fuck
Telecommunication (bell, rogers)
Current ratio = 1 or even less than 1
Because low inventory and clients are guaranteed to pay their bills

Quick ratio = current asset inventory / current liabilities

Take out illiquid account (biased by inventory)

Inventory = raw material + WIP + work finished

Cash ratio = cash + marketable securities / current liabilities
SHOW ME DA MUNEY!!
(tough ratio)
would look at bombardier with this ratio since high risk and in distress

Profitability
Goes together
ROA = EBIT / assets average = whole company performance (all
stakeholders)
We use EBIT because it takes out the part which are relevant only for the
stakeholders
(we want to see the debt holder stakes and the equity holder stakes)

ROE* = NI / equity = performance ONLY for common shareholders (more

important)

Margins (top down approach)

Industry performance
Gross profit margin = gross profit / sales

Management performance
Operating margin = operating income / sales

Tax department performance

Net profit margin = net income / sales
Indicate the efficiency of the company at its cost control
High

EBT
EBT
EBIT
EBIT
SALES
SALES
ASSETS
ASSETS
ROE Dupont=
EQUITY
NI/EBT = tax management
EBT/EBIT = interest management
EBIT/SALES = profitability
SALES/ASSETS = efficiency
ASSETS/EQUITY = leverage

Manufacturing, retail mature company

Market (valuation)
Market to book
DGM
P/E
DCF

Impuertante
Sustainable growth = ROE * retention rate
ROE * (1 div/NI)
What rate the corp. grow w/o external financing
Calculate 8% and real grow 14% going beyond his resource
Calculate 14% and real grow 8% underachieving

Limitation of Ratio analysis

- Not useful when viewed in isolation
- Based on accounting
- Different GAAP
- Based on accounting
- Multiple-industry companies
- All ratios must be considered together
- Industry knowledge is a must
- Historical data

All financial statements are audited

- Balance sheet
- Income statement
- Cash flow
- Notes to financial statement

I. Information on GAAP
a. Methods
b. Assumptions (depreciable life)
c. Debt maturities and interest rates
d. Contingent liabilities (not probable)
i. Law suits they will write the 100mil law suits in the
notes but not in the financial statement (strategic
inputs)
Advanced F/S analysis
1. Notes to financial position
2. Ratios
3. Pension accounting
4. Reserves
5. Deferred taxes
6. Off-balance sheet financing
7. Capitalizing
8. Earning quality
9. Red flags

II. The invisible crisis

Defined benefit: guarantees pension

Even bankrupt the TRUST, where the money in and different entity is
protected from any liabilities from the parent company

Defined contribution: pension at risk

PENSION ACCOUNTING (CFA II)

Accounting for the Future
- Wages increases
- Inflation
- Interest rates
- Turnover
- Mortality
- Investment returns
- Size of workforce
- Etc

Pension liability: $ (Funding)

Funded: Pension liability<funding
Unfunded: pension liability>funding

Unfunded means plenty liabilities (dangerous)

BANKS ANALYSIS
Net income LOW
Revenue
Interest from loans
PROVISION FOR NON-PERFORMING LOANS
Net interest revenue
Expenses
Interest paid on deposits
NET INCOME FROM LOANS

Provision for non-performing loans: banks have money set aside to pay loans
that default.
Ex.: oil prices are going down and banks will have many loans that will
default.
In low income periods, the banks will lower the provision account to increase
the net income
And vice versa
Income statement
Deferred taxes: fiction (fake bullshit)
Current taxes: gotta pay it for real

Balance sheet its fake

Conclusion
Add back deferred tax expense taxes to find CF, since you dont have to pay
it we want to see the real CF

In the balance sheet do no include deferred payable taxes as debt i.e. (D/E)

Off-balance sheet financing

Bond vs Lease
There is no difference
- Both are debt
- Rent or debt payments obligatory
- Have fixed due date
- Have maturity date

Financial risk (leverage)

D/E
If leases
(Debt + lease Pmt) / Equity

2 types of leases
Financial and Operating
Financial lease: shown on balance sheet
Operating lease: not shown on balance sheet (shown in NOTES)

Expense vs Capitalization
4.5mil / 30sec ads in GOODWILL and Expenses ADVERTISING.
affects the financial statement
expense: income statement: expenses advertising $4.5m
Capitalization: balance sheet assets (goodwill)

Red flags
Warnings signs
1. aggressive revenue recognition
Nortel (account revenue early and cost later) = SUPER PROFIT (fake tho)

2. divergence of CFO and earning

POSITIVE earnings but NEGATIVE cash flow

3. growth of revenue out of line with peers

diverge back to industry (Jeremy Lin)

4. deferral of maintenance
Ignore everything from income from discontinued operations and below
(extraordinary items)
Canada verglas = not including below since it is not recurrent
Japan tsunami n shit = include below since it is frequent

TAKE AWAY UNUSUAL OR INFREQUENT ITEMS TOO

5. useful economic lives

- depreciation and amortization expense

6. 4th quarter earnings SURPRISES

- dangerous