CFA

Today’s  CFA class was quite interesting.  I learned, unlearned, and relearned. Thanks to the Prof.

I now have a better understanding of some accounting concepts and terminologies which I would like to share with you.

Retained earnings:

There is this misconception about retained earnings in the finance world.   Retained earnings are usually a portion of profits that are not distributed as dividends to shareholders.

Now, we usually assume that because this profit was not paid to the shareholders, it is ploughed back into the business. 

This concept is faulty. In some businesses, profit does not necessarily mean the business has the cash to the tune of the profit that was made. Profit might just be accruals (paper Profit).

As managers the onus is on us to review the financial statements diligently especially in  mergers and acquisition deals.  Not paying attention to these things can  put the company into trouble. This is where the need to check the cashflow comes in. If this is not done, we would be assuming that the company is making profits while they are just passing entries.

Assets:

 I am aware that assets can be divided into non-current assets and current assets but in today’s class I saw another way in viewing assets.

Non-current assets are assets whose value will not be realised within a period of one year since they are not easily converted into cash,

Current assets are expected to be consumed, sold, or converted into cash either in one year or in the operating cycle, whichever is longer.

Assets can also be divided into . Income generating assets and non-income generating assets

Income Generating Assets: Are assets that generate consistent, recurrent revenue, cash flow or income over time for an organisation or individual?

Non-Income generating revenue: These assets do not generate any form of rental revenue or cash flow for the individual or organisation. An example is a car.

We were taught to always break down the assets into these two categories when analysing the financial statement of an organisation. 

In the financial statement, it might be stated that the company has a total asset of let’s say 5Bn but if we dig further, we might realise that it is just half of the total asset that is yielding returns.  This would help us in making informed decisions about a company. It will tell whether the company is efficiently and effectively  utilizing their assets

OWNERS CAPITAL

We can classify owners’ capital into two. Contributed capital and Earned Capital.

Contributed Capital is the cash or assets  contributed into the business by the founders of the business. This can be done via IPO and Rights issues.

 Earned capital is the company’s net income which it may elect to retain if not paid out as dividend or after paying out dividend.

Classifying the capital into two components is important . Contributed capital  gives a clearer picture of the investments  from the owners of the business, while the latter  indicates whether the business is earning and how much it is retaining.