Tag Archives: Financial Analysis

Solution to Management Science Series #197: Financial accounting as a forensic tool: Selling Receivables, aka pure factoring, Before the Collection Date

Financial accounting as a forensic tool: Selling Receivables, aka pure factoring, Before the Collection Date

Company A sold its receivables to a competitor and was paid in cash. You do not know whether the sale was made on nonrecourse basis or not. How would you label this transaction, financing or operating?

Company B sold its receivables to a bank and agreed to assume the risk of collection while also being granted a loan against the receivables sold. How would you label this transaction, financing or operating?

Company C, a manufacturer of trucks, sold its receivables to a bank on a nonrecourse basis. Nonetheless, if the bank were not able to collect the receivables, Company C should sell trucks in equivalent value to the bank and even repurchase the trucks if the bank were not able to sell them. How would you label this transaction, financing and operating?

As I’ve always been doing, in this article, I will solve this question and demystify the tricky accounts receivable account and what you need to look for lest you not get tricked by financial shenanigans related to receivables.

Solution to Management Science Series #196: Financial accounting as a forensic tool: This time, investigating restructuring projects

Financial accounting as a forensic tool: This time, investigating restructuring projects

Many analysts and investors have a hard time, grasping the reasons behind why companies, especially those that are publicly traded, announce bigger layoff plans than is financially warranted.

Laying off employees is almost always one of the first acts companies undertake in their restructuring efforts. Nonetheless, these restructuring projects may be utilized to smooth earnings. Do you know how? Try to solve the following example:

Assume that the automaker Alliance planned to lay off 200 people and published the developments accordingly. The company offers $60,000 severance package for each person who is going to be laid off.

In fact, laying off only 100 people would have sufficed; however, the company chose to announce a bigger number, i.e. 200 people, and stated the relevant accounts as if it had laid off 200 people.

Why would it do so? How will this restructuring charge affect current period’s operating profit?

How would the operating profit change if the company were to restate the relevant accounts and release the related reserve accounts to reflect the real number associated with these layoffs, i.e. 100 people rather than initially stated 200 people, in the following quarters?

Solution to Management Science Series #192: Accounting for Investments in Other Companies and Financial Forensics 🕵️

A publicly traded company, Museum Enterprises (ME) has had rough years lately not living up to the expectations of financial markets and equity investors, missing all of its target earnings.

ME, which stores and sells art collectibles, believes that organic growth is not viable given the current market conditions.

So, at the end of the last fiscal year, it purchased 65% of equity in Castle Entertainment. At the end of this fiscal year, Castle recorded $500M in revenues and incurred total expenses amounting to $230M.

-How will this investment affect ME’s revenues and operating income? Give a quantitatively concrete answer.

-How will this investment help ME’s income before income taxes? Give a quantitatively concrete answer.

-Assume that ME has 40 million shares of stock issued and outstanding and the corporate tax rate for ME is 21%. How will ME’s investment in Castle affect its EPS this year; calculate it!

Financial Accounting is a forensic tool! This time, the focus is accounting for receivables! Detecting frauds ranging from channel stuffing and bill and hold to roundtripping

Ability to use financial accounting at expert level gives the user a forensic tool.
Accounting frauds and schemes will become easier to detect, solve, and track when one masters it.
Innumerable scandals in the business world have been related to accounting frauds and they are still happening (why it is so is a long debate)
For example, think of a retailer having a hard time to hit its fourth quarter sales target. The trend shows that it will not hit the target by quarter end. However, by a sleight of hand, it magically hit the revenue target.
Where would you look at first? Which accounts and ratios would lead you to the detection of these inflated revenue numbers?
While answering all of these questions, I will also provide you with some recent examples of accounting scandals and how you could have detected them in the first place. I will also present you with some additional resources concerning the topic.

Deciphering financial ratios that could lead to bad management and investment decisions

Test your finance and accounting skills! 💹
This time through a story!
⬇️

You are a buy-side equity analyst.

You are poring over financial statements of different companies.

You are looking for a company that has showed strong growth potential in the last 5 years although you are aware that past-performance may not always be a good indicator for future performance.

After weeks of hard work, you think you found one: Ace Chemicals.

Its net revenues have been growing so have its net earnings.

Then, you remembered what your fellow classmate, who is also working as a buy-side equity analyst at a competitor firm and with whom you discuss financial markets superficially, had said about this company a few weeks ago: “I went to their factory. The place was falling apart…”

So, “How was that possible?”, you asked yourself.

“The company has been growing, at least based on the metrics that I think are important.

I also looked at the ratio, according to which the company was in a good position regarding its investments in physical assets”
—
Yes, it is possible and in reality, this company is not growing.

It escaped your notice as you did not look at the most important metric revealing a company’s operational performance clearly.

What is it?

What was the ratio tricking you into believing that the company was investing in physical assets (and in fact, it was not)?

Reporting and Interpreting Stockholders’ Equity: Solution

Your company has both debt-type AFS and passive equity-type AFS investments. You did not sell them during the fiscal year. Your debt investments increased in value while your equity investments depreciated. How will this situation affect your net earnings for the year end? Ignoring the effects of all other transactions, will your comprehensive income for the year be greater or lower than your net income? How will these changes affect your cash flows from operations? Can you make a definite judgement on the change in the ending balance of the stockholder’s equity on the balance sheet, assuming that the company did not pay any dividends at year end?

Predictive Power of VIX: Is it reliable?

Apart from traditional economic indicators that will help investors to monitor business cycles, VIX is also touted as a measure that may help investors foresee what is about to befall them.
Previously, I wrote about reliability issues with respect to complex financial models and measures here: https://bit.ly/3M8Lp0S
Is VIX any different from such models and measures? Does VIX really have such a predictive power? Is it reliable? Can VIX be manipulated, too as is the case with other financial securities?
In this article, I will answer these questions.

Financial Accounting Drill 2: Understanding Microsoft through Form 10-K

Ability to comprehend a company’s financial statements is an important and sought-after skill whether you are a retail investor, a corporate executive, an equity analyst, or an investment banker. These statements are generally full of accounting jargon and long-winded.
In this video, I used Microsoft’s most recent 10-K as an example to show you how to navigate through a 116-page financial document effectively and in a time-saving manner.
Important Note: People knowledgeable about financial accounting and corporate finance will find it easier to wade through such financial statements and in many instances financial accounting and corporate finance knowledge are prerequisites as they facilitate the process immensely. This is also true for this video.
Total duration of the video: Part 1: 33mins 48secs; Part 2: 16mins 45secs

Focusing on understanding and predicting risks rather than calculating them Part 2: Examples from Equities, ETFs and Cryptocurrencies

In the second part, I provide examples from equities, ETFs, and cryptocurrencies. These financial instruments are deemed inherently riskier than some types of fixed income securities are on which, as the name suggests, absolute returns are somewhat fixed. However, within each asset class except for cryptocurrencies, there are equities and ETFs for which perceived risks are lower. An equity that has both a diversified business model and an impeccable track record against downturns may be deemed less risky. By the same token, ETFs containing highly diversified (i.e. in very broad terms fewer perfectly correlated) stocks may be less risky. Obviously, these risks profiles will yield disparate returns in different future events such as upturns and downturns.
My focus will be again more diverted to understanding risks rather than calculating them.