05 Financing Activities.ppt
- 1. 1 Topik 1. Overview of Financial Reporting, Financial Statement Analysis, and Valuation (W1, S1) 2. Accounting Quality, Income v.s. Cash Flows (W2-3, W6, S2, S7) 3. Profitability analysis (W4, S8) 4. Risk analysis (W5, S10) 5. Financing Activities (W7, S3) 6. Investing and Operating Activities (W8-9, S4-6) 7. Forecasting Financial Statements (W10, S9) 8. Valuation (W11-14, S11) 9. Laporan Keuangan Pemerintah Pusat 10. Laporan Keuangan Pemerintah Daerah 11. Laporan Keuangan Bank Indonesia
- 3. Financing Companies operations are financed by various sources: • Capital (Stockholders’ Equity) • Liabilities • Off balance sheet transactions
- 4. Shareholders’ Equity Basics of Equity Financing Equity Analysis — involves analyzing equity characteristics, including: • Classifying and distinguishing different equity sources • Examining rights for equity classes and priorities in liquidation • Evaluating legal restrictions for equity distribution • Reviewing restrictions on retained earnings distribution • Assessing terms and provisions of potential equity issuances Equity Classes — two basic components: • Capital Stock • Retained Earnings Equity — refers to owner (shareholder) financing; its usual characteristics include: • Reflects claims of owners (shareholders) on net assets • Equity holders usually subordinate to creditors • Variation across equity holders on seniority • Exposed to maximum risk and return
- 5. Equity Financing • Book value of shareholders’ equity: • The amount of shareholders’ equity reported in the balance sheet. • Is the investment base for equity/net assets used in profitability analysis, risk analysis and residual income-based equity valuation. • Shareholders’ equity is affected by: • Investments by shareholders • Distributions to shareholders • Profitable operating and investing activities
- 6. Distributions to Shareholders: Dividends • Are simply a transfer (usually of cash) to shareholders of a portion of what they really own, namely, net assets of the firm. • The declaration of dividends is formalized by three important dates: • Date of declaration • Date of record • Date of payment
- 7. Types of dividends • Dividends are paid in the form of: • Cash • Scrip dividends (dividends with an interest-bearing promise to pay dividends) • Property dividends • Stock dividends • Liquidating dividends (where payments to shareholders exceed the retained earnings balance)
- 8. Accounting for dividends: Dividend Type Total Shareholder’s Equity Retained Earnings and Contributed capital Cash, Scrip, and Property dividends Reduces retained earnings and Reduces assets or increases current liabilities (if unpaid) Changes Stock Dividends As per accounting rules and jurisdictional legal requirements No change
- 9. Summary and Interpretation of Equity • Market-to-Book Ratio = Market Price per Share/Book Value per Share • Generally, Market-to-Book Ratio >1 because book value is less than market value due to • Conservatism of accounting • Non accounting for future growth opportunities
- 10. Debt Financing: • Critical for understanding the profitability and risk of the firm. • Reporting for debt involves: • Principles of Liability Recognition • involves a probable future sacrifice of economic benefits. • a present obligation. • transaction or event has already occurred. • Principles of Liability Valuation • Application of Criteria for Liability Recognition
- 11. Important Features in Analyzing Liabilities • Terms of indebtedness (such as maturity, interest rate, payment pattern, and amount). • Restrictions on deploying resources and pursuing business activities. • Ability and flexibility in pursuing further financing. • Obligations for working capital, debt to equity, and other financial figures. • Dilutive conversion features that liabilities are subject to. • Prohibitions on disbursements such as dividends.
- 12. Principles of Liability Valuation • Valuation for liabilities: • Requiring future cash payments • Requiring future delivery of goods or services • Representing cash advances from customers • Disclosure of the fair values of financial instrument as per U.S. GAAP and optionally under FASB Statement No.159 or IASB IAS 39
- 13. Criteria for Liability Recognition
- 14. Financing with Long-Term Debt • In the form of: • Notes payable (primarily to banks and other financial institutions). • Bonds payable (to any type of bondholder, including open-market debt investors). • Leases (entered into with property owners, equipment dealers, or finance companies) • Is evidenced by a bond indenture, promissory note, or lease agreement.
- 15. Reducing Debt: Early Retirement • Method of Reducing Debt • Methods to retire early • Accounting: • Income statement: • Realized Gain or Loss: The difference between the amounts used to extinguish the debt and the book value of the debt. • Cash Flows from financing activities: Cash flows used to reduce debt.
- 16. Accounting for Troubled Debt • Handling of troubled debt: • From debtor’s perspective • Settlement in cash or by issue of capital stock • A gain on debt settlement: the difference between the book value of the debt settled (principal plus any accrued interest) and the fair market value of the non- cash asset or cash transferred to retire the debt. • Modification of terms • Accounting • Is conservative • Ignores the present value in restructuring model
- 17. AdditionalIssues: HybridSecurities(i.e., compound financing instruments) • Securities have both debt and equity characteristics. • Methods of recording conversion under U.S.GAAP & IFRS. • Book Value Method • Market Value Method (rarely used)
- 18. Accounting for Hybrid Securities Preferred Stock U.S.GAAP IFRS Mandatorily redeemable Liability Liability Redeemable at firm’s option Equity Equity Redeemable at holder’s option Mezzanine section Liability Convertible Debt Financial Liability Debt and equity features are distinguished and valued at Fair Value Bonds issued with detachable warrants Debt and equity features are distinguished and valued at Fair Value
- 19. Off-Balance-Sheet Financing Off-Balance-Sheet Financing is the non-recording of financing obligations Motivation To keep debt off the balance sheet—part of ever-changing landscape, where as one accounting requirement is brought in to better reflect obligations from a specific off- balance-sheet financing transaction, new and innovative means are devised to take its place Transactions sometimes used as off-balance-sheet financing: • Operating leases that are indistinguishable from capital leases • Through-put agreements, where a company agrees to run goods through a processing facility • Take-or-pay arrangements, where a company guarantees to pay for goods whether needed or not • Certain joint ventures and limited partnerships • Product financing arrangements, where a company sells and agrees to either repurchase inventory or guarantee a selling price • Sell receivables with recourse and record them as sales rather than liabilities • Sell receivables as backing for debt sold to the public • Outstanding loan commitments Basics of Off-Balance-Sheet Financing GAAP
- 20. Off-Balance-Sheet Financing Sources of useful information: Notes and MD&A and SEC Filings Companies disclose the following info about financial instruments with off-balance-sheet risk of loss: • Face, contract, or principal amount • Terms of the instrument and info on its credit and market risk, cash requirements, and accounting Loss incurred if a party to the contract fails to perform • Collateral or other security, if any, for the amount at risk • Info about concentrations of credit risk from a counterparty or groups of counterparties Useful analyses: • Scrutinize management communications and press releases • Analyze notes about financing arrangements • Recognize a bias to not disclose financing obligations • Review SEC filings for details of financing arrangements Analysis of Off-Balance-Sheet Financing
- 21. Off-Balance-SheetFinancing Arrangements • Either or combination of approaches: • Sale of an existing asset or sale-leaseback. • Use of another entity (uncontrolled entity) to obtain financing. • Ways to avoid consolidation: • Joint venture • SPE/ VIE • Financial reporting does not recognized mutually unexecuted contracts as liabilities they are mere promises.
- 22. Off-Balance-SheetFinancingArrangements 1. Leases 2. Sale of Receivables 3. Product Financing Arrangements 4. Use of Another Entity to Obtain Financing 5. Use of Joint Ventures or Research and Development Financing Arrangements 6. Take-or-Pay or Throughput Contracts (usually using non-consolidated Special Purpose Entity)
- 25. Leases • Benefits to Lessees: • Ability to shift the tax benefits • Flexibility to change capacity • Ability to reduce the risk of technological obsolescence. • Ability to finance the “acquisition” of an asset. • Accounting Methods • Operating Lease Method • Capital Lease Method
- 26. Choosing the Accounting Method • Conditions for a capital lease: • Extends for at least 75 percent of the asset’s total expected economic life. • Transfers ownership to the lessee. • The “bargain purchase” option will be used. • The present value of the contractual minimum lease payments equals or exceeds 90 percent of the fair market value of the asset at the time of signing.
- 27. Converting Operating Leases to Capital Leases • By Analyst • To avoid understating the short-term liquidity or long-term solvency risk of the firm. • For various firms’ cross-sectional comparisons. • If the purpose appears to be financing rather than acquisition. • Provides a more conservative measure of liabilities. • Balance sheet restatements are more significant than income statement restatements.
- 28. Impact of Accounting for Operating Leases as Capital Leases • Though individually impact is relatively small, cumulatively can be significant. • Thus, important for analyst: • assessing the risk and accounting quality of a firm’s financial statements. • determining capital structure weights and debt costs for the weighted average cost of capital calculations in entity valuation.
- 29. Contingencies and Commitments Contingencies -- potential losses and gains whose resolution depends on one or more future events. Contingent liabilities -- contingencies with potential claims on resources -- to record a contingent liability (and loss) two conditions must be met: (i) probable i.e. an asset will be impaired or a liability incurred, and (ii) the amount of loss is reasonably estimable; -- to disclose a contingent liability (and loss) there must be at least a reasonable possibility of incurrence Contingent assets -- contingencies with potential additions to resources -- a contingent asset (and gain) is not recorded until the contingency is resolved -- a contingent asset (and gain) can be disclosed if probability of realization is very high Basics of Contingencies Contingencies should be . . .
- 30. Contingencies and Commitments Sources of useful information: Notes, MD&A, and Deferred Tax Disclosures Useful analyses: • Scrutinize management estimates • Analyze notes regarding contingencies, including • Description of contingency and its degree of risk • Amount at risk and how treated in assessing risk exposure • Charges, if any, against income • Recognize a bias to not record or underestimate contingent liabilities • Beware of big baths — loss reserves are contingencies • Review SEC filings for details of loss reserves • Analyze deferred tax notes for undisclosed provisions for future losses Note: Loss reserves do not alter risk exposure, have no cash flow consequences, and do not provide insurance Analyzing Contingencies
- 31. Contingencies and Commitments Commitments -- potential claims against a company’s resources due to future performance under contract Basics of Commitments Analyzing Commitments Sources of useful information: Notes and MD&A and SEC Filings Useful analyses: • Scrutinize management communications and press releases • Analyze notes regarding commitments, including • Description of commitment and its degree of risk • Amount at risk and how treated in assessing risk exposure • Contractual conditions and timing • Recognize a bias to not disclose commitments • Review SEC filings for details of commitments