BEC - Amazon Web Services · 2019-12-23 · BEC 2020 SuperfastCPA Review Notes. SAMPLE ONLY Table of Contents Corporate Governance 1 Internal Control Frameworks 1 Enterprise Risk

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BEC2020 SuperfastCPA Review Notes

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Table of Contents

Corporate Governance 1 Internal Control Frameworks 1 Enterprise Risk Management Frameworks 6 Other Regulatory Frameworks and Provisions 10

Economic Concepts and Analysis 13 Economic and Business Cycles 13 Market Influences on Business 19 Financial Risk Management 25

Financial Management 30 Capital Structure 30 Working Capital 36 Financial Valuation Methods 42

Information Technology 48 Information Technology Governance 48 Role of IT in Business 52 Information Security/Availability 56 Processing Integrity 60 Systems Development and Maintenance 66

Operations Management 69 Financial and Non-Financial Measures of Performance 69 Cost Accounting 75 Process Management 85

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30 Copyright © 2020 SuperfastCPA.com

Financial Management

Capital Structure

Capital structure is a how a firm uses different sources of funds to finance its operations and growth. This will be some combination of debt and equity: certain industries utilize more debt than stock and others use little debt and rely mostly on stock. Cost of Capital This refers to the opportunity cost of using capital in a project or investment compared to another. If $10 million can either be spent upgrading a company’s equipment vs purchasing bonds, the company would evaluate the expected returns of each option. If upgrading the equipment would produce a 10% return each year for 5 years, and the bonds pay 6% interest, then the equipment upgrade is a better use of the $10 million. Calculating Cost of Capital The average cost of capital is taking the relative weighted “costs” of the different capital sources, meaning the rate of return required by either investors or lenders, to arrive at the weighted average cost of capital for a business. This is then used to evaluate future project or investments, for example: once a business knows their capital has a cost of 9%, any project or investment needs to return more than 9% for the business to consider it.

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The weighted average cost of capital formula is:

Note: The “cost of equity” will be given to you in a problem, since it’s not a defined amount like an interest rate on debt. Example:

Asset Structure This refers to how a business uses assets to generate earnings. The primary metric for measuring a firm’s ability to generate earnings from assets is “return on assets”.

The first thing management decides is how to acquire assets: What blend of debt and equity financing should be used to acquire capital and then acquire assets? The second issue is how can the business maximize the returns on the asset base?

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The components of asset structure are the assets listed on the balance sheet, while “capital structure” refers to long-term debt and equity. Current assets provide the company’s liquidity, while long-term assets are geared towards generating earnings. What type of long-term assets a business holds depends on the business’s strategic goals and nature of its business, its industry, the markets it operates in, economic conditions, and competition. Here are some examples: A technology company would most likely have a large portion of long-term assets as intellectual property and other intangible assets, large amounts of current assets, and relatively small amounts of PPE. An insurance company would hold a lot of financial assets, with little PPE and little intangible assets. A manufacturing company would have a large amount of PPE and large amounts of current assets such as accounts receivable, cash, and inventory. Loan Covenants These are restrictions/requirement placed on a loan or line of credit by the lender, and if the borrower is found to be “out of covenant” by not meeting the requirements, the loan is due immediately.

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Some common examples of loan covenants are: • Meeting certain ratios such as debt to equity or working

capital requirements • Limits on taking on additional debt • Requirements on collateral attached to the loan

Growth Rate Growth rates can be used to evaluate an entire business, a business’s earnings or sales, expenses, or even entire economies.

Example: ABC’s sales in year 1 were $100,000, and sales in year 2 were $120,000. The calculation is:

It’s a very simple calculation to do in your head most of the time, but if the numbers aren’t easy to deal with, you should know the formula. Profitability This is the extent to which a business generates a profit. The most common measures of profitability are profit margin, return on assets, and return on equity.

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There are different measures of profit margin, such as: • Gross Margin: Revenue - COGS • Contribution Margin: Revenue - Variable Expenses • Operating Margin: Operating Income / Revenue • Pretax Margin: Earnings Before Tax / Revenue • Net Profit Margin: Net Income / Revenue

Leverage Financial leverage is the amount of debt a business uses to buy assets. So it’s really the ratio of debt to equity that a business uses to acquire assets. Leverage can result in a business earning a greater return on investment than by using existing assets. Example: ABC buys new equipment for $100,000 in cash and generates a profit of $20,000 with the new equipment. ABC’s return on assets is 20% and is not utilizing any leverage since they paid cash for the equipment. OR, ABC buys new equipment for $10,000 down and a loan of $90,000 and earns $20,000 with the new equipment. ABC’s ROA in this case is 200% by utilizing leverage. The more leverage a business uses, the more risk. As a business takes on more and more debt, the chances increase that they won’t be able to pay it all back. This can be especially risky for a cyclical business, or a business where there are low barriers to entry as competition can make sales fluctuate. A business that has steady and predictable revenue is better suited to utilize a large amount of leverage.

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Another key point is that debt has tax advantages, as interest expense is deductible, but as a firm increases their amount of debt, lenders will charge higher interest rates on additional debt and more strict covenants, thus increasing the risk of default. Risk Different types of financial risk were covered in the previous section, “Financial Risk Management”

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Working Capital

Working capital is the difference in a firm’s current assets and its current liabilities. The objective of working capital is to meet the operating needs of the company such as purchasing inventory and having enough cash to meet obligations as they become due. Working Capital Ratios Ratios to analyze working capital can be divided into two categories:

• Liquidity ratios • Operational ratios

Liquidity ratios:

Times interest earned is measuring the ability of current earnings to cover interest payments for a given period.

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Average collection period is measuring how long it takes for the business to receive payment owed from accounts receivable.

Operational Ratios:

The cash conversion cycle is measuring how long it takes cash invested in inventory to return as cash received from customers.

• The “days inventory outstanding” is the number of days it takes to sell a batch of inventory.

• The “days sales outstanding” is the number of days needed to collect accounts receivable

• The “days payable outstanding” is the days before the business needs to pay its own bills (The longer it can wait, the longer it can hold & invest cash)

Inventory turnover measures how many times inventory is cycled through in a period, and can help identify over or under stocking inventory, or obsolete or slow moving inventory.

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This is measuring how many times receivables are earned and collected in a period, which indicates the effectiveness of the collection policies. Inventory Management The main objective of inventory management is to determine and maintain the optimal amount of all inventories. The cost of carrying inventory is directly related to how much inventory a company should keep on hand. If the cost of carrying inventory rises, the company should carry less inventory, and vice versa. A ‘just in time’ inventory system is aimed at increasing efficiency and eliminating unnecessary costs by reduces inventory on hand but it requires more frequent deliveries from suppliers. Usually vendors will guarantee that their products/supplies are free from defects so that the purchaser doesn’t need to inspect them upon delivery. A JIT system does increase the chances of running out of inventory, but it also lowers inventory carrying costs. The ‘economic order quantity formula’ is a method that aims to determine the order size that will minimize the total inventory cost. Both order cost and carrying cost are assumed to be constant. Also, it is assumed that the periodic demand is known for economic order quantity to be feasible. Accounts Payable Management The way that a business manages their accounts payable, specifically to vendors, can have a big impact on profitability and cash flow. The most important thing is that the business pays their bills on time. This improves relationships with vendors & suppliers, and will result in favorable discounts and credit terms. Discounts and favorable credit terms can increase profitability for the business. As the business grows and develops relationships

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with more and more suppliers, it can lead to good relationships and discounts with all suppliers, which can significantly boost profitability for the business. Cash flow becomes crucial as the business obviously needs enough cash on hand to pay suppliers within the discount period and keep taking advantage of discounts. Lines of Credit and Debt Covenants Lines of credit are different than a long-term note payable, in that nothing is owed until the business makes charges agains the line of credit; it works like a credit card. Debt covenants are common when a business takes on long-term debt or a large line of credit with a bank. Debt covenants typically include stipulations on maintaining a certain level of working capital or staying above a certain working capital ratio. Cash Management Cash management means trying to make sure a firm doesn’t have too much cash or not enough cash. Too much cash is an inefficient use of resources, while not having enough cash causes obvious problems. A lock box system improves control over cash because customer payments are made directly to the bank where the lockbox is and the bank employees are the only ones who deal with the cash. A zero-balance account is a cash management tool that removes any excess cash at the end of each day and moves it to another account. Companies also use these types of accounts for specific purposes such as an account exclusively for paying payroll checks.

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Accounts Receivable Management The overall goal of accounts receivable management is to maximize profits (not sales). A policy that is too loose with granting credit to customers who aren’t creditworthy and will result in bad debt, but a policy that is too tight risks losing credit sales from customers who would pay. The receivables turnover ratio and the average collection period or “days sales outstanding” (see above) are ratios used to measure the effectiveness of collection and credit policies. With the receivables turnover ratio, a business wants to “turnover” their receivables as many times as possible during the year. The more times a business can turnover their receivables in a year, it shows how efficient the business is at collecting cash on credit sales, and that fewer credit sales are being written off. It also helps with liquidity to be efficiently bringing in cash on sales generated. With the average collection period, a business obviously wants to collect receivables in as short a time as possible, so a lower number is better. Some businesses will “factor” their receivables, which means they sell their receivables to a third party at a discount to receive the cash from the receivables sooner than waiting to collect from customers. Accepting credit cards is an example of factoring; businesses accept credit cards and receive cash from Visa or American Express and the business pays a fee to the credit card company.

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The risk that the customer doesn’t pay is then Visa’s problem, not that of the business.

Documents

BEC - Amazon Web Services · 2019-12-23 · BEC 2020 SuperfastCPA Review Notes. SAMPLE ONLY Table of Contents Corporate Governance 1 Internal Control Frameworks 1 Enterprise Risk