[SOLVED] CS ACCT6101 Session #1: Introduction to Valuation

ACCT6101 Session #1: Introduction to Valuation

PART 1 Background
assumed objective of management = maximize shareholders wealth
maximize share price!

roles / functions management executes in generating value
1. Controller function asset efficiency (efficient use of working capital)
2. Treasury function long-term funds acquisition (debt or equity?)
3. Capital budgeting real (productive) asset acquisition (fixed productive assets)
the fundamental decisions that ultimately determine the firms profitability and its operating risk
the Value Drivers

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ACCT7106 Session #5: Understanding the Financial Statements

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Our objective an understanding of how the firm (management) generates value

purpose development of the pro-forma Financial Statements

projected over the forecast horizon

core inputs into the valuation modelxg

Balance Sheet (B/S)
Income Statement (I/S)
Statement of Cash Flows (SCF)

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Stage 1 Understanding the Business
Strategy Analysis
product market
competition
regulatory constraints
business strategies
technology
Stage 2 Analysing Information
Accounting Analysis & Financial Analysis
quality of accounting information
reformulating the F/S to uncover business activities
ratio and cash flow analysis
Stages of the Analysis

Stage 3 Prospective Analysis: Forecasting
pro-forma Income Statement
Balance Sheet
Statement of Cash Flows

Stage 4 Prospective Analysis: Valuation
Abnormal Earnings Model
Alternative Valuation Models
Statement of Cash Flows
Stage 5 Prospective Analysis: Application
investment decision

investor decision to buy, hold, sell
manager decision to adopt strategy or not

e.g., proforma Income Statement
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caution for clean surplus and consistent estimates, the accounting system must reconcile
must concurrently develop the proforma Balance Sheets and Statement of Cash Flows
201920202021E2022E2023E
Sales38,17637,408 ? % ? % ? %
Other operating revenue288376
Cost of sales(29,253)(28,043) ? % ? % ? %
Other income428108
Administrative expenses(8,031)(8,081) ? % ? % ? %
Other expenses(146)
Share equity investments5(6)
Financing costs(42)(443) ? % ? % ? %
Income tax expense(347)(341) ? % ? % ? %

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tool box i.e.,
external factorseconomic climate (cycle), macroeconomic factors, political/regulatory, socio-cultural
industry structure and dynamicssuppliers, buyers, new entrants, substitutes, rivalry
competitive strategycost leader, differentiation, first mover
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Now seek to add an understanding of the firms underlying financial performance to the tool box by analysing the Financial Statements
why?insights into (among other factors), operating policies, production technologies and techniques, inventory and credit systems
operating decisionsfinancial performance
Step #1 the Financial Statements as presented Session #5
Step #2 reformulation of the Financial Statements
Step #3 assessment of accounting quality Sessions #6, 7, 8
Step #4 analysis ratios
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Reporting Obligations of Australian Publicly Listed Companies
Legally, publicly-listed Australian companies are public and disclosing entities under the Corporations Act (2001)

they must provide:
an annual financial report that includes financial statements, notes to the financial statements, and a directors report
the financial report must comply with Australian Accounting Standards (AASB standards) and must be audited
the directors report provides a summary across a broad range of aspects relating to the firm and its operations
a half-year report that has similar requirements, but usually does not provide as much detail, and might be reviewed rather than audited

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Listed companies must also comply with continuous disclosure requirements
they must immediately disclose information that might materially affect their share price through the Australian Stock Exchange (ASX) website
(in the US, this is done through the Securities Exchange Commission (SEC) website instead)

Information disclosed on the ASX website are called company announcements
https://www.asx.com.au/asx/statistics/announcements.do
includes annual/half year reports
news released under continuous disclosure rules
insider trading reports
significant ownership reports

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Accounting Standards (AASB)
Australian companies must comply with Australian Accounting Standards Board pronouncements (AASB standards)
these are a local variant of International Financial Reporting Standards (IFRS)
IFRS standards are used in most countries, usually with minor local tweaks
the US uses its own standards called US GAAP, that is not based on IFRS. However, IFRS and US GAAP are very similar

the tools developed in this course can be used broadly in any jurisdiction

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AASB 101 requires five things:
Balance Sheet (or Statement of Financial Position)
Income Statement (or Statement of Profit & Loss) and/or Statement of Comprehensive Income
Statement of Changes in Equity
Statement of Cash Flows
Notes to the financial statements

Comprehensive Income can be reported in two different ways:
prepare a Statement of Comprehensive Income separate from the Income Statement, but immediately following it (this is how Coles reports pages 98/99)
combine the two as one Statement of Profit/Loss and Comprehensive Income

Financial Statements must show at least two-years of comparative numbers under AASB 101 (e.g. FY19 and FY20 in the 2020 Annual Report)
Financial Statements

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the financial statements we will be using are Consolidated, meaning they represent the combined financial statements of the parent company and all the subsidiaries it controls

Parent Co
Subsidiary Co 1
Subsidiary Co 1
Subsidiary Co 1
Sub Co 1A
Sub Co 1A
Sub Co 1A
the consolidated entity produces one set of Financial Statements

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Cautions
the financial statements are general purpose; they are prepared for a variety of stakeholders (shareholders, creditors, suppliers, customers, etc.)
they are not set-out perfectly for shareholders and for doing valuation

need to reformulate the financial statements in order to make them more useful for fundamental analysis and valuation

separation of operating activities and financing activities

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Directors Report
Australian companies must provide a Directors Report in their Annual Report
usually placed towards the start of the Annual Report
similar the Management Discussion & Analysis (MD&A) provided by US firms

the requirements for the Directors Report are contain in the Corporations Act (2001, sections 299-300A) and Regulatory Guidance notes issued by ASIC (especially RG 247)

the Directors Report provides information useful for understanding how the company has performed, and some clues about how it might perform in the future e.g.,
description of the companys operations and strategy
explanation of the current years results
business strategies
risks
future outlook

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PART 2 The Accounting Process:
(1)Balance Sheet (B/S):position at a specific point in time measured in accordance with GAAP
(2)Income Statement (I/S): summary of activities for period, part of bridge between two B/S
(3)Statement of Cash Flows (SCF):uses and sources of cash
(4)Notes to F/S:supplementary information for full disclosure
The building blocks of Financial Accounting (GAAP) are:
1) basic elements definitions specific to accounting
2) qualitative characteristics characteristics necessary for the F/S to meet users needs
3) environmental assumptions structure of framework within which accounting must function
4) accounting principles broad standards/guidelines (man-made based on logic not on natural law)

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Basic Elementsdefinitions specific to accounting

e.g.,asset future benefit
controlled by the firm
result of a past transaction
liability currently exists, from a past transaction
determinable maturity value and date
payee identifiable
cannot avoid future sacrifice ( no offset)

assets, liabilities, owners equity, revenue, gain, expense, loss, earnings (net income)

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Qualitative Characteristicscharacteristics necessary for the F/S to meet users needs
1. relevance makes a difference in decisions i.e., improves predictive ability, confirms expectations
2. reliability dependability
3. timeliness information available before it loses capacity to influence decisions
4. verifiability
5. neutrality
6. comparability improves both reliability and relevance
7. consistency select the same method each year
8. uniformity same method used by all firms

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Environmental Assumptions
provide structure of framework within which accounting functions

1. economic (separate) entity assumption each enterprise is considered as an accounting unit separate and apart from the owners and other entities irrespective of legal status
e.g., proprietorship: unlimited liability BUT keep books of store separately!
2. periodicity assumption recognizes the need for short-term, periodic F/S even though the results can not be know specifically until liquidation
3. continuity assumption in absence of evidence to the contrary, the business entity is assumed to remain in operation long enough to carry out its contemplated operations, contracts, and commitments
4. monetary unit assumption money is the best common denominator since it is relevant, simple, available, understood, and useful (also states that fluctuations in the value of the dollar can be ignored without impairing usefulness)
5. dual aspect there are 2 sides to every transaction

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Accounting Principles
rules giving guidance to measurement, classification, and interpretation of economic information
broad standards or guidelines (are man-made based on logic not on natural law)
The next set of slides (#18 #24) presents an illustration of the mechanics of accounting for a small retail organisation, and thereby the development of its Financial Statements *** this material is illustrative only; it is not eligible for examination ***

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Example #5-1
In late 20X0, CM and MC decided to open a sporting goods wholesale operation, CMMC Ltd. The firms balance sheet as at 31 December 31, 20X0 consisted of only two items, cash of $1,000,000 and contributed capital of $1,000,000. Information concerning the firm and its activities during 20X1 follows:
1.On January 1, 20X1, CMMC purchased land and a building for $500,000, paying $300,000 in cash and financing the remainder with a new $200,000 10-year 12% bond issue. The fair market value of the land at that date was $300,000. The building had an estimated life of 20 years and has no expected scrap value.
2.Because of its relative immaturity, CMMC decided to focus its attention on the distribution of only one item, sailboards. The following purchases were made on credit during 20X1:
2 January: 350 units @ $200 each30 June: 400 units @ $300 each
CMMC still owed suppliers $55,000 at the end of the year.
3. Sales for the year were $350,000 (700 units). While all sales were on credit, only $85,000 remained uncollected at year-end. CMMC decided to use the FIFO method of inventory valuation. Based on the experiences of similar firms, CMMC believes that 1.5% of the outstanding receivables will ultimately be uncollectible.
4. CMMC paid $4,000 for a two-year insurance policy on July 1, 20X1.
5. Administrative, selling, and general expenses (other than interest, depreciation, and labour) were $31,000 for the year. All of these expenses had been paid by the end of the year.
6. Labour wages for 20X1 were to $45,000. Of this amount, only wages from the last half of December remain unpaid (assume wages are earned uniformly throughout the year).
7. CMMC declared a dividend of $30,000 on December 31, 20X1, to be paid on January 10, 20X2.
8. The firms tax rate is 43%

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Mechanics

Step #1: Journal Entries
identifies each event and amount in the journals

Step #2: t-accounts
summarises each event and amount by account, and produces final balances

Step #3: Financial Statements
structured presentation of the final balances from the t-accounts

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Shareholders equity
Liabilities
Assets

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CMMC Ltd.
Income Statement for the year ended December 31, 20X1

Sales 350,000
COGS(175,000)
Gross Profit 175,000
Operating Expenses
depreciation10,000
bad debt expense 1,275
insurance 1,000
administrative31,000
labour expense45,000 (88,275)
Operating Income86,725
Financing costs (interest expense) (24,000)
NIBT 62,725
tax expense (43%)(26,972)
Net Income35,753

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CMMC Ltd.
Balance Sheet, December 31, 20X1

cash700,903
accounts receivable 85,000
allowance (1,275) 83,725
inventory 15,000
prepaid insurance3,000
land300,000
building200,000
acc depn(10,000)190,000
Total Assets 1,292,628

accounts payable 55,000
wages payable 1,875
dividends payable 30,000
bonds payable200,000
capital stock1,000,000
retained earnings5,753
Total Liabilities and Shareholders Equity1,292,628

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CMMC Ltd.
Statement of Cash Flows for the year ended December 31, 20X5

Operations:
Cash receipts 265,000
purchases(135,000)
insurance(4,000)
G,S & A expenses (31,000)
labour (43,125)
interest (24,000)
taxes (26,972)903

Investing:
purchase of land(300,000)
purchase of building(200,000)(500,000)

Financing:
bonds payable 200,000
dividends(0)200,000

Net Decrease in Cash(299,097)

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PART 3 The Financial Statements

1. Balance Sheet (Statement of Financial Position:
presents the companys financial position as at a particular point in time (end of the reporting period)
classifications: Assets, Liabilities and Equity
Assets and Liabilities further classified into:
current (realised within 12 months)
non-current (economic value to firm > 12 months)
Accounting relation: Total Assets = Total Liabilities + Common Shareholders Equity

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Companies must show at least the following items on the face of the Balance Sheet (assuming the item exists for the company) (AASB 101):
Assets:
Property, plant and equipment (PPE)
Investment property
Intangible assets
Financial assets
Investment accounted for using the equity method
Inventories
Trade and other receivables
Cash & cash equivalents
Assets held for sale as part of discontinued operations
Deferred tax assets
Liabilities:
Trades and other payables
Provisions
Financial liabilities
Income tax payable
Deferred tax liabilities
Liabilities associated with discontinued operations
Equity:
Non-controlling interests (NCI)
Issued capital
Reserves
Total Assets = Total Liabilities + Shareholders Equity

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2. Income Statement (Statement of Financial Performance or Profit and Loss Statement)
shows financial performance over a period of time (usually 12 months)
the core aspect of the I/S typically has the following basic structure:
Revenue
Cost of goods sold (COGS)
= Gross margin (or gross profit)
Operating expenses (SG&A, wages, advertising, R&D)
= Earnings before interest, tax, depreciation and amortisation (EBITDA)
Depreciation and amortisation
= Earnings before interest and tax (EBIT)
Net interest expense (or net of interest revenue)
= Profit before tax (PBT)
Income tax expense
= Net profit after tax (NPAT) (but before extraordinary items)
extraordinary items
= Net Income
Preferred dividends
= Net Income to Common Shareholders

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3. Statement of Changes in Shareholders Equity
provides a detailed break-down of changes in equity accounts over the period
Shareholders Equity typically consists of up to five accounts:
Contributed capital: how much shareholders have historically invested in the company
Treasury stock: cost of shares repurchased (but not retired)
Retained earnings: (basically) sum of past profits less past dividends
Non-controlling interest (minority interest): portion of controlled subsidiaries not owned by the parent company
Reserves: used for various items that affect equity, but do not pass into retained earnings (typically these items go through Other Comprehensive Income) e.g.,
if PPE is revalued upwards to fair value, the increment is placed in a Revaluation Reserve (AASB 116)
most companies place share-based payments in a reserve until the share-based payments (typically options) are exercised/expire (AASB 2)
translation of foreign operations into the companys presentation currency (AASB 121)

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changes in equity accounts can be classified into two categories:
Comprehensive income (CI):
=NPAT
+OCI
Net transactions with shareholders:
= Cash dividends
+ Share repurchases (treasury share repurchased, etc.)
Shares issued (dividend reinvestment plans, issued to executives or NCI, treasury shares issued, etc.)

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4. Statement of Cash Flows
sources and uses of cash over a period of time (usually 12 months)
similar to the Income Statement, but based on cash accounting, rather than accrual accounting
structure:
cash flow from operations (CFO):
cash flow from investing (CFI):
cash flow from financing (CFF):
CFO can be presented in two different ways in Australia:
Direct method: itemised cash receipts less cash payments related to operations
Indirect method: profit +/- non-cash items and net changes in working capital
the direct method was historically required in Australia and is still the most common
the indirect method can be used in Australia and is very common in other countries
in Australia, if the direct method is used, the indirect method must be shown in the notes

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indirect method from Footnote 2.1

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5. Notes to the Financial Statements (pages 103 148 of Coles 2020 Annual Report)
usually appear at the end of the financial report after the financial statements
typically provide details of the following:
description of accounting policies
details of segments
finer detail on financial statement items
miscellaneous disclosures required under Australian law, such as list of subsidiaries, shareholder statistics, major shareholders

The details provided in the Notes are an imperative for fully understanding the information conveyed by the Financial Statements (I/S, B/S, and SCF)

The Articulation of the Financial Statements (Figure 2.1, page 42)
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Investment and disinvestment by owners (including dividends)

+ Net income and other earnings (comprehensive)
Net change in owners equity
Statement of Shareholders Equity

Revenues

Net income
Income Statement

Cash from operations
Cash from investing
Cash from financing
Net change in cash
Cash Flow Statement

Cash
Liabilities
Total Assets
Owners equity
Beginning Balance Sheet

+ Other Assets
Liabilities
Cash
Total Assets
Owners equity

Ending Balance Sheet

Beginning stocks
Flows
Ending stocks

+ Other Assets
Expenses

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PART 4 Comprehensive income (CI) (and dirty versus clean surplus)
The clean surplus relation is the standard accounting identity

Ending book value (shareholders equity)
= beginning book value +income dividends changes in contributed capital

BVt = BVt-1 + Et Dt NCCt

The key within this equation is that income (E) is in fact comprehensive income (CI) and not net profit after tax (NPAT or OI)
consider Coles again

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Accounting adjustment
Comprehensive Income
Dividends
BVt-1
BVt
NCC

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Comprehensive Income (CI)
basically a more complete measure of performance than net profit after tax (NPAT)
CI = NPAT + Other Comprehensive Income (OCI)
OCI is also called dirty surplus it is termed dirty because it is not counted towards NPAT (note surplus is an old name for profit)
CI satisfies an important relation called the clean surplus relation (CSR):
(usually, net profit does not satisfy this relation)
a list of OCI items appears in AASB 101 (and is summarised following):
bottom line basically a lot of messy, complicated things; the most common ones are FX translation gains/losses and cash flow hedging gains/losses

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(a)changes in revaluation surplus (AASB 116 Property, Plant and Equipment and AASB 138 Intangible Assets);
(b)re-measurements of defined benefit plans (AASB 119 Employee Benefits);
(c)gains and losses arising from translating the financial statements of a foreign operation (AASB 121 The Effects of Changes in Foreign Exchange Rates);
(d)gains and losses from investments in equity instruments designated at fair value through other comprehensive income in accordance with paragraph 5.7.5 of AASB 9 Financial Instruments;
(da)gains and losses on financial assets measured at fair value through other comprehensive income in accordance with paragraph 4.1.2A of AASB 9.
the effective portion of gains and losses on hedging instruments in a cash flow hedge and the gains and losses on hedging instruments that hedge investments in equity instruments measured at fair value through other comprehensive income in accordance with paragraph 5.7.5 of AASB 9 (Chapter 6 of AASB 9);
(f)for particular liabilities designated as at fair value through profit or loss, the amount of the change in fair value that is attributable to changes in the liabilitys credit risk (paragraph 5.7.7 of AASB 9);
(g)changes in the value of the time value of options when separating the intrinsic value and time value of an option contract and designating as the hedging instrument only the changes in the intrinsic value (Chapter 6 of AASB 9); and
(h)changes in the value of the forward elements of forward contracts when separating the forward element and spot element of a forward contract and designating as the hedging instrument only the changes in the spot element, and changes in the value of the foreign currency basis spread of a financial instrument when excluding it from the designation of that financial instrument as the hedging instrument (see Chapter 6 of AASB 9).

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PART 5 Accounting Concepts: Recognition and Disclosure
Recognitionformally including an item in the financial statements
Disclosuremerely disclosing the existence of an item in the Notes, but not formally including it in the financial statements
Example: contingent liabilities
A possible obligation that arises from past events and whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the entity (AASB 137)
e.g., a loan guarantee will only become a liability only if the other company defaults (or becomes likely to default)
does NOT currently meet the definition of a liability and hence can not be formally recognised (included) in the Balance Sheet (see Slide #16 for definition of a liability)
disclosed in the notes (see Coles 2020 Annual Report Note 6.2 on page 143)

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Accounting Policies

Revenue Realization Principle:
revenue is the creation of wealth
any inflow other than from owners equity or creditors, measured as net cash equivalent price from an arms-length transaction
in general, revenue is recognized when there has been an exchange transaction and the earnings process is essentially complete
sales basis (employed when collection of price in full is reasonably certain and when related expenses are determinable)

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Matching Principle:

based on cause and effect i.e., all expenses incurred in generating revenue should be reported in the period when the revenue is recognized

definitions:
expenditure decrease in asset or increase in liability associated with incurrence of a cost
expense using up of resources by entitys earnings activities during current period

an expenditure may benefit the period in which it occurs and/or future periods (e.g., acquisition of fixed assets) whereas an expense is of benefit only to the period in which it is consumed
an item of cost must either be defined as an asset or as an expense
e.g., purchase inventory for resale becomes cost of goods sold (COGS) on I/S only in period when sold else held on the B/S as an asset (inventory)

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exceptions to the matching principle include

a) period expenses
costs of doing business e.g., administrative costs, costs of accountant, etc.
these costs are expensed in the period in which they are incurred
why? they dont have an obvious link to revenue of some future period
question what about advertising expenses? will impact on future revenue BUT causal link is difficult to establish
are typically expensed in period when incurred

b) dividends
dividends are not expenses from the accounting perspective
recorded directly to Retained Earnings (as a reduction) when declared

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Accounting Concepts: Accruals
Why accrual accounting?
recognises revenues (expenses) when they are earned (incurred), rather than when the cash is received (paid)
resulting earnings generally provides a better measure of economic value added than cash flow
e.g.,suppose a company made $10m in cash sales and $100m in credit sales for a year looking only at cash sales would provide an incomplete picture of the companys performance
accruals accounting is better for forecasting it produces smoother and more predictable earning
accrual accounting simply changes the timing of when items are recognised in the F/S over the life of the company, cash flows and revenues/expenses must be the same
accruals involve some estimation (e.g., provision for doubtful debts) this introduces the possibility of estimation errors

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the main measure of performance under accrual accounting is NPAT (or CI)
the main measure under cash accounting is CFO
total accruals = NPAT CFO

From the Coles presentation in Footnote 2.1 of its CFO using the indirect method

Profit = 978

Accruals = 1,574 (adding up all the adjustments and changes in assets and liabilities)

CFO = 2,552

caution determination of accruals involves managerial discretion (e.g., estimates) and thereby can impact the quality of the accounting figures

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PART 6 Accounting Concepts: Measurement
having decided to recognise an item in the Financial Statements, its value (amount) must then be measured

four main measurements methods used under AASB/IFRS (see Conceptual Framework):
Historical Cost: how much the item originally cost less (if applicable) accumulated depreciation/amortisation and less (if applicable) accumulated impairments
Fair Value (or current cost): basically current market value what would it cost today to buy the asset or to repay the liability
Realisable Value: what could the asset be sold for today?
Present Value: present value of future cash flows related to the asset or liability

(note typically, Realisable Value and Present Value are viewed as being the same as Fair value)

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Cash and Cash EquivalentsFair value (cash is cash)
Accounts Receivable, net of Provision for Doubtful DebtsExpected amount to be collected from receivables. This should be close to Fair value
InventoriesLower of cost and net realisable value
Property, plant and equipment (PPE)Can be carried at Historical cost (most companies) or Fair value less depreciation and impairments
IntangiblesCan be carried at Historical cost (most companies) or Fair value less amortisation and impairments
GoodwillHistorical cost (with impairments, but no amortisation)
Investment propertyFair value (typically) or Historical cost

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Accounts payableHistorical cost, which is usually close to fair value
BorrowingsAmortised cost (usually); fair value is permitted, but not used often by industrial companies
Deferred revenueEstimated revenue to be earned in the future. This should be close to fair value
Provisions, e.g., provision for warranty expensesPresent value of estimated future expenses. This should be close to fair value

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Measurement Equity Investments
For equity investments in another company, the accounting depends on whether the company has control, significant influence, or neither
Control (usually >50% ownership):
the investee company is known as a subsidiary and the owner is called the parent
consolidation method: basically add the subsidiary and parents accounts together no separate asset for the investment is recognised
Significant influence (usually 20-50% ownership):
the investee company is known as an associate
equity method of accounting: recognise an asset on balance sheet; recognise share of profits/losses of associate; recognise dividends received from associate
Joint control (usually 50% ownership):
the investee company is known as a joint venture
equity method of accounting is used
Neither (usually < 20% ownership):recognise an assetmeasurementdepends on managements intention58For investments in debt securities (e.g. bonds) and minor investments in equity securities (<20% ownership), measurement depends on managements intentions with respect to the investmentHeld to maturity (debt only)management intends to hold the debt until it maturesmeasurement is at amortised costHeld for trading (debt/equity)management intends profit from trading the debt/equitymeasurement at fair value, with gains/losses recognised in the Income StatementAvailable for sale (debt/equity)managements intention is not to hold to maturity or hold for tradingmeasurement at fair value, with gains/losses recognised in OCI(note see updated AASB 9 for specific details)59Accounting Concepts: Classificationonce an item is recognised and measured, the final decision is how to classify the itemtypical issues:is an item a liability or equity? (Balance Sheet)is an item a recurring or non-recurring item (e.g. an extraordinary item)? (Income Statement)is it an operating, investing or financing cash flow (e.g. interest paid)? (Cash Flow Statement)our interest is also in re-classificationexample: preference shares financial instruments that have features of both equity and liabilitiesequity: pay dividends; rank below debt in payment of dividends and repayment on liquidationliability: typically dividends are fixed; rank above ordinary shares for dividends and repaymentsdifficult to classify in the Balance Sheet: are they liabilities or equity?in practice, can be classified as liabilities, equity or split into both (depending on the exact terms of the preference share)we will reclassify all preference shares as financial obligations60Accounting Concepts: Going Concern AssumptionIFRS/AASB accounting is done on the basis that the company will continue to operate for the foreseeable future (it is a going concern) (continuity assumption, Slide #18)the business/company/venture is an ongoing, continuing businessAASB 101:management must assess whether the company is a going concern i.e., it is not likely to be liquidated or cease to trade management must disclose if there is uncertaintyif a going concern, normal accounting is used; if not, the company should disclose the accounting method (could be anything)auditors must check on managements going concern assessment (see ASA 570)for purposes of the valuation exercise, we typically assume the company is a going concern (there are special valuation techniques for companies that are not going concerns, for example asset-based valuation)61PART 7 Summary: Sessions #1 #5overarching focus fundamental value (intrinsic value)requires an understanding of the value driversneed to accumulate a tool kit as the basis for developing the pro forma Financial StatementsSTEP 1Understanding the pastInformation collectionUnderstanding the businessAccounting analysisFinancial ratio analysisCash flow analysis STEP 2Forecasting the futureStructured forecastingIncome Statement forecastsBalance sheet forecastsCash flow forecasts STEP 3ValuationCost of capitalValuation models AE, FCF, DValuation ratiosComplicationsNegative valuesValue creation and destructionFigure 1.1Lundholm & Sloan, Framework for Equity Valuation62Stage 1 Understanding the BusinessStrategy Analysisproduct marketcompetitionregulatory constraintsbusiness strategiestechnologyStage 2 Analysing InformationAccounting Analysis & Financial Analysisquality of accounting informationreformulating the F/S to uncover business activitiesratio and cash flow analysis Stages of the AnalysisStage 3 Prospective Analysis: Forecasting pro-forma – Income Statement- Balance Sheet- Statement of Cash FlowsStage 4 Prospective Analysis: ValuationAbnormal Earnings ModelAlternative Valuation ModelsStatement of Cash FlowsStage 5 Prospective Analysis: ApplicationInvestment decisioninvestor decision to buy, hold, sellmanager decision to adopt strategy or not63external environment economic prospectsmacroeconomic factorssocio-cultural forcespolitical / regulatoryIndustry dynamics Porters five forces(suppliers, buyers, new entrants, substitutes, rivalry)Analysis of Financial Statementsunderstanding current F/Sre-formulating the F/Saccounting quality??e.g., proforma Income Statement64caution for clean surplus and consistent estimates, the accounting system must reconcilemust concurrently develop the proforma Balance Sheets and Statement of Cash Flows201920202021E2022E2023ESales38,17637,408 ? % ? % ? %Other operating revenue288376Cost of sales(29,253)(28,043) ? % ? % ? %Other income428108Administrative expenses(8,031)(8,081) ? % ? % ? %Other expenses(146)—Share equity investments5(6)Financing costs(42)(443) ? % ? % ? %Income tax expense(347)(341) ? % ? % ? %640V =tx( 1+ tkt)t =1 =E( tx )t(1+k)t=1n +E( nx ) (1+ g)k g1n(1+k)0V=tx(1+tkt)t=1=E(tx)t(1+k)t=1n+E(nx)(1+g)k-g1n(1+k)/docProps/thumbnail.jpeg