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Financial Analyst's Professional Manual

Disclaimer: the information provided in this guide to readers has been prepared solely for informational purposes and should not be construed as an offer to buy or sell or a solicitation of an offer to buy or sell any security or instrument or to participate in any transaction or trading activity. The Four-Week MBA accepts no liability with regard to the user’s reliance on it. This guide and the information contained herein are not intended to be a source of advice or credit analysis with respect to the material presented.

Copyright: All rights reserved. No part of this publication may be reproduced, distributed, or transmitted in any form or by any means, including photocopying, recording, or other electronic or mechanical methods, without the prior written permission of the publisher, except in the case of brief quotations embodied in critical reviews and certain other noncommercial uses permitted by copyright law.

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Table of Contents

The Power Of Accounting 7

GAAP Principles 8

Double-Entry System 11

T-Accounts: The Foundation 12

Journal Entry: The Double Faced Entry 13

Accounts And Chart of Accounts (COA) 14

How To Record Journal Entries 18

Cash vs. Accrual 19

The General Ledger 21

The Accounting Wheel 22

The Angry Boss 22

The Happy CFO 26

  • A Brief Overview of The Main Financial Statements 27*

  • Introduction To The Main Financial Statements 28*

[* Income Statement (P&L): Show me The Bottom Line 29*]

Balance Sheet: The Power Of The Now 30

Cash Flow Statement (CFS): Cash Is King 30

Real Life Analogy 31

The Income Statement 32

Revenue 34

Expense 36

[* Net Profit: Get Ready For a Shocking Truth 39*]

The Balance Sheet 42

[* A Simple Equation: Assets = Liabilities + Equity 44*]

Assets: The Future of The Business 49

Current Assets 51

Non-Current or Long-Term Fixed Assets 56

[* Liabilities: Too Much Of It Can Get You In Trouble 63*]

Current Liabilities 65

Equity: Strike The Right Balance 67

Stocks 69

Retained profit 69

Reserves 69

Balancing The Books 70

The Cash Flow Statement 71

Cash Is King 72

The Three Main Sources Of Cash 74

Cash Inflow versus Cash Outflow 76

The Net Profit Is a Liar 78

[* Cash Flow From Operations: Are We Efficient? 79*]

[* Cash Flow From Investing: Are We Killing The Goose? 85*]

[* Cash Flow From Financing: The Cash Paradox 87*]

Fundamental Analysis Simplified Manual 92

Why Ratio Analysis? 93

PART ONEFINANCIAL RATIOS 95

1. Liquidity Ratios 95

Current Ratio 96

Quick Ratio (Acid or Liquid Test) 97

Absolute Ratio 98

2. Profitability Ratios 100

Gross Profit Margin 102

Operating Profit Margin 103

Return on capital employed 104

Return on Equity 105

3. Solvency Ratios 107

Debt to equity ratio 108

Interest Coverage Ratio 110

Debt to Assets Ratio 111

4. Efficiency Ratios 112

Inventory Turnover 113

Accounts Receivable Turnover or collection period 115

Accounts Payable Turnover Ratio 117

5. Valuation Ratios 119

Earnings Per Share 120

Price/Earnings Ratio 120

Dividend Yield 121

Payout Ratio 122

Financial Ratios – Handle With Care! 122

PART TWOFUNDAMENTAL ANALYSIS 125

Analysis Set Up 126

WHAT to LOOK For? 126

[* Step-One: Financial Ratios Set-Up & Two-Year Comparison 132*]

Step Number Two: DuPont Analysis 135

WHAT IS the PURPOSE of the DUPONT ANALYSIS? 135

WHAT RATIOS COMPRISE the DUPONT ANALYSIS 138

[* Step-Three: Select Comparable Set-Up and Comparative Analysis Completion 140*]

Business Profile 141

Financial Profile 142

Select Comparable 143

Perform Comparative Analysis 145

Wrap-Up and Conclusions 146

Fundamental Analysis Conclusions 148

[* Why in the World Did I Write a Book About Corporate Finance? 149*]

Who Is This Book For? 150

Value in Corporate Finance 151

Firm’s Balance Sheet 152

  • Personal Balance Sheet and Income Statement 153*

Investing Decision 161

Financing Decision 163

Dividends Decision 165

Financial Manager’s Toolbox 166

The Investing Decision 168

What Is Risk? 169

Risk’s Components 171

Not All Kinds of Risks Are Diversifiable 174

How to Measure Risk 176

CAPM Framework 180

Risk-Free Rate 181

Time Value of Money 183

Present Value 183

Future Value 185

Beta – Introduction 186

Beta – Apple Inc. Case Study 187

Expected Return of the Market 192

Apple Inc. CAPM – Case study 193

Risk – Summary and Conclusions 196

The Financing Decision 198

Components of Cost Financing 199

Cost of Debt and the Cost of Equity 201

Cost of Debt – Definition and Meaning 204

How to Measure the Cost of Debt 205

Hot to Measure the Interest on Debt or the Cost of Debt 209

Cost of Equity 213

Summary and Conclusions 213

  • Putting Investment and Financing Decision Together with WACC 214*

Cost of Capital – Apple Inc. Case Study 216

Summary and Conclusions 218

The Dividend Decision 218

Summary and Conclusions 222

Corporate Finance Conclusions 224

Option Basics: Simplified Manual 225

What Is an Option? 225

[* Do You Have to Be Smart to Deal with Options? 227*]

[* What Influences the Price of an Option? 228*]

Practical Examples 229

Time Decay 232

Volatility 236

Risk-Free Interest Rate 238

Dividends 240

American and European Options 242

Summary 243

[* Option’s Greeks – How to interpret them? 244*]

About the Author 246

E-Books 247

Online Courses 248

  • Additional Free Resources for the Financial Analyst 249*

  • Bibliography and Additional Suggested Reading 250*

[]The Power Of Accounting

You have to understand accounting and you have to understand the nuances of accounting. It’s the language of business and it’s an imperfect language” Warren Buffett

In a globalized world, where change happens so quickly that companies that existed for centuries (such as Lehman Brothers, founded in 1850, bankrupted in 2008) just few things stick for centuries.

The current accounting system is one of the few survivors. Born in 1494, when a Venetian Merchant, Luca Pacioli, in his “Summa de Arithmetica, Geometria, Proportioni et Proportionailta,” described for the first time the double entry-system. This practical manual gave official birth to a system that is still used in current accounting.

Even people who hate accounting recognize the importance of it. If you either own a small business, or you are a CFO, CEO, COO, a common citizen, you have to understand accounting to recognize what is behind each one of the 14 trillions transactions per day, just in US^.^

[]GAAP Principles

Although, the fundamental accounting system hasn’t changed, the principle and rules applying today have been updated in the last century.

The general accepted accounting principles are standards and procedures used by organizations to submit their financial statements. Today we have two main accepted frameworks, globally: GAAP and IFRS; in this chapter I will focus mainly on GAAP. Indeed, after the 1929 market crash, American government felt the necessity to create a set of rules to discipline and conform the accounting system, and avoid what had happened. In the decade after the 1929 market crash institutions such as the Securities and Exchange Commission were created. In 1934, the SEC, assisted by the American Institute of Accountants (AIA), started to work on the GAAP. The AIA subsequently instituted an organism to specifically create these principles: The Committee on Accounting Procedure (CAP). Finally, the first set of GAAP was created and in 1973 and the CAP board was substituted by the Financial Accounting Standards Board (FASB). From this work came out 10 basic principles, that are the foundation of the modern accounting system in US:

*
h3<>{color:#9a8d09;}. Economic entity assumption: If you have a business, even if you are a sole proprietor, the accountant will consider yourself separately from your business.

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h3<>{color:#9a8d09;}. Monetary Unit Assumption: The Business activity you undertake is considered in US Dollars.

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h3<>{color:#9a8d09;}. Time Period Assumption: Business activity you undertake can be reported in separated time intervals, such as weeks, months, quarters or fiscal years.

*
h3<>{color:#9a8d09;}. Cost Principle: If you buy an item in 1980 at $100, it will be reported on your balance sheet as worth $100 today, independently on inflation or appreciation of the asset.

*
h3<>{color:#9a8d09;}. Full Disclosure Principle: You have to report all the relevant information of the business in the financial statements or in the footnotes.

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h3<>{color:#9a8d09;}. Going Concern: The accountant assumes that your business will continue its operations in the foreseeable future.

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h3<>{color:#9a8d09;}. Matching Principle: If you incur an expense, it should be matched with the revenues, according to the accrual principle. If you decide to pay your employees a bonus related to 2015 but you pay it in 2016, you still will report it as 2015. You will report the expense when it was recognized and not when actual cash was disbursed (accrual principle).

*
h3<>{color:#9a8d09;}. Revenue Recognition Principle: if you sell a product in January 2015 but you will receive the money from the customer in April 2015, you will report the sale in January, since it was the period when the actual sale was realized.

*
h3<>{color:#9a8d09;}. Materiality Principle: when you report the financials, it will be allowed to round them, since if an amount is insignificant can be neglected by your accountant.

*
h3<>{color:#9a8d09;}. Conservatism Principle: When in doubt between $80 and $100 loss, your accountant has to choose the most conservative alternative, report $100.

These principles are the “ten commandments” for the accountant. Keep them in mind. They will guide you throughout the book. In addition, the accrual principle in practical terms states: “Revenues and expenses are recognized when occurred, independently from cash disbursement.”

This principle is crucial to build our main financial statements, in particular the Income Statement and Balance Sheet.

[][] Double-Entry System

“You have to know accounting. It’s the language of practical business life. It was a very useful thing to deliver to civilization. I’ve heard it came to civilization through Venice, which of course was once the great commercial power in the Mediterranean. However, double entry bookkeeping was a hell of an invention.” Charlie Munger^.^

As any other language, the accounting system has its own. Indeed, in accounting in order for you to record a transaction you have to use the double-entry system. Double-entry means that each single transaction needs to be recorded twice, on the left side if debited and on the right side if credited. Usually, when you think of debit or credit in real life is different compared to debit or credit in accounting. In fact, debit does not mean that you have a debt to be paid back; neither credit means that you have money to receive.

For example, in the accounting world, when cash is debited, it means the cash on your bank account increased. Therefore, you received cash. I know it may sound counterintuitive, but this system was created five hundred of years ago and it is the system today’s accountants use to record each single transactions.

h2<>{color:#7c959a;}.

[] T-Accounts: The Foundation

The most effective way that accountants use to record each single transaction in the ledger is the T-Account. Although, most of the accounting Software today do it automatically, it is helpful to know how it works.

[++]

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Financial Analyst's Professional Manual

This Professional Manual comprises four manuals that tackle the following topic areas: - Financial Accounting ($2.99) - Fundamental Analysis ($2.99) - Corporate Finance ($2.99) - Financial Options ($2.99) Each of these topics has been tackled in detail but also with a simple language. The Professional Manual has been offered at a special rate compared to the value of each single manual that comprises it. What Is That Drives Me in Writing About These Topics? When I was seventeen I watched for the first time a movie that made me dream. Even though the main character of the movie was greedy and ruthless I wanted to be part of that game. The movie was called “Wall Street,” and Michael Douglas interpreted it. After few years I totally changed my point of view on that world and no more I wanted to be part of it. On the other hand, I eventually enrolled in an MBA to understand more about the real world, rather than pure financial markets and stock prices. There I took as concentration corporate finance and a new world opened in front of my eyes. In fact, I could finally find a subject that although artificial (we make many assumptions in corporate finance) it was way more coherent to reality than pure financial speculation. I found this learning experience very challenging, considering that corporate finance was out of my domain (I had a legal background) but like all stimulating adventures eventually it turned better than I could ever expect. Furthermore, after completing the MBA I landed a job in California as Financial Analyst/Assistant Controller where I had the chance to bridge the gaps in my knowledge due to the difference between theory and practice. In these years I had to fit complex financial concepts in my already overloaded brain. This made me simplify things. In fact, this professional manual wants to be my way of making complex concepts as simple as possible, without losing the technical substance of them. This Professional Manual tackles many theoretical topics, but its main focus is practical advice. In short, this is a manual of practical counsel on what tools the finance professional can use to make his life easier.

  • ISBN: 9781310660856
  • Author: gcuofano
  • Published: 2016-05-03 11:50:07
  • Words: 39200
Financial Analyst's Professional Manual Financial Analyst's Professional Manual