Accounting Questions - Couple of questions for interview
Hi guys,
Quite a few here-need to quickly clarify these for interview next week:
a) On CF statement under operating activities we add in non-cash expenses that affect net income? Why do we add back in AP as this does not affect net income?
b) Why use FCF in valuation as opposed to net cash flow found on the penultimate line of the CF statement? Net cash flow reflects the net cash generated by the company so isn't this a better way of measuring cash flow than FCF?
c)If I buy 1% of a company’s shares outstanding I just pay the equity value of those shares. If I purchase 10% I still just pay equity value. If I buy 100% of equity do I just pay the equity value or the EV? When am I legally obliged to pay down debt and all the other things included in the EV?
d) If company has a negative EV does this mean that its equity must be trading at less than the value of the cash on the balance sheet? If I wanted to buy a company with a negative EV does this mean they would give me money to acquire them? I don’t understand what negative EV would mean in practical terms.
e) Does negative SE always mean a company is bankrupt?
f) If we are valuing a private company using multiples obtained from public comps, will we need to reduce the multiples slightly to reflect the lower liquidity of the private company? i.e. should the private company have a lower valuation due to its illiquidity?
g) If a target is acquired by a buyer who has a completely different brand and business model could this cause brand dilution of the target even if the target continued to operate under its pre-existing brand? From the seller's point of view are there any disadvantages to selling to a buyer with a completely different business model?
Here are some inputs from an accounting major perspective:
a) For AP, you add in increases and subtract decreases. Why? Think about it this way. If your AP goes up YOY, you're forgoing paying out money, which means less cash paid out from CFO. If AP goes down YOY, that means you paid out additional cash to settle those accounts. That cash has gotta come from somewhere, so you take it out of CFO. Since the payment (or deferment) is not represented on the IS as an expense (to get to NI), you have to make adjustments to get to CFO.
b) Net cash flow is not very helpful compared to FCF because you're more interested in where the money is coming from, not that the Co. is generating money. Think about it this way: Which is better? A Co. losing $30k from their Ops, but has a $100k cash inflow from CFF and/or CFI giving it a net positive cash flow of $70k, or a Co, that is generating $70k straight from Ops and none from CFF/CFI? Both will have a net positive cash flow of $70k, but obviously one is more healthy than the other. There's different ways to get to FCF but I prefer CFO - Cap. Exp since it fits the example above. Obviously we are concerned about the remaining being cash available to owners/stockholders/debters/ect.
e) Negative stockholders merely means that your liabilities are greater than your assets, since A = L + SE. However, items on the balance sheet does not necessarily equal their FMV. For example, land/buildings/equipment/ect. are recorded at historical costs, and/or are depreciated. If a Co. has owned a piece of land for 40 years, and it's worth 50 times as much today, that's not necessarily going to be reflected on the BS (under most circumstances). While I can't tell from a IB perspective, negative SE does not does not instantly equal bankruptcy. It's definitely not a good sign though.
As for the rest I imagine there are better people out there who can explain those than I. Good luck w/ your interview.
Thanks Crackjack appreciate the responses. Just to add to that: a) I understand that if AP goes down you would subtract it out of cash as this represents a cash outflow. However, if AP goes up this is listed on the BS as a liability but it is not listed as an expense on the P&L. Since it is not listed on the P&L it does not lower our net income and since it does not lower our net income why should we add it back to net income in the CF statement?
Guess an example would work the best to demonstrate this. Say you had an AP balance of $15,000 for year one and an AP balance of $20,000 for year two. Now let's say you're a office supply store. You're going to be buying your merchandise from suppliers, and those costs are going to be paid out of your cash eventually (particularly your cash from operations). Since there's an increase in your AP, you're basically postponing the transfer of cash at the time the statement of cash flows is made up. In this instance you're going to have $5,000 more in cash than you would have had you paid your suppliers in cash rather than postponing the payment(s) into AP. Because of that, you add in the increase in AP into your NI, since it will not reflect this through the revenues or expenses on the IS. The substance of the transaction is a higher cash balance (for ops) because of the deferred payments.
Does that help?
Maybe another way to look at it:
Example 1: Increase in AP $5,000: Beginning AP: $15,000 Plus Amount Charged to AP: $30,000 Equals Total in AP for Year: $45,000 Less: AP Paid with Cash: $25,000
Equals AP Ending Balance: $20,000
Example 2: No AP Change: Beginning AP: $15,000 Plus Amount Charged to AP: $30,000 Equals Total in AP for Year: $45,000 Less: AP Paid with Cash: $30,000 Equals AP Ending Balance: $15,000
As you can see, and increase in AP means that less cash is paid out, which is not reflected in NI, hence why you add it in to get to CFO.
An increase in AP does hit the income statement usually in COGS or SGA Expense. In order to increase AP which is a liability the account must be credited and in order for the journal entry to balance an expense account must be debited. For example accruing wages that have yet to be paid would incur salary expense and increase salaries payable.
Are you sure it is reflected in COGS/SGA? Do you agree with this crackjack?
dude, read a cash flow statement chapter from an introductory accounting textbook - it's very clear you don't understand the operations section of the CFS
To answer your questions - yes, an increase in AP represents a non-cash expense (non-cash deduction from net income). That is why we add increases back to NI for OCF purposes.
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