Financial Analysis Week 4

1. Jim Slater of National Motor Corporation, Hansen and Goldsmith (Good Year Tires)
1. Later worked for Slater Walker, corporate raider
2. Splitting companies up brings an arbitrage opportunity, huge financial gain
3. Earnings (profitable bit) and break-up value (unprofitable bit)
4. directors began to split themselves pre-emptively to avoid being raided
5. Private equity looks for carrion on which to feast - vulture capitalism?
2. Cosmetic Accounting, or creative accounting
1. Enron is the best example. Tremendous incentive to do creative accounting
2. Over-reporting profits brings companies benefit
3. Taxation leads to an incentive to under report profits
4. many incentives to do it. Directors often have share based compensation
5. accounting regulation
1. set of principles- show the economic substance over legal form
2. related to British legal structure- Common law
3. Roman law-detailed codification. If not prohibited, you can do it 
4. Asset and Liability definitions lacking.
6. Timing Based
1. trying to shift expenses from one period to another
2. undercharge depreciation, report higher profit (comes back to haunt you)
3. changing sales cut off (credit based transactions, when does transaction occur? upon payment?)
4. Normal rule is that as soon as contract is legally recognized
5. changing expenses cut off
7. Valuation Based
1. asset valuation important to
1. shareholders
2. lenders
3. all profit calculations
2. multiple valuation methods -- pick one
1. historic cost
2. depreciated historic cost
3. current cost
4. realizable value
5. replacement cost
6. mark to market (or mark to model)
7. fair value (the current favorite!)
1. if the market is thinly traded we can attempt to model fair value 
2. the new standard (circa 2008) has already been sidestepped
3. European commission repealed fair value during crisis
8. Recognition based
1. when is an asset not an asset?
2. when it has passed out of legal ownership
3. Ex: Special Purpose Vehicles (SPVs)
4. Leasing
5. Sale and buyback- Whiskey Industry sells Whiskey kegs to Bank which assumes legal ownership
6. Reclassify an asset as a "bundle of services" Private Finance Initiative
1. Government doesn't own hospital but rather hospital services (off balance sheet)
7. When it is expensed
8. Capitalization: when an expense is classified as an asset
1. IT failure capitalization (J. Sainsburys)
9. Off balance sheet finance
1. why go off balance sheet? Stay within borrowing limits
1. to avoid breaching loan covenants
2. to improve credit rating
3. to look better to investors and lenders
2. leasing- you don't own the asset (IAS 17)
1. operating lease- lessor repairs, cost of ownership with lessor
2. capital lease-
3. financial lease-
3. provisions- particularly post-takeover reorganization provisions
1. general provision- something that might happen 
2. store income (income is a credit)
3. put income to one side for a while
4. outlawed by the Accounting standards board
5. One form of provision allowed -> post-takeover reorganization
4. Effects: capital gearing ratio drops
1. examples: consignment stock (return the ones that don't sell) stock becomes what you sell. Wicks - DIY retailer
2. leasing- has allowed fixed costs to be variable (airline industries) easier to get the assets from the bank's leasing department Variable cost based businesses are safer than fixed cost based
3. debt factoring- bank will buy debt from you at 80 cents on the dollar
4. private finance initiative
5. Contingent Liability- court case settlements (included in notes off B/S) 
6. SPV's bundled service companies get together to put an asset in SPVs which effectively lead to the asset's disappearance  
10. Accounting for share options
1. opportunity cost of price difference between shares and share options
2. Ex: $5 vs $0.50
3. In the US, share options are not expensed, leads to tremendous CEO pay packages. Current trend in US to show as expense
4. corporate profits simply disappear, and corporate stock buybacks (to compensate for dilution due to option sales) pay for CEO bonus
11. BSE: A = L + SE
1. Assets
1. NCA
2. CA: inventory, payables, cash
2. SE
1. OSC ordinary share capital
2. Retained Earnings (accumulated earnings)
3. Solve BSE for CASH
1. What happens if