Wall Street Prep: Accounting

These are my newbie notes from the first time I ever came across the subject of “Accounting”.

8-K acquisition or materially significant event
Form 14A (Proxy) for annual shareholder meetings
S-1 for IPO
COGS:, Direct Manufacture, Direct Procurement
Merchandisers are responsible for everything that happens to a product from the moment it is delivered to the store to the moment a shopper picks it up from the shelf
Revenue recognition: it's only the factory overhead and direct labour that was DIRECTLY involved in the products that were sold
R&D expenses include compensation for R&D employees
Depreciation baked into SG&A/COGS, significant expense - which makes an income statement a poor tool for tracking a company's cash position
Intangible assets: Trademarks and Goodwill are considered to have an indefinite useful life and are not amortized
SBC is embedded into normal compensation, (obvs depending on function of employee will show whether it goes in SG&A or COGS). SBC is non-cash, added on CFS.
The tax expense companies recognize on their income statement does not equal the actual CASH taxes they pay (bc of deferring)
Turnover = Revenue
If you buy a cash register for 2 years, don't put the price of the cash register on the SG&A, put the DEPRECIATION of the cash register on the SG&A
Weighted average shares means (TOTAL number of shares in 1st period * time) + (TOTAL number of shares in 2nd period * time).. it's cumulative, so the addition of new shares will increase total number of shares in 2nd period.
Apple's trademark won't be an intangible asset on the BS unless it is ACQUIRED.
Balance sheet shows Assets, and how they were funded (Liabilities and Equity)
Every little transaction has sources (credits) and uses (debits). Can either add or subtract from both sides of the BS.
Accounts Payable is just credit to suppliers. Accounts Receivable is credit to us.
Issuing stock: source is common stock in equity, use is cash balance is increase
Increase to L/E is a credit, Increase to A is a debit
Always start with credits (sources) and end with debits (uses)
For depreciation, PPE is credited and retained earnings are debited
Prepaid expenses have not yet been used, so are not recognised on the IS. As they are used up, they are recognised on the IS.
Prepaid expenses include utilities, insurance, rent.
For a manufacturer, inventory includes costs, raw materials, factory overhead.
LIFO/FIFO/Average Cost used if the inventory cost changes, different prices for the inventory at different periods. What inventory cost do we use etc. FIFO is first purchased inventory assigned to first items sold.
LIFO only allowed under US GAAP
Average Cost = COGS/Proportion of Goods COGS = Proportion of Goods x Average Cost
You have to convert LIFO (US GAAP) into FIFO (IFRS) inventory and COGS using 2 equations: LIFO COGS - LIFO RESERVES = FIFO COGS LIFO INVENTORY + LIFO RESERVE = FIFO INVENTORY
For PPE's effect on BS. At purchase, no depreciation and so full cost is credited/debited. After a year, account for depreciation.
A contra account is a negative account, reduces a PARTICULAR asset. Accumulated depreciation is a contra account to PP&E. Amortization is a contra account to Intangible Assets.
Remember that (net) book values can be written down. Upon PP&E sale, net book value is removed from PP&E line, and any excess gain (loss) is recognized on I/S.
Deferred revenue is a liability because you have to deliver that product/service in the future, even though you received cash for it now, when the deferred revenue comes off balance sheet and into income statement it increases revenue and so increases taxes paid (even though you already received cash in the past)
For long-term debt, the interest expense doesn't decrease the Principal on the BS. BS will only record book value of debt. Interest expense separate, credit to cash and debit to RE.
Finance (ownership) lease consists of 3 separate payments:

Annual Lease Payments
Depreciation of the PP&E
Interest Expense (discount rate x lease liability balance)

Unlike finance leases, which simply calculate depreciation on a straight line basis, depreciation for operating leases is calculated as the rent expense, net of the interest expense (under US GAAP only)
Preferred stock has priority over dividends and claims on assets in bankruptcy
Additional Paid in Capital (APIC) is the extra value above Par Value. Old convention.
Can't write up Equity Value (historical cost principle) to reflect share price. So this is NOT Market Value of Equity.
So total Shareholder Equity on BS is not Market Value of Equity (which we care about more)
Issuing SBC debits RE and credits Stock & APIC
OCI (other comprehensive income) is gains/losses from currencies and securities that are not on IS. Statement of Comprehensive Income breaks these down.
Remember to include Prepaid Expenses in your "Assets" section.
Remember to include Deferred Revenue in your "Liabilities" section.'
For every product you sell, it will generate both a revenue and a cost.
CFS. Subtract increase in assets. Add increase in liabilities.
You need both IS and BS to build CFS. It's the CHANGE in BS from beginning of period to end of period that's used to build CFS.
Working Capital (within 12 months) Assets = A/R, Prepaid Expenses, Inventories
Working Capital Liabilities = A/P, Accrued Expenses, Deferred Revenue
Gains on sale, Impairments, Stock Based Compensation, DTAs/DTLs are all on the CFO. Using subtract increase in assets, add increase in liabilities... you can work out.
CFI and CFF are more straightforward than CFO. Just track simple cash outflows/inflows.
CapEx is just PP&E.
On BS, when interest expense is paid out, nothing happens to the Principal. Remember debt includes both interest expenses and then the final principal at the end upon maturity, which amortizes (principal payments due every year)
CFS is a magnifying glass on Cash in the BS
CFI: Capex, Intangibles, Asset Sales, Securities
CFF: Issuance/Payment of Debt, Issuance, Repurchase of Equity, Dividends
Remember that CFI includes Asset Sales.
Remember Impairment charges for CFO, you have to factor them in
4 Ratios: Liquidity Ratios (current ratio) Profitability Ratios (margins, EPS) Activity Ratios (turnovers e.g) Solvency Ratios (debt/equity etc)
Inventory Turnover = Revenue/Inventory
Asset Turnover = Revenue/Assets
High Inventory Turnover means you can turnover inventory quicker, can carry less inventory for higher revenue.
High Inventory and Receivables Turnover is good, because it means you carry less inventory and AR. High AP is also good, because it shows you can negotiate good credit terms - more flexibility in payments.
Debt/Equity always should use Market Value of equity (bc of historical cost principle making book value very low)
Working Capital = Current Assets - Current Liabilities
Working Capital tells you about liquidity, but ONLY IN CONTEXT. A -$16.6mn negative working capital tells you there are $16.6mn more liabilities due in the year, than there are assets to cover them. But, if inventory is quickly sold, that's OK, you'll have less inventory, or what if you have high AP Turnover etc. So not always bad.
Operating Cycle is no. of days a company takes from spending cash to make a product to receiving cash for selling the product.
Inventory Days = Days Amount / Total Days in Year

Trying to get the proportion of days and then apply

Operating Cycle = Inventory Days + Receivables Days
Cash Conversion Cycle = Operating Cycle - PPP

Shorter cash conversion cycle, the better

Depreciation is recorded only starting in the first year after the CapEx spending
Liabilities represent a future financial cost to us
The CFS is just to deal with the mismatch between Net Income on IS and actual Cash generated
You only add non-cash expenses on the CFS, because the Net Income doesn't show you what's actually happening to cash thanks to Accrual Accounting (revenue recognition etc). So you can reconcile the cash difference from Net Income to Cash. You don't add cash expenses, they're already reconciled.
Anything that affects taxes, goes on the IS (taxable and in current period).
Depreciation reduces taxes and increases cash balance. How? Don't think of Net Income as Cash. It's not. Depreciation reduces company's taxes as it's listed on the IS, but the company doesn't pay for the expense in cash.
Raising debt boosts a company's cash balance, because you get more cash when you get the debt
Dividends and share buybacks are not taxed, so not on IS.
If you delay payment, your cash flow will increase
Non-cash EXPENSE reduces company's taxes since it's listed on the IS, BUT THE COMPANY DOESN'T HAVE TO PAY THE EXPENSE IN CASH. Because it's a non-cash expense. This is why you add it back, cash flow increases.
In an acquisition, there's always a write-off of seller's equity
To appear in IS:

Current Period of IS
Affects company's taxes

Repaying debt principal is not tax-deductible, but interest expense is
Non-cash means reduce a company's taxes but don't result in a cash payment
The 3 statements exist because of the mismatch between Net Income and what actually Happens to Cash.
Asset is something that could potentially produce more CASH
Liability is something that could potentially decrease CASH
Prepaid expenses are an asset because they are non-cash expense, will reduce taxes in the future, thus saving us more cash.
Short-Term debt is a revolver, sort of like a credit card
Prepaid expenses will reduce taxes in the future as they are expensed. AP, already recorded the expense, but must pay cash in the future.
AP (one-time) and Accrued Expenses (recurring) are similar in how they operate.
Each item on the BS must have a corresponding line item on the CFS, and vice versa
CFO derived from IS and operational parts of BS
CFI and CFF flows into the BS
Linking CFS to BS. Subtract everything on Assets side, add L/E side. e.g. for PP&E subtract both depreciation and CapEx when you link them to PP&E on the BS
IFRS uses the Direct Method (with poor display of CFO). We have to convert to Indirect Method (US GAAP). Can do this by reconciling their 'Cash Generated from Operations' to our normal stuff.
Remember a change in SBC will affect Common Stock & APIC
If it's delivered, then it will change the IS. When doing Operational Item changes on 3 financial statements, check to see if it features on the IS or not.
ALWAYS START BY UNDERSTANDING WHAT THE ITEM IS, AND WHETHER THERE IS AN IMPACT ON THE IS BY INCREASING/DECREASING IT
A decrease in Prepaid Expenses reduces your tax expenses, so you have to add it back on to CFO. It's the same impact as Depreciation. Same impact as decreasing inventory. It saves you tax expenses, which saves you cash.
DON'T MISUNDERESTIMATE REDUCING TAX EXPENSES, it will literally increase your cash flow lol.
Accrued Expenses and AP are when you have used a product or service but haven't paid for it yet, they affect 3FS the same. Accrued Expenses and AP are linked to Operating Expenses.
When finding what on the BS is impacted, think Cash first, then the thing that's increased/decreased, then try and make up the difference with Retained Earnings.
Deferred Revenue decrease (meaning revenue is recognised) means you'll pay more tax than you otherwise would have but not BY CASH. So you subtract cash.
Issuing Dividends, retained earnings and cash will decrease, cash outflow on CFF
Impairment charges are operating expenses. Impairments are non-cash expenses so we have to add them back onto CFO.
FCF = CFO - Capex (you can get levered, and un-levered variations of this)
On CFO, instead of saying working capital, say Operating Working Capital (OWC) (AR/Inventory/Prepaid Expenses and Deferred Revenue/Accrued Expenses/AP)
Change in Working Capital = Old WC - New WC Because when working capital increases, it uses up cash (think an increase in $100 - that uses cash)
So a negative change in working capital actually means you are adding more assets (increase in net assets)
Retailers have negative Changes in Working Capital because they spend on inventory before selling. Subscription-based software companies have positive Changes in Working Capital because they collect cash upfront but they have high deferred revenue. The continuation of this pattern creates the directional continuation in change in working capital.
The more negative the change in working capital, the more it suggests the company needs to spend more cash to fuel its growth
Because EBIT is after D&A, it's a proxy for FCF (CFO - Capex)
DSO is literally how long it takes to sell your inventory, shorter the better
EBITDA is before D&A, so it's a proxy for CFO (before capex)
NOPAT = EBIT * (1 - Tax Rate) NOPAT is what the company's after-tax profits would be if it ignored all non-operating expenses/side stuff.
NOPAT (net operating profit after tax) is just after-tax Operating Profit
ROIC = NOPAT/Debt + Equity It's for each $1 of equity and debt raised, how much after-tax operating profit does company generate. ROIC measures how much it costs the business to grow (remember both risk and return).
Spending more to grow using debt can result in higher interest expense and lower net income on the IS, so that funding will still cost you.
Debt/EBITDA measures how much debt a company has relative to its ability to repay that debt
Dividend Payout Ratio = Dividend/Net Income
SBC is on the IS in operating expenses (remember it goes same as regular compensation)
PP&E writedown is on IS as a operating expense
BUYING SHORT-TERM INVESTMENTS DOES NOT SHOW UP ON COMPANY'S IS. Only the interest income from them does.
Only consider non-cash stuff to add back on from IS to CFO
Remember gains/losses on sale of assets are in CFO
Goodwill writedowns are in Opex on the IS
Even though Taxes can be deferred, they're still recognised on the IS, they are just added back on in CFS
Interest expense is a cash expense
PP&E writedown will be on IS, it does affect taxes
Remember Net Income on IS is linked to CFS.
But Preferred Dividends are not tax-deductible. Taxes play a huge role in investment decisions. Since Interest Income is tax-deductible, but Preferred Dividends are not. So, Preferred Dividends are higher than Interest Income (which is taxed). And this causes company to lose money. Hence investment decisions are influenced by tax.

Mistakes

Non-cash expenses reduce the amount of taxes you pay because they reduce your pre-tax profit (even though you don't pay those taxes in cash which is why they are added back on CFO)
When you sell a factory, you have to show in CFI
Issuing dividends will decrease Retained Earnings on the BS, even though it won't appear on IS
Dividends and interest income/expenses (from any investment) are cash expenses, so won't appear on CFS
It goes CFO, CFI and then CFF
Decrease in inventory is a non-cash expense because it's an increase in COGS which reduces the company's tax burden
When deferred revenue increases, revenue is not recorded on the IS
Share buybacks don't appear on CFI, they only appear on CFF
On CFS when you sell an asset, you don't record the book value you record the actual cash you received upon sale
Foregone interest on cash - The buyer loses the interest it would have otherwise earned, if it uses cash for the acquisition - so that reduces pre-tax income, net income, and EPS
It repays 20% of debt balance each year, that you means you have to do cash outflow on CFF of 20% each year
A dividend-paying company has just issued 100 common shares at a share price of $10.00 each to fund a new overseas expansion effort. Its dividend yield is 5%. Dividend yield = dividend per share/share price. If dividend yield is $0.50/share then * 100 shares = $50
Don't confuse Current Ratio with Working Capital.
Most retailers collect cash quickly so small DRO.