Professional Documents
Culture Documents
Xlri Accounting SEMINAR 2011: PBS Paribas
Xlri Accounting SEMINAR 2011: PBS Paribas
SEMINAR 2011
PBS Paribas
Copyright © 2010 Deen Kemsley
Course Title
A = L + OE
A = L + OE
Capital Retained
Cash A/R A/P LTD Stock Earnings
• Each and every entry in the cash column must enter the
cash flow statement. No other information should enter
the statement.
• Each and every entry in the retained earnings column
must enter the income statement. No other information
should enter the statement.
– Exception: Dividends affect retained earnings but not earnings
• Apply the tax rate to pretax earnings (not to total
revenue)
New Wave Ice-Tea must accrue taxes for any profits earned
each year. Assume the taxes are paid in the following
year.
• Dec 31, 2011: Leased the space in front of business school for $3000 per year.
Paid three years of rent in advance ($9,000).
• Dec 31, 2011: Purchased a juice stand for $10,000 in cash. The stand has a 10-
year life with $0 salvage value. Depreciation will be $1,000 each year.
• Dec 31, 2011: The 5 owners of New Wave Ice-Tea agree to earn a small salary of
$1000 each for the entire year. You do not need other employees at this point in
time.
• Dec 31, 2011: Purchased 6,000 ice-tea cans from Napa at a price of $0.75 each,
for a total amount of $4,500 that was paid for in cash. Napa was able to deliver
them the same day.
• Inventory used
• Depreciation expense on the stand ($10,000 / 10 year =
$1,000)
• Rental expense for leasing the space in front of school
• Taxes accrued for pretax income earned this year (at
40%). These taxes will not be paid until next year.
Beg
Bal
End
Bal
Total Assets
Long-term Debt
Total Liabilities
Stockholders' Equity:
Capital Stock
Retained Earnings
Total Stockholders' Equity
Purchased Stand
Issue Stock
End
Bal
Total Assets
Sales
Costs and Expenses:
Cost of Sales
Selling, general and administrative
Depreciation
Interest
Total Costs and Expenses
Earnings before Taxes
Income Taxes
Net Earnings
End
Bal
Copyright © 2010 Deen Kemsley
New Wave Ice Tea
2013 Template: Balance Sheet
Assets
Current Assets:
Cash
Receivables
Inventories
Prepaid Expenses
Total Current Assets
Land, Building and Equipment
Less Accumulated Depreciation
Total Assets
Sales
Costs and Expenses:
Cost of Sales
Selling, general and administrative
Depreciation
Interest
Total Costs and Expenses
Earnings before Taxes
Income Taxes (@40%)
Net Earnings
Purchased Computer
Issue Bonds
Net Income
Shareholder’s Equity
ROE
ROE
Return on
RNOA
RNOA + Debt on
Return
Debt
= Operating Profit after Tax = Debt/Equity Ratio x Financing Spread
Net Operating Assets
RNOA
RNOA
Operating
Operating Operating
OperatingAsset
Asset
X
Profit
ProfitMargin
Margin Turnover
Turnover
= Operating Profit after Tax = Operating Revenue
Operating Revenue Net Operating Assets
“DuPont Analysis”
*Note: Required adjustment because in the absence of debt, tax expense would
be greater than reported.
Note: If you know the tax rate (t), it’s sometimes simpler to account for
taxes using: Operating Profit After Tax = Operating Income x (1 – t).
• RNOA
• Operating Profit Margin
• Operating Asset Turnover
Gross
GrossProfit
Profit - Operating
Operating
Margin
Margin Expense
ExpenseMargin
Margin
SG&A
SG&A Depreciation
Depreciation Taxes
Taxes Other
Other
Exp. + + +
Exp.Margin
Margin Exp.
Exp.Margin
Margin Exp.
Exp.Margin
Margin Exp.
Exp.Margin
Margin
* Excluding COGS ** Taxes as reported plus the tax benefit from debt
Copyright © 2010 Deen Kemsley
Exercise 2
(1) Decompose Cool Ice Tea’s Operating Profit Margin into its
subcomponents of Gross Profit Margin and Operating
Expense Margin.
Inventory + Accounts
Accounts + Fixed
Fixed - Accounts
Accounts +/- Other
Inventory Receivable Assets Payable Other
Receivable Assets Payable
ROE
ROE
+Return on
RNOA Return on
RNOA Debt
Debt
= Operating Profit after Tax = Debt/Equity Ratio x Financing Spread
Net Operating Assets
Debt/Equity
Debt
Debt/Equity
Debt Financing
Financing
Ratio X Spread
Ratio Spread
Cost
Costof
of
Debt
Debt ÷ Equity
Equity RNOA
RNOA - Debt
Debt
Interest
Interest
Expense
Expense ÷ Debt
Debt
(1-t)
(1-t)
(2) Express Cool Ice Tea’s ROE in terms of RNOA and the
Return on Debt
ROE
GPM OpExp% OpRev NOA Tot. Debt Equity RNOA Cst Debt
SG&A % Depr% Tax% Cash A/R Inventory Accr. Tax Prepaids PPE A/P
Int Exp LT Debt
(1-t)
Valuation Methods
And Analysis
• Dividends
• Share repurchases
• Liquidating distributions
DDM
DDM
DCF
DCF RIM
RIM
• Fundamental Value equals the present value of all future free cash
flows
• Often, analysts measure FCFs for operations as a whole, although it
is easy to adjust this value to focus on equity investors alone. When
focusing on operations, r equals the weighted-average cost of capital
(WACC)
Cons: In many cases, current cash flow is not highly correlated with
future cash flow, and the correct use of WACC is tricky
Copyright © 2010 Deen Kemsley
DCF Equity – Method One
There are two related ways to adjust DCF Operations to DCF
Equity. The first way is simply to subtract the value of
debt from the value of operations:
FCF Operations
+ Net Financial Income
- Net Debt Reductions
FCF Equity
Exercises
• For the first two periods, you forecast free cash flows for
total operations of 60,000 and 65,000 respectively.
• Beyond the first two periods, you forecast free cash flows
will grow by 5 percent per year in perpetuity. Hence, free
cash flow for Period 3 is 68,250 (1.05 x 65,000).
• You forecast that debt will remain unchanged and that the
market value of debt equals the book value reported on
the balance sheets.
• The discount rate is 12 percent.
• For the first two periods, you forecast that earnings will
grow by 5 percent per year
• You forecast that the shareholders’ equity will grow by 5
percent for the first year
• Beyond the first two periods, you forecast that residual
income will fade to zero (linearly) over 3 years
• The discount rate is 10 percent
Interest Rate 0%
Credit Analysis
Standard
Standard
Moody’s
Moody’s &&Poor’s
Poor’s
Credit
Credit
Analysis
Analysis
Credit
Credit
Ratings
Ratings
Standard
Standard
Moody’s
Moody’s &&Poor’s
Poor’s
Estimated
Estimated Default
Default
Recovery
Recovery Risk
Risk
Overall Credit
Analysis
Management
Management
Character
Character
Country
Country
Collateral
Collateral Risks
Risks
Business
Business Risk
Business Industry
Industry
Stability
Stability Risks
Risks
Operational
Operational Competitive
Competitive
Diversity
Diversity Position
Position
Cash
Cash
Profitability
Profitability Flow
Flow
Financial
Risk
Capital
Capital Liquidity
Liquidity
Structure
Structure
EBIT/Total Assets
Operating Income/Sales
EBIT/Interest Expense
EBITDA/Interest Expense
ROE: Net Income/Equity
ROA: Net Income/Total Assets
Earnings Growth %
FFO/Total Liabilities
Operating Cash Flow/Total Liabilities
(Free Operating Cash Flow + Interest Expense)/Interest
Expense
FFO/CAPEX
Operating Cash Flow/CAPEX
Country Risks:
Industry Risks:
Competitive Position:
Operational Diversity:
Business Stability:
Collateral:
December 31,
2009 2008
CURRENT ASSETS
Cash and cash equivalents $ 896 $ 561
Investment securities 240 —
Receivables, less allowance (2009-$6; 2008-$5) 81 86
Inventories, less allowance (2009-$3; 2008-$4) 40 30
Restricted cash 13 78
Prepaid expenses 147 91
Other 43 10
Deferred income taxes 78 106
Total current assets 1,538 962
PROPERTY AND EQUIPMENT
Flight equipment 4,170 3,832
Predelivery deposits for flight equipment 139 163
4,309 3,995
Less accumulated depreciation 540 406
3,769 3,589
Other property and equipment 515 487
Less accumulated depreciation 169 134
346 353
Assets constructed for others 549 533
Less accumulated depreciation 26 5
523 528
Total property and equipment 4,638 4,470
OTHER ASSETS
Investment securities 6 244
Restricted cash 64 69
Other 308 275
Total other assets 378 588
TOTAL ASSETS Copyright © 2010 Deen Kemsley $ 6,554 $ 6,020
Jet Blue Liabilities and Equity
December 31,
2009 2008
LIABILITIES AND STOCKHOLDERS’ EQUITY
CURRENT LIABILITIES
Accounts payable $ 93 $ 144
Air traffic liability 455 445
Accrued salaries, wages and benefits 121 107
Other accrued liabilities 116 113
Short-term borrowings — 120
Current maturities of long-term debt and capital leases 384 152
Total current liabilities 1,169 1,081
LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS 2,920 2,872
CONSTRUCTION OBLIGATION 529 512
DEFERRED TAXES AND OTHER LIABILITIES
Deferred income taxes 259 197
Other 138 92
397 289
STOCKHOLDERS’ EQUITY
Common Stock 3 3
Treasury stock, at cost; 27,102,136 and 16,878,876 shares in 2009 and
2008, respectively (2) —
Additional paid-in capital 1,419 1,287
Retained earnings 118 60
Accumulated other comprehensive income (loss), net of taxes 1 (84)
Total stockholders’ equity Copyright © 2010 Deen Kemsley 1,539 1,266
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY $ 6,554 $ 6,020
Jet Blue Income Statements
Earnings Quality
Quality
Quality
Earnings
Earnings
Reliable
Reliable Relevant
Relevant Conservative
Conservative Sustainable
Sustainable
Possibility
Possibilityfor
for
Earnings
Earnings
Management
Management
Audits
Auditsare
arenot
not Flexibility
Flexibilityin
in
Perfect
Perfect GAAP
GAAP
Detectors
Detectors Requires
Requires
of
ofFraud
Fraud Judgment
Judgment
Employment
Employment Behavior
of Fraudulent
of flexibility beyond the
conventional financial
that strains boundaries
GAAP reporting
GAAP of GAAP
flexibility
Revenue
Revenue
Recognition
Recognition
Criteria
Criteria
Substantial Confidence
Confidence Good
GoodHandle
Handle
Substantial In On
Performance
Performance In On
Collections
Collections Costs
Costs
3.5
2.5
Percentage
1.5
0.5
0
1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
Year
60
50
40
Percentage
30
20
10
0
1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
Year
Copyright © 2010 Deen Kemsley
Mini Cases
Duane Read Pharmacies in New York (October, 2008)
• Asked suppliers to give DR a credit for purchases
• Promised to pay back the credit after year end
• Asked suppliers to send a “construction project” invoice
for the credit.
• Total Ploy = $17.5 million
Q:What ploy(s) was Duane Read using?
Xerox (1998)
• Treated equipment rentals to customers as capital leases
so they could record “sales” ($592 million).
Q: What ploy(s) was Xerox using?
Copyright © 2010 Deen Kemsley
Part 2
Detecting the
Ploys
• A qualified opinion
• Any reservations the auditors may express regarding the
financials
• Any changes in accounting methods the auditors
highlight
Key Point: Note that the indicators listed in this table often
can be interpreted two ways. On the one hand, they
could reflect earnings management. On the other hand,
they could reflect actual strength or improvement for the
firm. Therefore, when an indicator is detected, it simply
means that further analysis must be conducted to
distinguish between actual strength and feigned strength.
Earnings Quality
Cases
January
Satyam Computer Services Inflated figures for cash and related sales
2009
Copyright © 2010 Deen Kemsley
156
Earnings Quality Cases II
Company Allegations Ploy
AOL booked ads it sold on behalf of others as revenue instead of just
AOL Time Warner
booking the commission AOL earned.
Using steep discounts, McAfee sold millions of dollars of product to its
McAfee Anti-Virus distributors that the distributors did not yet need, and then secretly paid the
distributors to keep the extra product rather than return it to McAfee.
• Budget Surplus for the year 2000 sets a new record: $236
billion (2.4% of GDP)
• The CBO projects large, rising surpluses for the next ten
years
Actual
Surplus
(Deficit) 128 (158) (378) (413) (318) (248) (162) (455) (1413)
Percent of
GDP
1.3 (1.5) (3.5) (3.6) (2.6) (1.9) (1.2) (3.2) (10)
CBO
Proj. :
-1349 -980 -650 -539 -475 -480 -521 -525 -542 -649 -687
Percent
of GDP
-9.2 -6.5 -4.1 -3.2 -2.7 -2.6 -2.7 -2.6 -2.6 -3.0 -3.0
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
WH
Proj. -1471 -1416 -911 -736 -698 -762 -758 -721 -749 -822 -900
7/2010
Percent
of GDP
-10.0 -9.2 -5.6 -4.3 -3.8 -4.0 -3.8 -3.4 -3.4 -3.6 -3.8
Copyright © 2011 Deen Kemsley
167
White House Projection: Selected
Assumptions
• A strong, sustained economic recovery will occur, with GDP growth of
3.9% in 2010, 4.7% in 2011, 5.8% in 2012, 5.9% in 2013, etc.
• Projections for 2016-2020 all assume full employment (5.2%)
• These projections do not include the December, 2010 extension of
unemployment benefits and Bush tax cuts.
• Any new health care plan will reduce the sum of deficits by $122B
(Gross cost of $590B offset by $712B of new taxes and savings)
• Total disaster costs over the 10-year period will be $44B
• As a percentage of GDP, defense and security spending will fall
dramatically (from 5.8% in 2010 to 4.1% in 2020)
• As a percentage of GDP, discretionary spending will drop to lower levels
than it has been for 50 years (from 3.8% in 2010 to 2.2% in 2019)
• State budget deficits are excluded.
Discussion: What are your views on these assumptions?
Copyright © 2011 Deen Kemsley
168
Paying for the Deficits
There are three fundamental ways to pay for the deficits. All
three ways represent tough choices.
• Reduce spending
Obstacles
• The bulk of spending occurs in programs that are hard to
cut, including social security, Medicare, Medicaid, defense,
interest, etc.
• Cutting spending requires conscious political decisions to
induce pain now
– Lower GDP
– More Unemployment
– Lower Growth
Obstacles:
The most common way the Fed monetizes the debt is to print
more money and use that money to buy treasuries (i.e.,
print money to pay off its debt).
Public
Debt 7545 9298 10498 11472 12326 13139 13988 14833 15686 16535 17502 18573
% of
GDP 53.0 63.6 68.6 70.8 71.7 72.2 72.9 73.6 74.2 74.9 75.9 77.2
2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
Gross
with 11876 13787 15144 16336 17453 18532 19683 20837 22011 23197 24450 25777
intra-
govt
% of
GDP 83.4 94.3 99.0 100.8 101.5 101.8 102.6 103.4 104.1 105.1 106.0 107.1
Copyright © 2011 Deen Kemsley
176
Federal Public Debt:
CBO’s 10-Year Projection
Potential Outcomes
Strategy:
• Monetize the debt by printing money
Consequences:
• The dollar crashes
• The price of imported goods skyrockets
• Interest rates skyrocket
• Investment plummets
• Wealth is destroyed
The Project:
• Choose a (possibly U.S.-based) company to analyze (in some cases, you also may choose a
competitor)
• Use any combination of the techniques from the course to analyze the primary company.
Only use relevant techniques from the course. Ignore techniques that do not relate well to
your company.
• Write a report on the relevant aspect(s) of the company you have chosen to emphasize. The
report is not intended to be a comprehensive investment report. Instead, you should report
on a key item for investors to consider.
• Example Topics (this list is far from complete): Indicators of potential earnings management;
unique capital structure decisions; insights obtained from a DuPont analysis; the impact of fair
value accounting; a specific bond rating upgrade or downgrade, or the potential for a change
in rating; a critical analysis of analysts’ buy/hold/sell recommendations; a residual-income-
based valuation; the viability of a particular bank, etc.