6 Pages

Accounting & Financial Management
Course Code
AFM 101
Donna Psutka

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Capital Gains: Big Cash Hoards - When companies have lots of cash, they don’t know where to allocate it? o Some companies pile it away - Distorted picture of company’s performance because most of what they earn is from investments of cash, rather than operating What do companies use this cash for? 1) Paying dividends 2) Reinvesting by repurchasing shares, acquiring new companies 3) Storing the cash in banks 4) Paying off debts - Managers make poor decisions because cash is readily available - Investors can’t evaluate the performance of a company if lots of earning is from investments of cash (rather than operating) Cash Flow Reigns Once Again - Earnings Quality: Company wants to know that a dollar earned is actually a dollar earned o Cash Flow helps evaluate the quality of earnings Cash flows are harder to manipulate, it is a clean way to assess company’s health Free Cash Flow: Cash from Operating Activities – Money going towards Investments - When there is a negative cash flow, it is due to heavy expenditures - Companies need positive cash flow Companies risk future growth if they store away cash and do not invest in it - Investors buy stocks that are going up and sell those that are falling - Rising Accruals (in receivables and unpaid bills) signals BAD CASH FLOW Informative or Misleading? - Proforma Earnings: reporting earnings in a NON GAAP way Informative because: - They reflect company’s earnings for the year very well - Predict company’s future earnings very well - Matches current stock price Misleading: - Companies may use proforma earning because: o Revenue for proforma reporting is higher than GAAP reporting of earnings o They want to meet/exceed forecasted earnings o Proforma would report an INCOME rather than a LOSS from GAAP reporting  Therefore, investors would focus on a gain rather than a loss Adjustments made to GAAP 1) Costs related to business 2) Non-Cash Expenses 3) Non- Recurring Items Hide and Seek - Companies use dirty legal accounting tricks o Investors need to beware of these 10: 1) Big Bath: - make the company look like it’s losing as much as possible, make the company look really bad and in the next year, the company will look much profitable and better 2) Everything but the Bad Stuff Accounting (Proforma Accounting) - Highlight all the good things, nothing bad 3) Moving Debt Off Balance Sheet - Moving debt off the balance sheet o Makes liabilities look less - Would be hard for investors to see how much debt they actually have 4) Pension Plan Makeover - Pension plan must be funded at a certain level o Company makes shortfalls 5) Turning Expenses into Assets - Move the expenses into the Balance Sheet o Just a timing issue o Will reverse and hit the company in the future - Turning costs into assets 6) Not all Earnings are Created Equally - Earnings can include: o Operating o Sale of assets o Tax credits  When company reports a net loss, they get a tax credit  This gives a false impression of the company’s actual performance 7) Adding Water into Wine - Increasing the profit by offering employees the incentive to buy shares o Company wouldn’t have to record wages expense but actually record the issuance of shares 8) Channel Stuffing - Company tells distributors to take the inventory now and pay later o This makes the company look like they sold a lot  But the invento
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