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Accounting Re-casting Consolidated Standardized:

Balance Sheet

Standard Classification
Cash & Marketable Securities (CA)

Trade receivables (CA)

Inventory (CA)

Other (CA) current assets

Non-current tangible assets (NCA)

Non-current intangible assets (NCA)

Deferred tax asset (NCA)

Minority Equity Investments (NCA)
Other Non-operating Investments (NCA)

Assets held for sale


Income Statement
Standard Classification
Cost of Sales

SG&A (Selling, general &

administrative expense)

Other operating expense

Net Interest Expense/ Income

Investment income
Other income

Other expense

Tax expense
Profit for period


Typical Line Item

Cash, Short-term investments, time
Other financial assets
Account receivables, trade debtors
Inventory, Finished goods, Raw materials,
work in progress, stocks

Standard Classification
Current debt (CL)

Prepaid/Deferred expenses, tax

refundable, current assets of discontinued
ops, Due from associates, Due from
PPE, land, Non-current assets of
discontinued ops
Goodwill, Software development costs,
Deferred costs, Trademarks & licences,
Customer list

Non-current debt (NCL)

Interest in net assets of Joint Venture

Interest in net assets of associates
Pension asset for funded schemes in
Financial assets, Non-current receivables,
Fair Value of Biological assets,
Other non-financial assets
Non-current assets held for sale

Minority Interest

Deferred/Unearned revenues (Non-current),

Other non-current liabilities,
Pensions & post-retirement healthcare liabilities
Non-controlling interest

Shareholders equity

Share capital, Paid in capital, retained earnings, reserves & treasury shares

Trade payables (CL)

Other (CL) Current Liabilities (CL)

Typical Line Item

Bank overdraft, Notes payable, Financial Liabilities
Non-current debt (Current portion),
Capital lease obligation(Current portion)
Accounts payables, Trade Creditors
Accrued expenses/ Liabilities, Taxes payable/Current tax liabilities, Deferred /unearned
revenue, Customers advances, other payables, employee benefits/social security &
sundry taxes, provisions
Non-current borrowings/debt/financial liabilities, Convertible notes,
Subordinated debt, Finance lease obligations,
Post-employment benefits provisions (Funded/unfunded schemes), decommissioning

Deferred tax liabilities (NCL)

Other (NCL) Non-Currently Liabilities

Typical Line Item
Revenue, Turnover, Commissions, Licences
Cost of merchandise sold,
Cost of products sold,
Cost of revenues, Cost of services,
Depreciation on manufacturing facilities
General & Administrative,
Marketing & Sales, Distribution,
Salaries & Benefits, Servicing & Maintenance,
Depreciation on selling & administrative
Amortisation of intangibles, Product
development, Research & Development
Losses on credit sales provision, pre-opening
costs, special charges
Finance costs (Debt & preference shares
dividend payout), Interest income/ expense
Share of income from associates, Dividend
received, rental income
Gains on sale of investments/ non-current
FX gains
Loss on sale of investments/ non-current
FX losses, Pre-tax losses from accounting
changes, Restructuring charges, Merger
Income Tax expense

Cashflow Statement
Standard Classification
Operating Cashflows
(Other than net finance cost)
Under the indirect method:
Profit before taxation (EBIT)
Adjustments for (depreciation,
amortisation & other non-cash items)
Net liquidation/ investments of
operating (WC) Working Capital
Non-operating losses (Gains)
Investing Cashflows
Net (Investments in) or liquidation of
operating or investment Non-Current
Interest received
Dividend received
Financing Cashflow
(-)Interest cost/ Payments
Net debt (+) issuance/ (-) repayment
Net (+)issuance/ (-)repurchase of shares

(-)Dividend payment
Accounting Analysis:
1. Identifying key accounting policies:
Identify & evaluate (policies & estimates) that are used to measure its critical factors &
2. Assess accounting flexibility:
Some organisations have accounting choices that are severely constrained by accounting
standards & conventions
< Flexibility: Accounting data will yield < information about the organisations
> Flexibility: Accounting numbers have the potential to be informative

3. Evaluate accounting strategy:

Accounting flexibility used to effectively communicate organisations economic situation
or hide true performance?
Organisations accounting policies comparable to industry norms? If dissimilar, valid
Examine managers incentive to manage earnings- Has there be any significant business
transactions to achieve certain accounting objectives?
Has there been any changes in policies & estimate without proper justification?
Has the companys policies & estimates been realistic in the past?
Are there large year-end adjustments?
History of write-offs may be a sign of prior earnings management
4. Evaluate the quality of disclosure
Adequate disclosure to assess business strategy & economic consequence
Do footnotes adequately explain key accounting policies, assumptions & logic
Current performance adequately explained?
Given restrictive accounting rules & conventions, are additional disclosure provided to
help outsiders understand how these factors are being managed?
Quality of segment disclosure for businesses with multiple business segments?
How forthcoming is management with respect to bad news?
5. Identify potential red flags
Unexplained changes in accounting policy
Unexplained transactions that boost profit
Receivables relative to Sales relaxation of credit policies probability of write-off
Inventory relative to Sales sign of slowing demand
Divergence between income and CashFlow indicate subtle s in accrual estimates
Divergence between reported income & tax incomeMay indicate aggressive financial
Novel financing methods: R&D partnerships, SPV & Sale of receivables with recourse
Unexpected large write-offs- suggest that management is slow to incorporate changing

Typical Line Item

Under direct method:
Cash from customers- Payments to suppliers- Taxes paid
Net Profit + taxation + Net finance cost
- (Depreciation, amortisation & impairment)-(Pensions & similar obligations
less payments)+ Provisions less payments+ Non-cash charge for share-based
compensation + Other adjustment
Inventories Trade & other current receivables + Trade payables & other
Elimination of (profits)/losses on disposals
Purchase/Sale of intangible assets, acquisition of R&D, Acquisition/Disposal
of business (Group companies, JV& Associates),
Purchase/Disposal of PPE, Purchase/ Disposal of financial assets
Purchase/Disposal of other NC (Non-current) assets
Capitalisation of computer software development costs,
Cost in excess of fair-value (Net assets acquired),
Investment in Sales-type & direct financing lease
Interest received
Dividends received from joint ventures, associates & other non-current
Interest received/paid + Preference Dividend Payout
Principal payment on debt,
Borrowings (repayment)under credit facility,
Issuance (repayment)of non-current debt,
Net increase (decrease) in short-term borrowings,
Notes payable
Proceeds from issuance of ordinary shares,
Issue of ordinary shares for services,
Issue(redemption of preference shares),
Issue of subsidiarys shares
Purchase (issue) of treasury stock
Dividend paid on ordinary share capital

Statement of changes in equity:

Ending balance= Beginning balance + Comprehensive income + (+Insurance/- Repurchase of common stock) + Dividend
Comprehensive Income = Net Income + Other Comprehensive Income
Other comprehensive income include:
1. FX translation gains & losses
2. Adjustment for minimum pension liability
3. Unrealized gains & losses from cash flow hedging derivatives
4. Unrealized gains & losses from available-for-sale securities
NOPAT =Net Operating Profit after Tax
Must be adjusted to remove nonrecurring income:
Restructuring charges
Gains from asset sales
Interest income on financial assets

Firm value= Debt Value + Equity Value

Intrinsic premium= (Intrinsic Value- Book Value) of equity
Market premium= (Market Value-Book Value) of equity

Factors influencing accounting quality/ Potential source of noise & bias:

Rigidity in Accounting Rules
Rule-based (Capitalisation VS Expensing)
Random Forecast Errors
Managers cannot predict future consequences of current transactions perfectly
Managers accounting choices:
Incentive to exercise their accounting discretion to achieve the following objectives:
|Accounting-based debt covenants| Management compensation| Corporate control contests| Tax
considerations | Regulatory considerations| Capital Markets considerations| Stakeholder considerations(Labour unions & negotiation)|Competitive considerations Not disclose data on new product line
/Discourage new entrants by making income accounting choices|
Industry Analysis: (Where??)
Porters 5 forces:
1.Rivalry among existing firms
|Competitionprices/ Innovation| Intra & Inter industry growth rate comparison| Collusion VS Competition|
Differentiation & switching cost| Economics of Scale | Excess capacity & exit barrier|
2. Threats of new entrants
|Economics of Scale| First-mover advantage| Set standards, suppliers tied up long term| Access to channels of distribution|
Legal barriers|
3. Threats of new substitute products
|Relative price & performance of competing product/services| Willingness of customers to accept substitutes|
4&5. Bargaining power of buyers & suppliers
|Price-sensitive buyers| Relative bargaining power based on difference in sizes of buyers & sellers| Switching costs|

business circumstances
Large Adjustments or reserves
Related party transactions-lack objectivity of the marketplace
Qualified Audit report
Common distortions & adjustments:
|Provisions| Asset impairment| Timing of revenue| Expense capitalisation|
6. Undoing accounting distortions
Use of Cashflow statements & FS footnotes to undistort suspected accounting distortions
Can use tax-reporting as a reference as it is often more conservative

Basic features:
1. Accrual accounting: Transactions & events are reported in periods in which they occur, not
when cash is received or paid.
2. Delegation of reporting to management (Application of accounting method):
Management have intimate knowledge of organisation business, in best position to make
appropriate judgements in portraying myriad business
Probability of potential default amount among cash receivables?
Uncertain payoffs from R&D outlays to be capitalised or expensed?
Management may have the incentive & conflict of interest to distort the accounting
3. Reporting standards:
Establishment of uniformed accounting standards to eliminate unsatisfactory reporting
practices promoting consistency & comparability over time & across organisations
IFRS(Principles-based): Approach better for reflecting the economic substances of an
organisation as it still allows the management some flexibility to reflect genuine business
US GAAP (Rules-based): Approach has greater verifiability & uniformity
4. External Auditing:
Unqualified Opinion
Free from material omissions & errors
Qualified Opinion
Exceptions to accounting principles
Adverse opinion
Not presented fairly or materially
nonconforming with accounting standards
Disclaimer of Opinion
Unable to express opinion
Provision of an independent 3 party opinion ensure estimates are reasonable &
accounting rules & conventions are followed consistently over time
Possibility of lapse of judgement by auditors who fail to challenge management for fear of
losing future business
Accounting Analysis misconceptions:
1. Conservative accounting is not good accounting
Opportunities for income smoothening which may prevent analysis from recognising
poor performance in a timely manner
2. Not all unusual accounting is questionable
Important to evaluate a companys accounting choices in the context of its business
Important to consider all possible explanations for accounting s & investigate them with
all information using the qualitative information available in FS
Competitive Strategy Analysis/ Positioning: (What??)
Analyse firm within industry context:
*Identify: Key Profit drivers, business risks
Cost Leadership:
* Supply same product/service @lower cost

Economies of scale & scope

Efficient production

Simpler product designs

Lower input costs

Low-cost distribution

Little R&D/ Brand advertising

Tight cost control system

*Supply a unique product/service at a
value-for-$$ price relative to the
product/service uniqueness:
Superior product quality (/&) variety
Superior customer service
More flexible delivery
Investment in brand image
Investment in R&D
Control system focus on creativity &

Competitive Advantage:
Match between firms core competencies & key success factors to execute
Match between firms value chain & activities required to execute strategy
Sustainability of competitive advantage- How difficult would it be for competitors
to imitate them.
Objective: (Financial performance & LT competitive position)
Game plan management for:
1.Market positioning
2. Achievement of organizational objectives
3. Evaluation of managerial decisions:

Market selection

Competitive approaches

Operational Process

What to look-out for?

Diversification of markets- Are there new potential markets to be tapped?

Response to s in external environment- What are competitors up to?

Mergers & Strategic alliances

Innovation & Technological advancements

Debt Coverage Ratio:

Business Analysis:
1. Products:
|Types| Consumer demand| Substitutes, product differentiation| Pricing power| Patent protection|
2. Technology behind bringing the products/ service to the market:
|Manufacturing process| Promotion & marketing process| Distribution channels| supplier network, supply chain| Cost
structure| Economies of Scale|
3. Firms knowledge base:
|Pace of technological change| Direction of firm| R&D plans| Information networks| Innovation- product development,
product technology|
4. Firms competitive environment:
|Industry concentration, number of firms, sizes| Barriers to entry| Threat from new entrants| Switching costs| Position in
the industry| Cost advantage| Operational capacity| Alliances, relationships, networks|
5. Firms management:
|Track record| Entrepreneurialism| Shareholders or management centric- Management compensation incentive|
Personality- Self-serving/ Empire-building| Corporate Governance, ethics|
6. Political, Legal, regulatory & ethical environment
|Market presence| Authoritative| Alliance? Political, Industry, focus groups| Legal & regulatory constraints-consumer,
labour, environmental, antitrust/anti-monopoly/trade practices |Taxation- Transfer pricing, Base Erosion Profit
Financial Analysis
#1- RATIO ANALYSIS- Asses how all the different line item in the FS relate to each other, measure relative performance
Key Measurements of Investor returns:
1: Basic EPS =

3. ROCE (Return on Capital Employed)=

(Most Preferred)

ROE-Return on EquityMeasure of Overall profitability

)= (ROA)(Financial Leverage)

Original DuPont:


Extended DuPont:



)= (Net Profit Margin)(Asset Turnover)(Financial Leverage)



=(Tax Burden)(Interest Burden)(Operating Profit Margin) (Asset Turnover)(Financial Leverage)

=(Return on Business Assets(ROBA))-(Return on Business Assets- Effective Interest rate after tax) Financial Leverage
= Return on Business Assets- spread Financial Leverage
*Business assets= Operating assets +Investment assets
=NOPAT Margin Operating asset turnover

Operating Working Capital= Current Assets- Excess Cash & marketable securities - Current liabilities + Current debt & current
portion of non-current debt
Operating Margins:

Working Capital Management:

Liquidity Analysis:

Sustainable growth rate:

Long-Term Asset Management:

Net long-term assets= (Total long-term assets Non-interest-bearing long-term liabilities)

(Less Preferred)


Analysing Cash Flow:

Strength of internal cashflow generation? If ve why?? Is it a growing company or its operations are
unprofitable or poor capital management?
Able to use its operating cashflow meet its short-term financial obligations?
Internal Cashflow to finance growth or reliance on external funding?
Types of external funding does company rely on? Consistent with the companys overall business risk?