Module 1 Flashcards
(111 cards)
1
Q
What is the main objective of financial reporting?
A
To provide users with information that supports investment and management decisions
2
Q
What are the three main user groups of financial reporting?
A
- Investors & equity analysts
- Lenders & credit analysts
- Company managers
3
Q
What do investors & equity analysts use financial statement information for?
A
to judge the company’s profitability and financial strength, and to make reasonable estimates of the value of the company’s equity securities (stock)
4
Q
What do lender & credit analysts use financial statement information for?
A
to assess the company’s ability to repay its debts and to determine how to manage credit risk associated with the company’s debt securities
5
Q
What do company managers use financial statement information for?
A
to inform decisions such as where to invest scarce resources, how to finance those investments, how to maximize the company’s profitability, and how much cash to maintain
6
Q
Operating Activities
A
companies hire & train employees, manufacture products, deliver services, market & sell their products & services, and manage after-sale customer support
7
Q
Investing Activities
A
companies acquire land, buildings & equipment, grow the business with new products & services, or acquire other companies to expand into new markets
8
Q
Financing Activities
A
companies raise cash to fund the operating & investing activities (this includes selling stock to equity investors and borrowing funds from banks & other lenders)
9
Q
What are some examples of business forces & how do they affect the way the company does business?
A
Market conditions, competitive pressures, regulations. Shapes the company’s overarching goals & objectives along with the company’s strategy & strategic planning process
10
Q
What does a company’s strategic (or business) plan reflect?
A
how the company plans to achieve its goals & objectives
11
Q
What does a company’s business plan’s success depend on?
A
Effective analysis of market demand & supply.
Specifically, a company must assess demand for its products & services and assess the supply of its inputs (both labor & capital)
12
Q
What must the strategic plan contain?
A
Competitive analyses, opportunity assessments, & consideration of business threats
13
Q
What broad classes of users demand financial accounting information?
A
- managers & employees
- investment analysts & information intermediaries
- creditors & suppliers
- stockholders & directors
- customers & strategic partners
- regulators & tax agencies
- voters & their representatives
14
Q
Why do managers & employees demand financial accounting information?
A
They are interested in the company’s current & future financial health, therefore they desire accounting information on the financial condition, profitability, and prospects of their company, as well as comparative financial information on competing companies and business opportunities
15
Q
Which users of financial accounting information use that information for compensation & bonus contracts that are tied to such numbers?
A
Managers & Employees
16
Q
Which users of financial accounting information use that information for union contracts that link wage negotiations to accounting numbers and for monitoring pension & benefit plans whose solvency depends on company performance?
A
Managers & Employees
17
Q
What questions do financial statements help company managers address?
A
- What product lines, geographic areas, or other segments are performing well compared with our peer company’s and our own benchmarks?
- Should we consider expanding or contracting our business?
- How will current profit levels impact incentive and share-based compensation?
18
Q
What are two types of information intermediaries?
A
financial press writers & business commentators
19
Q
Why are investment analysts & information intermediaries interested in financial accounting information?
A
they’re interested in predicting a company’s future performance & condition in order to make informed stock recommendations or write commentaries
20
Q
What questions do financial statements help investment analysts & information intermediaries address?
A
- What are expected future profits, cash flows, and dividends for input into stock-price models?
- Is the company financially solvent and able to meet its financial obligations?
- How do expectations about the economy, interest rates, and the competitive environment affect the company?
21
Q
Why are creditors & suppliers interested in financial accounting information?
A
to help determine loan amounts, loan terms, interest rates, and required collateral
22
Q
What are covenants?
A
contractual requirements in loan agreements
23
Q
What questions do financial statements help creditors & suppliers address?
A
- Should we extend the credit in the form of a loan or line of credit for inventory purchases?
- What interest rate is reasonable given the company’s current debt load and overall risk profile?
- Is the company in compliance with the existing loan covenants?
24
Q
What does EBITDA stand for?
A
earnings before interest, tax, depreciation, and amortization
25
What does EPS stand for?
earnings per share
26
Why are stockholders & directors (and others, such as investment analysts, brokers, & potential investors) interested in financial accounting information?
to assess the profitability & risks of companies and to obtain other information useful in their investment decisions
27
Fundamental analysis
uses financial information to estimate company value and to form buy-sell stock strategies
28
What questions do financial statements help stockholders & directors (and others, such as investment analysts, brokers, & potential investors) address?
* Is company management demonstrating good stewardship of the resources that have been entrusted to it?
* Do we have the information needed to critically evaluate strategic initiatives that management proposes?
29
Why are customers interested in financial accounting information?
to assess a company's ability to provide products or services and to assess a company's staying power & reliability
30
Why are strategic partners interested in financial accounting information?
wish to estimate the company's profitability to assess the fairness of returns on mutual transactions & strategic alliances
31
What questions do financial statements help customers and strategic partners address?
* Will the company be a reliable supplier?
* Is the strategic partnership providing reasonable returns to both parties?
32
Why are regulators & tax agencies interested in financial accounting information?
for antitrust assessments, public protection, setting prices, import-export analyses, and setting tax policies
33
Why are voters & their representatives interested in financial accounting information?
to inform policy decisions & to monitor government spending. Contributors to nonprofit organizations also demand information to assess the impact of their donations.
34
What are the two main filings that publicly traded firms in the US must file with the SEC?
Form 10-K & Form 10-Q
35
What is the form 10-K and what does it include?
audited annual report that includes the four financial statements with explanatory notes and the management's decision & analysis (MD&A) of financial results
36
What does MD&A stand for?
management decision & analysis
37
What is the form 10-Q and what does it include?
unaudited quarterly report that includes summary versions of the four financial statements and limited additional disclosures
38
What benefits incentivize companies to disclose financial accounting information?
* A company's performance in the input/output market depends on success with its business activities AND the market's awareness of that success
* Companies reap the benefits of disclosure with good news about the products, processes, management, etc.
* Real economic incentives for companies to disclose reliable (audited) accounting information, enabling them to better compete in capital, labor, input and output markets.
39
What are the costs associated with a company's disclosure of financial accounting information?
* Preparation & dissemination costs
* Competitive disadvantages
* Litigation
* Political costs
40
What does GAAP stand for?
Generally Accepted Accounting Principles
41
What does IFRS stand for?
International Financial Reporting Standards
42
What does IASP stand for?
International Accounting Standards Board
43
What does FASB stand for?
Financial Accounting Standards Board
44
Why are comparable global accounting standards desirable?
* improve the quality of financial reports
* benefit investors, companies, and other market participants who make global investment decisions
* reduce costs for both users & preparers of financial statements
* make worldwide capital markets more efficient
45
What are the four financial statements?
* balance sheet
* income statement
* statement of stockholders' equity
* statement of cash flows
46
What does a balance sheet report?
* reports a company's financial position AT A POINT IN TIME
* reports on the cumulative effects of investing & financing activities
* reports the company's resources (assets), what the company owns
* reports the sources of asset financing
47
What are the two ways companies can finance their assets?
owner financing & nonowner financing
48
Where is money raised from with owner financing?
stockholders
49
Where is money raised from with nonowner financing?
banks or other creditors/suppliers
50
What are owner claims on assets referred to as?
equity
51
What are nonowner claims on assets referred to as?
liabilities (or debt)
52
Balance Sheet Equation
Assets = Liabilities + Equity
53
What are investing activities represented by?
the company's assets
54
In what order are assets listed on the balance sheet?
in order of their nearness to cash, with short-term assets (also called current assets) expected to generate cash within one year of balance statement date (i.e., cash > accounts receivable > inventories)
55
What are some examples of long-term assets?
land, buildings, and equipment
56
What are financing activities for?
to pay for assets (can be with a combination of owner & nonowner financing)
57
What are the two components of owner financing?
1. Resources (mostly cash, but sometimes non-cash assets) contributed to the company by its owners
2. Profits retained by the company
58
What does an income statement report?
a company's performance over a period of time. Lists amounts for its top line revenues (sales) and its expenses
59
Income Statement Formula
Revenues - Expenses = Net Income
60
What are the two kinds of operating expenses?
Cost of Goods Sold (COGS) - can also be called cost of sales
Selling, general, & administrative expenses (SG&A)
61
What do COGS represent?
while revenues represent retail selling price of the goods sold to customers, COGS is the amount the company paid to purchase or manufacture the goods (inventories) that it sold
62
Gross profit formula
Gross profit = revenues - COGS
63
What does gross profit mean?
gross means profit available to cover all other expenses
64
What does the SG&A represent?
overhead. including salaries, marketing costs, occupancy costs, HR & IT costs, and all other operating expenses the company incurs other than the cost of purchasing or manufacturing inventory (which is included in COGS)
65
To generate income, companies engage in what?
Operating activities that use company resources to produce, promote, and sell products and services.
These activities extend from input markets involving suppliers of materials and labor to a company's output markets, involving customers of products & services
66
Input markets generate most...
expenses (costs), such as inventory, salaries, materials & logistics
67
Output markets generate most...
revenues (sales), but also generate some expenses such as marketing & distributing products & services to customers
68
Relative profitability
Relative profitability = net income as a percentage of sales
69
What does the statement of stockholders' equity report?
Year-over-year changes in the equity accounts that are reported on the balance sheet
For each type of equity, the statement reports the beginning balance, a summary of the activity in the account during the year, and the ending balance
70
What is contributed capital?
the stock/shareholders' net contributions to the company
71
What does contributed capital represent?
the assets the company receives from issuing stock to stockholders
72
What are retained earnings?
net income over the life of the company minus all dividends ever paid (also called earned capital or reinvested capital)
73
What do retained earnings represent?
the cumulative total amount of income the company has earned and that has been retained in the business (that is, not distributed to stockholders in the form of dividends)
74
Statement of stockholders' equity formula (retained earnings formula)
Beginning Retained Earnings
+ Net income for the period
- dividends for the period
= Ending Retained Earnings
75
What does the statement of cash flows report?
the change (either an increase or decrease) in a company's cash balance over a period of time
also reports cash inflows & outflows from operating, investing, and financing activities over a period of time
76
What are PP&E assets?
property, plant & equipment
77
Other means of communicating important financial info about a company to various decision makers other than the four financial statements include:
* management discussion & analysis (MD&A)
* independent auditor report
* financial statement footnotes
* regulatory filings, including proxy statements & other SEC findings
78
Since the enactment of the Sarbanes-Oxley Act (SOX) in 2002, the SEC requires CEO & CFO to personally sign a statement attesting to the accuracy & completeness of financial statements. These statements include the following declarations:
* Both the CEO & CFO have personally reviewed the financial report
* There are no untrue statements of a material fact that would make the statements misleading
* Financial statements fairly present in all material respects the financial condition of the company
* All material facts are disclosed to the company's auditors & board of directors
* No changes to its system of internal controls are made unless properly communicated
79
A company's profitability must be assessed with respect to what?
The size of its investment
80
ROA formula
Return on assets = net income for that period divided by the average total assets during that period
ROA = PM x AT
(PM = net income/sales ; AT = sales/avg. asset)
81
What are the two components of ROA?
productivity & profitability
82
Describe profitability as it relates to ROA
Profitability relates profit to sales
83
What is profit margin and what does it reflect?
(PM) ratio relating profit to sales - reflects the net income (profit after tax) earned on each sales dollar
84
Describe productivity as it relates to ROA
productivity relates sales to assets
85
What is asset turnover and what does it reflect?
(AT) ratio relating sales to average assets - reflects sales generated by each dollar of assets
86
Does management want high or low PM & AT?
High for both. Management wants to earn as much profit as possible from sales and wants to maximize asset productivity to achieve the highest possible sales level for a given level of assets (or to achieve a given level of sales with the smallest level of assets)
87
Profitability (Profit Margin) formula
net income divided by sales
88
Productivity (Asset Turnover) formula
Sales divided by average assets
89
What is ROE?
return on equity
90
ROE formula
ROE = net income/avg. stockholders' equity
91
average equity formula
avg. equity = (beginning year equity + ending year equity) / 2
92
What does ROE reflect and how does it differ from ROA?
return to stockholders
ROA is the return for the entire company
93
What are the 5 forces that influence financial statements by determining competitive intensity and serving as key determinants of profitability?
* Industry competition
* Bargaining power of buyers
* Bargaining power of suppliers
* Threat of substitution
* Threat of entry
94
Describe how industry competition influences financial statements
competition and rivalry increase the cost of doing business as companies must hire and train competitive workers, advertise products, research & develop products, and engage in other related activities
95
Describe how bargaining power of buyers influences financial statements
buyers with strong bargaining power can extract price concessions and demand a higher level of service and delayed payment terms; this force reduces both profits from sales and the operating cash flows to sellers
96
Describe how bargaining power of suppliers influences financial statements
Suppliers with strong bargaining power can demand higher prices and earlier payments, yielding adverse effects on profits and cash flow to buyers
97
Describe how threat of substitution influences financial statements
as the number of product substitutes increases, sellers have less power to raise prices and/or pass on costs to buyers; therefore the threat of substitution places downward pressure on profits of sellers
98
Describe how threat of entry influences financial statements
new market entrants increase competition; to mitigate that threat, companies expend money on activities such as new technology, promotions, and human development to erect barriers to entry and to create economies of scale
99
What does SWOT (in SWOT analysis) stand for?
Strengths & Weaknesses (internal factors) and Opportunities & Threats (external factors)
100
What is a proxy statement?
a document containing the information the SEC requires companies to provide to shareholders so they can make informed decisions about matters that will be brought up at annual or special stockholder meetings
101
What are some issues that can be covered in a proxy statement?
proposals for new additions to the board of directors, information on directors' salaries, information on bonus or options plans for directors, and declarations made by the company's management
102
How are proxy statements used?
must be filed by a publicly traded company before shareholder meetings - discloses material matters of the company relevant for soliciting shareholder votes and final approval of nominated directors
103
What is the proxy statement form called?
DEF 14A
104
What does EDGAR stand for?
Electronic Data Gathering, Analysis, & Retrieval system
105
What are the benefits of proxy statements?
can aid potential investors in assessing qualifications and compensation of management teams and the board of directors
106
What is a shareholder letter?
letter written by a firm's top executives to its shareholders to provide a broad overview of the firm's operations throughout the year
107
What does the shareholder letter typically cover?
the firm's basic financial results, its current position in the market, and some of its plans. Can also speak to specific events that have happened throughout the year, changes in the company's stock price, or reiterate aspects of its vision. It's a chance for executives to speak directly to shareholders.
108
How often is the shareholder letter typically shared and where can it be found?
generally written once a year and is included at the beginning of the firm's annual report
109
In regards to ethical conduct, what does management do to ensure accuracy of a company's financial info?
* maintains a system of controls over the records and assets
* hires external independent auditors
* forms a committee of the board of directors to review these other two safeguards
110
What assertions does a "clean" audit report include?
* financial statements are management's responsibility. Auditor responsiblity is to express an opinion on those statements
*auditing involves a sampling of transactions, not an investigation of each transaction
* audit transaction provides reasonable assurance that the statements are free of material misstatements, not a guarantee
* Auditors review accounting policies used by management and the estimates used in preparing the statements
* Financial statements present fairly, in all material respsects, a company's financial condition in conformity with GAAP
111
SOX contains several provisions designed to encourage auditor independence. What are they?
* it established the Public Company Accounting Oversight Board (PCAOB) to oversee the development of audit standards and to monitor the effectiveness of auditors
* it prohibits auditors from offering certain types of consulting services and requires audit partners to rotate clients every 5 years
* it requires audit committees to consist of independent members
