Accounting and Financial Reporting

 See the current position and compare with previous balance sheet
o Liquidity: current assets/current liabilities
o The higher the liquidity ratio, the better the company’s liquidity position.
 Understand and identify different sources of finance
 Discuss whether movements affect equity or not
o Stockholder's equity includes a company's cumulative earnings and the amount of
capital invested by its shareholders in exchange for shares of its common and
preferred stock. When an increase occurs in a company's earnings or capital, the
overall result is an increase to the company's stockholder's equity balance.
Shareholder's equity may increase from selling shares of stock, raising the company's
revenues and decreasing its operating expenses.
o How Shareholder's Equity is Increased
A corporation may plan the precise amount of increase to stockholder's equity, as in
the case of a stock issuance of common and preferred shares at an established price.
This change differs from an increase that may occur to stockholder's equity as a
result of net income; while the corporation plans to profit from operations, its actual
net income is known only after the fiscal year has ended.
o Increases from Capital
When a company issues shares of common and preferred stock, the shareholder's
equity section of the balance sheet is increased by the issue price of the shares. The
par value may be shown as a separate line item from additional paid-in capital on
the shares, or the balance may be totaled on the same line. A company may raise
stockholder's equity by issuing shares of capital to pay off its debts and reduce
interest costs.
o Increases from Earnings
The net income a company earned from its fiscal year results in an increase to the
equity account "retained earnings." A component of stockholder's equity, retained
earnings includes the net income a company has earned to date, minus any
distributions of profits it made to its shareholders. A corporation can raise
stockholder's equity by raising the prices on its products, reducing management
personnel and imposing a strict operating budget on all its employees.
 Discuss whether movements are cash or non-cash
o The first fundamental rule of doing business is ensuring a company generates
the needed cash to pay for fixed and variable expenses while still turning a
profit. Investors use a variety of methods to determine the cash flow of a
company over several periods, but you can easily determine a company’s
cash flow directly from its quarterly and annual reports. Obtain copies of
these reports online from the publicly traded company or ask to have a copy
mailed to you.
o Calculate a company’s operating cash flow ratio. Determine this by dividing
the total current liabilities found on the company’s balance sheet by the
company’s cash flow from operations, which can be found on the company’s
cash flow statement. Factoring these numbers allows a potential investor to

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 determine if the company currently generates enough cash to pay for its
current liabilities.
o Figure out a company's earnings before depreciation and amortization. Write
down net income from operations and add to it amortization and
depreciation. This is known in the investment world as EBDA and is used to
determine "accounting" cash flow. Obtain this information from the cash
flow or income and expense statements.
 Calculate Solvency Ratio (Equity as percentage of balance sheet total)
o Solvency Ratio: Equity/total balance sheet
o Indicates whether a company’s cash flow is sufficient to meet its short- and
long-term liabilities.
o higher than 20% is financially sound.
 Give an estimation of Interest-Bearing Debt by looking at profit and loss account
o Interest-bearing debt ratio=Debt/(debt +equity)
o The interest-bearing debt ratio, or debt to equity ratio, is calculated by
dividing the total long-term, interest-bearing debt of the company by the
equity value. For example, if a company is financed with $6 million in debt
and $4 million in equity, the interest-bearing debt ratio would be $6
million divided by $4 million, which could be expressed variously as 1.5 or
3:2.
o The debt-to-capital ratio gives analysts and investors a better idea of a
company's financial structure and whether or not the company is a suitable
investment. All else being equal, the higher the debt-to-capital ratio, the
riskier the company. However, while a specific amount of debt may be
crippling for one company yet barely affect another. Thus, using total capital
give a more accurate picture of the company's health.

 Calculate EBITDA and calculate Net Debt-EBITDA

o EBIT=operating result
 Calculate ‘Quick and Dirty Cash Flow’
o Q & D cash flow=net profit(loss) + DA
o Net profit = profit for the year (not total comprehensive income/loss)
 Calculate CAPEX
o CAPEX=investment cash flow = total non-current assets +DA
o Total non-current assets =Fixed assets
 Analyze working capital (gap) and understand ‘working capital management’
o Working capital management is a business strategy designed to ensure that a
company operates efficiently by monitoring and using its current assets and
liabilities to the best effect. The primary purpose of working capital management
is to enable the company to maintain sufficient cash flow to meet its short-term
operating costs and short-term debt obligations.
o A company's working capital=current assets - its current liabilities.
o Current assets include anything that can be easily converted into cash within 12
months. These are the company's highly liquid assets. Some current assets
include cash, accounts receivable, inventory, and short-term investments.
o Although numbers vary by industry, a working capital ratio below 1.0 generally
indicates that a company is having trouble meeting its short-term obligations.

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 That is, the company's debts due in the upcoming year would not be covered by
its liquid assets. In this case, the company may have to resort to selling off assets,
securing long-term debt, or using other financing options to cover its short-term
debt obligations.
 Analyze whether capital contributions or dividend payments have been made
o Dividend = total (group) equity – Net Profit/ + Net Loss for the year
 Understand cash flow statements
 Assess cash consequences of forming, using and releasing provisions
 Discuss banker’s perspective on finance: loan to value, solvency ratio and Net
Debt/EBITDA
o Loan to value = Borrowings/total Assets (or liabilities); LTV ratio is a financial
term used by lenders to express the ratio of a loan to the value of an assets
purchased.
o Solvency Ratio: Equity/Total balance sheet; indicates whether a company’s cash
flow is sufficient to meet its short- and long-term liabilities. Higher than 20%
o Net Debt/EBiTDA: which is a measurement of leverage, shows how many years it
would take for a company to pay back its debt if net debt and EBiTDA are held
constant; negative means more cash than debt; Banking ratios
 Calculate Enterprise and Equity Value on the basis of EBITDA-multiples
o The Enterprise-value-to-EBITDA: As a general guideline, an EV/EBITDA value
below 10 is commonly interpreted as healthy and above average by analysts and
investors. – financial leverage

Inter. Bear.
Debt
Enterprise
Cash
value =
6*EBITDA Equity value

You should also be able to:

 Draw up your own balance sheet and incorporate changes
 Work with negative equity and Identify different ways of restoring solvency
o Negative equity means that you owe more money on your car loan than the
vehicle itself is worth. This is also referred to as being “upside down” on a loan
and it can have an impact on your ability to sell or trade-in your car for a new
one. Keep reading for everything you need to know about negative equity and
some tips for getting yourself back on stable financial ground.
o Option no.1: delay the trade-in
o Option no.2: pay off the negative equity
o Option no.3: refinance the loan - Refinancing involves working with your lender
to get a new loan that better matches your current financial situation. That could
mean securing a lower interest rate or extending the term of your loan.
o Option no.4: shift the debt - Move your car loan into a lower interest line of
credit or home equity loan. This doesn’t solve the problem, but it can make
payments more manageable in the interim.

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 o Option no.5: find some added income -
 Be able to link legal debates to balance sheets and P&L accounts
 Discuss different valuation methods and also their relevance for Insolvency Law
 Liquidation value vs going concern
 Going concern: DCF (complicated) or EBITDA-multiple
o Going concern value is a value that assumes the company will remain in business
indefinitely and continue to be. A company should always be considered a going
concern unless there is a good reason to believe that it will be going out of
business.
o Goodwill: The difference between the going-concern value of a company and its
liquidation value is known as goodwill. Goodwill consists of intangible assets,
such as company brand names, trademarks, patents and customer loyalty.
Typically the going-concern value will be greater than the liquidation value.
When a company is acquired, the purchase price is typically based on its going-
concern value. This means that a company being acquired can charge a pricing
premium that is higher than the value of its assets and takes into account the
value of its future profitability, intangible assets, and goodwill.
o The going-concern value of a company is typically much higher than its
liquidation value because it includes intangible assets and customer loyalty as
well as any potential for future returns. The liquidation value of a company will
even be lower than the value of the company’s tangible assets, because the
company may have to sell off its tangible assets at a discount—often, a deep
discount—in order to liquidate them before ceasing operations. Examples of
tangible assets that might be sold at a loss include equipment, unsold inventory,
real estate, vehicles, patents and other intellectual property (IP), furniture, and
fixtures.

o Discuss how American, English and German law would deal with the loan granted by
the shareholder in case the company goes bankrupt anyway. Also discuss which
system you prefer and why.

Developments under German law:

 Origin: case law in the 1950’s.
 Initially: subordination of shareholders loans granted at a moment of crisis.
 Rationale: The shareholders will be the ones to benefit if companies can trade
themselves out of financial difficulties. Since the benefits will be reaped by the
shareholders, they are also the ones who should bear the risks.
 Rules were codified in 1980’s.
 Case law remained important. Statutory provisions (80’s) were held to be a ‘mere
supplement to the judge-made rules’
 Rules became increasingly complex, for example.
 How to treat loans that have been granted years before any crisis, but were
not repaid because of a financial crisis?
 Solution: if you don’t demand payment and don’t enforce your demands, ‘the
leaving of the funds’ in the company is seen as providing loans at the
moment of crisis.

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Overhaul of German Law:
 Rules had become overly complex.
 New rules in 2009, by MoMiG.
 “Modernisierung des GmbH-Rechts und zur Bekämpfung von Missbräuchen”
or “Law for the Modernisation of the German Limited Liability Company Law
and the Prevention of Misuse”.
 No longer loans granted at a moment of crisis, but all loans (§ 39 InsO):
 The following creditors will rank after the insolvency creditors:
v) claims for the repayment of shareholder loans.
`(1) Im Rang nach den übrigen Forderungen der Insolvenzgläubiger werden in
folgender Rangfolge, bei gleichem Rang nach dem Verhältnis ihrer Beträge, berichtigt (..)
nach Maßgabe der Absätze 4 und 5 Forderungen auf Rückgewähr eines
Gesellschafterdarlehens oder Forderungen aus Rechtshandlungen, die einem solchen
Darlehen wirtschaftlich entsprechen.
 Exception: less than 10% shareholders who are also not involved in the management
of the company.
 Is there a new rationale? It is no longer simply an end game problem. So yes. See
D.A. Verse:
“The most plausible explanation is that subordination of all shareholder loans will
simply ensure that the shareholders adequately participate in the entrepreneurial risk of the
company.”
 Also a general ban on shareholder security rights in art. 135 InsO
 Q2: scenario 2 and 3 would not be possible under German Law.

American Law: Subordination

 Subordination in case of inequitable conduct
 Equitable subordination. Article 510 BA:
a) A subordination agreement is enforceable in a case under this title to the same
extent that such agreement is enforceable under applicable nonbankruptcy law.
(…)
(c) Notwithstanding subsections (a) and (b) of this section, after notice and a hearing,
the court may - (1) under principles of equitable subordination, subordinate for purposes of
distribution all or part of an allowed claim to all or part of another allowed claim or all or
part of an allowed interest to all or part of another allowed interest;
 Following Re Mobile Steel, 3 requirements:
 Shareholder acted in an inequitable manner
 Conduct must have resulted in injury to creditors
 Subordination must fit within the framework of the bankruptcy act
 Q 2: Outcome under US law is uncertain. No per se subordination, so scenario 2 and
3 possible.

English Law:
 Proposal by the Cork committee: No general subordination of all shareholder
claims.

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 “We recommend that, on a winding up of a company, those of its liabilities whether
secured or unsecured which are owned to connected persons or companies, and which
appear to the court to represent all or part of the long-term capital structure of the
company, shall be deferred.”
 The relevant factors should include, according to the Cork committee:
 The debt-equity ratio
 The adequacy of the paid-up share capital
 The absence of reasonable expectation of payment
 The terms on which the advance was made and the length of time for
which it has been outstanding
 Whether outsiders would make such advances; and
 The motives of parties
 Proposal not implemented. There are (still) no rules on the subordination of
shareholder loans in English law.
 Q2: scenario 2 and 3 realistic under English law.