How will you recognise revenue in case sale is made on FOB basis and in case of CIF basis? Explain.
A. The recognition of revenue in case of FOB (Free on Board) and CIF (Cost, Insurance and Freight) basis is determined by the point at which the ownership of the goods is transferred to the buyer.
In case of FOB (Free on Board) basis, the ownership of the goods is transferred to the buyer once the goods are loaded on the shipping vessel or mode of transportation at the point of origin. The seller is responsible for the costs of loading the goods and the buyer is responsible for all costs and risks associated with the transportation of the goods from the point of origin to the final destination. Revenue can be recognized by the seller at the point of loading of goods on the shipping vessel, when the goods are transferred to the buyer, and the buyer takes on the risk and the title of the goods.
In case of CIF (Cost, Insurance and Freight) basis, the ownership of the goods is transferred to the buyer once the goods are loaded on the shipping vessel or mode of transportation at the point of origin. The seller is responsible for the costs of loading the goods, arranging and paying for insurance and the cost of transportation of the goods to the final destination. Revenue can be recognized by the seller at the point of loading of goods on the shipping vessel, when the goods are transferred to the buyer, and the buyer takes on the risk and the title of the goods.
What is Operating/Financial Leverage?
A. Operating leverage and financial leverage are two types of leverage that refer to how a company uses debt to amplify the returns on its operations or investments.
Operating leverage is the extent to which a company’s operations are financed with fixed costs, such as salaries and rent, as opposed to variable costs, such as materials and labour. A company with a high degree of operating leverage will have a larger proportion of fixed costs in its cost structure, which can amplify the impact of changes in revenue on its profitability. A company with high operating leverage will be more sensitive to revenue changes, and hence, more volatile in its earnings.
Financial leverage, on the other hand, refers to the extent to which a company uses debt to finance its operations and investments. A company with a high degree of financial leverage will have a larger proportion of debt in its capital structure, which can amplify the impact of changes in earnings on its return on equity. Financial leverage can increase the returns on equity for shareholders, but it also increases the risk of default if the company’s earnings decline.
A company usually cannot control operating leverage as that is determined by the industry in which it operates. But it can decide its financial leverage by adjusting capital structure. Companies with high OL should aim for lower FL, and vice versa
All Financial Ratios and profitability ratios.
A. Financial ratios are used to evaluate a company’s financial performance and health by comparing different financial metrics. There are many different financial ratios that can be used, but some of the most common ratios include:
Liquidity Ratios:
1. Current Ratio: Current Assets/Current Liabilities
2. Quick Ratio or Acid Test Ratio: (Current Assets – Inventory)/Current Liabilities
Solvency Ratios:
1. Debt to Equity Ratio: Total Liabilities/Shareholders’ Equity
2. Debt to Asset Ratio: Total Liabilities/Total Assets
Profitability Ratios:
1. Gross Profit Margin: Gross Profit/Net Sales
2. Operating Profit Margin: Operating Profit/Net Sales
3. Net Profit Margin: Net Income/Net Sales
4. Return on Equity (ROE): Net Income/Shareholders’ Equity
5. Return on Assets (ROA): Net Income/Total Assets
Efficiency Ratios:
1. Days Sales Outstanding (DSO): (Accounts Receivable/Annual Credit Sales) x 365 days
2. Inventory Turnover: Cost of goods sold/Inventory
3. Asset Turnover: Net Sales/Total Assets
Market Valuation Ratios:
1. Price-to-Earnings (P/E) Ratio: Market Price per Share/Earnings per Share (EPS)
2. Price-to-Book (P/B) Ratio: Market Price per Share/Book Value per Share
What is negative working capital?
A. Working capital is a measure of a company’s short-term liquidity and is calculated as the difference between a company’s current assets and its current liabilities. Negative working capital occurs when a company’s current liabilities exceed its current assets. This means that a company’s short-term obligations are greater than its short-term resources.
When a company has negative working capital, it can be an indication that the company is having difficulty meeting its short-term financial obligations. This can be a warning sign that the company may have trouble paying its bills on time or may be at risk of defaulting on its loans. Negative working capital can also be an indication that the company is not effectively managing its inventory or accounts receivable.
Negative working capital is not always a negative thing, as it could be a sign of a healthy business that is generating cash faster than it’s using it. For example, a company with a high level of accounts receivable and a low level of accounts payable may have negative working capital, but this could be an indication that the company is generating cash quickly and efficiently.
Amazon is famous for taking a benefit out of negative working capital. It collects from customers while taking orders or on delivery. It pays suppliers after a credit period as per its policy. This leaves it with extra cash perpetually – because the operating cycle itself is negative! So Amazon gets access to capital for free, which it invests in business growth
However, Negative working capital can also be a sign of a company that is struggling to meet its short-term obligations, which could lead to financial difficulties in the future. During due diligence, it is important to review the company’s working capital position and understand its implications on the company’s short-term liquidity and financial performance.
How to calculate free cash flows?
A. Free cash flow (FCF) is a measure of a company’s cash flow that is available for distribution after accounting for capital expenditures. It is the cash that a company generates after accounting for the funds necessary for maintaining and growing its business operations.
The formula for calculating free cash flow is:
Free Cash Flow = Operating Cash Flow – Capital Expenditures
Operating cash flow can be calculated by taking net income, adding back non-cash expenses such as depreciation and amortization, and then subtracting changes in working capital items such as accounts receivable and accounts payable.
Capital expenditures (CapEx) are the funds a company uses to acquire or upgrade physical assets such as property, plant, and equipment. It can be found on the cash flow statement.
What is the most important thing you would look for in annual report while performing due diligence?
A. The most important thing to look for in an annual report while performing financial due diligence is the financial statements, including the income statement, balance sheet, and cash flow statement. These statements provide a detailed picture of the company’s financial performance over the past year and can be used to analyze trends and key drivers of the company’s financial performance.
Additionally, it is important to review the notes to the financial statements, which provide additional information and disclosures about the company’s accounting policies, financial position, and potential risks.
Another important thing to look for in the annual report is the management’s discussion and analysis (MD&A) section, which provides an overview of the company’s financial performance and highlights any significant events or trends that may have impacted the company’s financial results.
Additionally, it is important to review the auditor’s report, which includes the opinion of the independent auditor on the financial statements, to ensure that the financial statements are presented fairly and that they are in compliance with accounting standards.
Lastly, it is important to review the company’s board of director’s report and the CEO’s report, which provide information about the company’s governance and management structure, and the company’s future plans, these can give insight into the company’s vision, management’s perception of the company’s performance and future plans.
