Financial Statement Analysis�for Startups

FIN143 · Week 3

Revenue quality, cash needs, and the financial drivers of value

Devon Coombs, CPA, MBA�Santa Clara University · Fall 2026

The four moves of the analysis

1. Verify the data. Reconcile financial reports to contracts, bank activity, and supporting records.
2. Follow the cash. Identify collection timing, required payments, and funding needs.
3. Compute the drivers. Connect operating metrics to free cash flow, burn, and runway.
4. Test the story. Examine revenue durability, contractual claims, and the assumptions behind the forecast.

Course analysis framework.

FIN143 · Week 3

02

Financial Statement Analysis

Devon Coombs, CPA, MBA�Santa Clara University

FIN143 · Week 3

03

The financial statements and how they connect

Assets = liabilities + equity.

Profit flows into retained earnings. Cash flows reconcile beginning and ending cash. Notes explain the accounting policies and commitments behind the totals.

SEC: financial statements

FIN143 · Week 3

04

One transaction, three connected statements

Illustration: a company receives $120,000 on January 1 for a year of service�delivered evenly. It buys $24,000 of equipment that day; useful life is two years,�with no residual value. Ignore taxes and all other activity.

Assets increase $119,000; liabilities plus equity increase $119,000. Profit enters�equity, while collections and capital spending explain the different cash�movement.

Devon Coombs CPA, MBA | Santa Clara University | FIN143

05

Question: Connecting profit and cash

A startup collects $180,000 on January 1 for twelve months of service delivered�evenly. It purchases $36,000 of equipment the same day, depreciated straight-line�over three years with no residual value. Ignore taxes and all other activity.

At January 31, which combination is correct?

A. Profit $15,000; net cash increase $144,000; deferred revenue $165,000.

B. Profit $14,000; net cash increase $144,000; deferred revenue $165,000.

C. Profit $14,000; net cash increase $179,000; deferred revenue $165,000.

D. Profit $14,000; net cash increase $144,000; deferred revenue $180,000.

E. Profit $179,000; net cash increase $144,000; deferred revenue $0.

Devon Coombs CPA, MBA | Santa Clara University | FIN143

06

W3-S006

143

Hard (6/8)

Answer: Connecting profit and cash

B. Profit $14,000; net cash increase $144,000; deferred revenue $165,000.

January revenue = $180,000 / 12 = $15,000. Depreciation = $36,000 / 36 =�$1,000; profit is $14,000.

Cash increases by $180,000 − $36,000 = $144,000. Deferred revenue is $180,000�− $15,000 = $165,000.

A omits depreciation; C treats depreciation as the equipment cash payment; D�omits revenue released from the liability; E recognizes the entire advance as�January revenue.

Devon Coombs CPA, MBA | Santa Clara University | FIN143

07

W3-S006

143

Hard (6/8)

Key Financial Ratios

FIN143 · Week 3

Vertical, horizontal, and peer analysis

Assess a financeable path to sustainable operating cash flow. The earliest possible break-even date is not always the best growth decision.

Course analytical methods. Match periods, definitions, and the question being tested.

FIN143 · Week 3

09

Question: Vertical analysis

KNOWLEDGE CHECK

An analyst wants to see what share of each revenue dollar goes to cost of goods sold and operating expenses. Which tool answers this directly?

A. Horizontal analysis

B. Peer benchmarking

C. Vertical analysis

D. Cohort analysis

E. Terminal value analysis

Devon Coombs CPA, MBA | Santa Clara University | FIN143

10

W3-S010

143

Easy (0/8)

Answer: Vertical analysis

KNOWLEDGE CHECK

C. Vertical analysis

Case: The analyst wants costs as a�share of revenue.

Why: Vertical analysis expresses�each line item as a percentage of a�base, usually revenue.

Key takeaway: Vertical is�proportion within a period;�horizontal is trend over time; peer is�comparison across firms.

Other choices: D tracks customer�groups; E values cash flows beyond�the forecast.

Devon Coombs CPA, MBA | Santa Clara University | FIN143

11

W3-S010

143

Easy (0/8)

Liquidity ratios need a cash-timing check

Current ratio = current assets / current liabilities.

Quick ratio = (cash + short-term marketable securities + net receivables) /�current liabilities. This course convention excludes inventory and prepayments.

A ratio is a balance-sheet snapshot. Test whether receivables will collect, inventory�can sell, and cash is unrestricted before treating assets as payment capacity.

Customer advances can create current liabilities settled by service delivery rather�than repayment of their full face value. Forecast delivery costs and any refund�obligations.

A ratio above 1 does not prove the business can meet each payment on time.

Devon Coombs CPA, MBA | Santa Clara University | FIN143

12

Question: Ratios and payment capacity

A startup reports $300,000 cash, $600,000 net receivables, $400,000 inventory, and�$200,000 prepaid costs. Current liabilities are $1 million. There are no marketable�securities. Most receivables arrive in 90 days, while a large supplier payment is due in�30 days. Under the stated course definitions, which assessment is correct?

A. Current ratio 0.90×; quick ratio 1.50×; the receivable balance proves timely�payment capacity.

B. Current ratio 1.50×; quick ratio 0.90×; the collection and payment schedule still�needs testing.

C. Current ratio 1.50×; quick ratio 1.30×; inventory should be included in the�quick-ratio numerator.

D. Current ratio 1.30×; quick ratio 0.90×; prepaid costs should be excluded from�current assets.

E. Current ratio 1.50×; quick ratio 1.10×; prepaid costs can fund the upcoming supplier�payment.

Devon Coombs CPA, MBA | Santa Clara University | FIN143

13

W3-S013

143

Hard (6/8)

Answer: Ratios and payment capacity

B. Current ratio 1.50×; quick ratio 0.90×; the collection and payment schedule�still needs testing.

Calculation: Current assets = $0.3m + $0.6m + $0.4m + $0.2m = $1.5m. Quick�assets = $0.3m + $0.6m = $0.9m. Divide each by $1.0m of current liabilities.

Interpretation: Receivables due in 90 days may not fund a payment due in 30. The�case does not provide enough payment detail to conclude that default is certain.

Other choices: A reverses the ratios. C includes inventory in quick assets. D�excludes prepaid current assets from the current ratio. E treats prepaid costs as�quick assets.

Devon Coombs CPA, MBA | Santa Clara University | FIN143

14

W3-S013

143

Hard (6/8)

Startup financial data may be incomplete

• Accounting teams may be small, outsourced, or absent.
• Reports may combine cash-basis records, accrual adjustments, and internal operating metrics.
• Management may emphasize measures that present momentum most favorably.
• Check reporting periods, accounting policies, and metric definitions before comparing results.

Reconcile the narrative to contracts, bank records, invoices, and operating evidence. Incomplete reporting creates a verification task, not an automatic investment verdict.

Course diligence guidance. No claim about the percentage of startups using a particular accounting method.

FIN143 · Week 3

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When revenue is earned

Under ASC 606, revenue follows fulfillment of the contract’s performance obligations.

The analysis identifies the customer contract, the promised goods or services, the transaction price, and its allocation to those promises.

• A product sale may qualify when control transfers at a point in time.
• A qualifying service may earn revenue as the company performs over time.
• Signing, invoicing, and receiving cash do not independently establish that the company earned revenue.

Timing depends on the contract and what the company has delivered.

FASB: Topic 606, recognition and contract liabilities

FIN143 · Week 3

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Question: Analyst posture

KNOWLEDGE CHECK

A founder presents financials that recognize revenue at signing and emphasize cash inflows over outflows.. What posture should the analyst take?

A. Accept the statements, since founders know the business best

B. Reject the company as uninvestable on accounting grounds

C. Verify data quality and reconcile to cash

D. Require audited GAAP statements before any analysis

E. Rely on the income statement and set the cash flows aside

Devon Coombs CPA, MBA | Santa Clara University | FIN143

17

W3-S017

143

Easy (1/8)

Answer: Analyst posture

KNOWLEDGE CHECK

C. Verify data quality and reconcile to cash

Case: The founder records revenue�at signing and emphasizes inflows.

Why: Assume the data is imperfect,�stay skeptical, and reconcile it to�contracts, cash, and operating�evidence.

Key takeaway: Startup data is�often incomplete. Reconcile the�narrative to contracts, cash, and�operating evidence.

Other choices: A accepts�unverified reports; B jumps to�rejection; D makes an audit a�prerequisite to analysis; E ignores�cash timing.

Devon Coombs CPA, MBA | Santa Clara University | FIN143

18

W3-S017

143

Easy (1/8)

Revenue analytics

Revenue recognition: When has the company earned revenue?

Gross versus net: Does it provide the promised good or service, or arrange for another party to provide it?

Bookings, billings, revenue, and collections: What does each number measure?

FIN143 · Week 3

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Principal or agent under ASC 606

Principal: Controls the specified good or service before transfer. Recognizes the gross amount to which it is entitled.

Agent: Arranges for another party to provide the specified good or service. Recognizes its fee or commission.

Fulfillment responsibility, inventory risk, and pricing discretion are indicators that inform the control assessment. They are not three mandatory conditions.

Assess each specified good or service. One company can act as principal in some arrangements and agent in others.

FASB: principal versus agent, ASU 2016-08

FIN143 · Week 3

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Uber: Gross Bookings and revenue

Q4 2025, historical example

Gross Bookings measures platform activity. It differs from GAAP revenue and from signed-contract bookings in a subscription business.

The 26.5% ratio is a consolidated comparison, not a uniform commission rate. Uber reports some activities net and others gross.

Uber: Q4 2025 results · Uber: 2025 Form 10-K, revenue policies

FIN143 · Week 3

21

Question: Agent revenue

KNOWLEDGE CHECK

A platform facilitates $10 million of customer transactions during the year and�retains a 15% commission on each transaction. The platform has 250,000 active�users, an average transaction value of $40, and incurred $600,000 of marketing�costs and $400,000 of platform-development costs during the year. The third-party�sellers are responsible for fulfilling the orders, and the platform does not control the�underlying goods or services before they are transferred to customers.

Under ASC 606, how much revenue should the platform report?

A. $10 million, the full amount it processed

B. $8.5 million, net of the fee it pays out

C. $11.5 million gross, with the payout as expense

D. $1.5 million, the fee it retains as agent

E. Either amount, since net income is the same

Devon Coombs CPA, MBA | Santa Clara University | FIN143

22

W3-S022

143

Medium (3/8)

Answer: Agent revenue

KNOWLEDGE CHECK

D. $1.5 million, the fee it retains as agent

Control determines the treatment

The platform does not control the�goods or services before transfer. It�acts as an agent and reports its�commission as revenue.

Revenue = $10m × 15% = $1.5m

Marketing and development costs do�not determine whether revenue is�reported gross or net.

Why the other choices are wrong

A: $10m is total transaction volume.

B: $8.5m is the sellers’ share.

C: $11.5m adds a commission already�included in the $10m.

E: Gross versus net reporting follows�the control assessment. It is not a�reporting choice.

Devon Coombs CPA, MBA | Santa Clara University | FIN143

23

W3-S022

143

Medium (3/8)

Bookings, billings, revenue, and collections

A three-year $360,000 contract can produce $360,000 of bookings and $120,000 of first-year billings.

Net-45 terms mean payment is due 45 days after the invoice date. Actual receipt can be earlier or later.

Bookings and billings are operating measures whose definitions can vary. FASB: Topic 606, recognition and contract liabilities

FIN143 · Week 3

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One $360,000 service contract

Assume a firm three-year contract signed on January 1, uniform service, $120,000 billed annually in advance, and payment on day 45. No other performance obligations or price adjustments.

The four measures describe the same contract from different perspectives.

Illustrative course example. Straight-line recognition requires the stated service pattern. FASB: Topic 606, recognition and contract liabilities

FIN143 · Week 3

25

Question: Cash collections

KNOWLEDGE CHECK

A founder says the company 'did $5 million last quarter.' Which figure most directly shows cash actually received from customers during that quarter?

A. Bookings

B. Cash collections

C. Billings

D. Recognized revenue

E. Annual recurring revenue

Devon Coombs CPA, MBA | Santa Clara University | FIN143

26

W3-S026

143

Easy (0/8)

Answer: Cash collections

KNOWLEDGE CHECK

B. Cash collections

Case: A founder says the company “did $5 million” in a quarter.

Why: Cash collections measure customer payments received during the�quarter. Cash still on hand also depends on beginning cash and every cash�inflow and outflow.

Key takeaway: Bookings, billings, revenue, and collections measure�different things. Reconcile cash movements to the ending cash balance.

Other choices: A is signed contracts; C is invoices; D is earned revenue; E�is recurring revenue scale. None establishes customer payment.

SEC: financial statements

Devon Coombs CPA, MBA | Santa Clara University | FIN143

27

W3-S026

143

Easy (0/8)

Deferred revenue and delivery obligations

Deferred revenue is a contract liability for goods or services still owed to a customer. It can arise when payment is received or becomes due before performance.

A $2 million cash balance and $1.5 million deferred-revenue balance do not imply only $500,000 is usable. The cash needed to fulfill the obligation depends on delivery costs, refund rights, and other commitments.

Customer prepayments can support a sound business. Test fulfillment margins and cash needs if advance collections slow.

FASB: Topic 606, recognition and contract liabilities · Deferred revenue does not, by itself, legally restrict an equal amount of cash.

FIN143 · Week 3

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Question: Deferred revenue

KNOWLEDGE CHECK

A startup's operating cash flow is positive because customers increasingly pay before the company delivers, creating deferred revenue.�This indicates that:

A. Delivered revenue is growing strongly this period

B. The company carries no future delivery obligations

C. Net income is being understated this period

D. The cash can be recognized as revenue now

E. Cash arrived ahead of an obligation to deliver

Devon Coombs CPA, MBA | Santa Clara University | FIN143

29

W3-S029

143

Easy (1/8)

Answer: Deferred revenue

KNOWLEDGE CHECK

E. Cash arrived ahead of an obligation to deliver

Case: Advance customer payments drive positive operating cash flow.

Why: In this case, customers paid before delivery. The company still owes�the promised goods or services.

Key takeaway: Customer advances can support the business. Test the�costs and timing of delivery, refunds, and future collections.

Other choices: A/C infer unsupported performance or profit effects. B�ignores delivery obligations; D recognizes revenue before performance.

FASB: Topic 606, recognition and contract liabilities

Devon Coombs CPA, MBA | Santa Clara University | FIN143

30

W3-S029

143

Easy (1/8)

Question: Deferred revenue and refunds

KNOWLEDGE CHECK

A SaaS company begins the year with $84,000 of deferred revenue.�Customers pay before the related service revenue is recognized, and the�company has no accounts receivable.

The company reports the following activity for the first three quarters:

Every refund returns an unearned customer advance already included in�deferred revenue. None reverses revenue that was previously recognized,�and there are no other changes to the deferred-revenue balance.

Management highlights the strong third-quarter cash collections in its�investor update.

At September 30, what is the deferred-revenue balance, and how do�year-to-date customer cash collections after refunds compare with�year-to-date recognized revenue?

A. Deferred revenue:�$60,000; net collections are�$24,000 below recognized�revenue.

B. Deferred revenue:�$75,000; net collections are�$9,000 below recognized�revenue.

C. Deferred revenue:�$99,000; net collections are�$15,000 above recognized�revenue.

D. Deferred revenue:�$105,000; net collections�are $21,000 above�recognized revenue.

E. Deferred revenue:�$123,000; net collections are�$39,000 above recognized�revenue.

Devon Coombs CPA, MBA | Santa Clara University | FIN143

31

W3-S031

143

Hard (6/8)

Answer: Deferred revenue and refunds

KNOWLEDGE CHECK

B. Deferred revenue: $75,000; net collections are $9,000 below recognized revenue.

Work the calculation

Gross collections = $180,000 + $120,000 +�$225,000 = $525,000. Refunds total $24,000, so�net customer collections are $501,000.

Recognized revenue = $150,000 + $165,000 +�$195,000 = $510,000. Net collections are�therefore $9,000 below revenue.

Ending deferred revenue = opening deferred�revenue + gross collections − refunds −�recognized revenue = $84,000 + $525,000 −�$24,000 − $510,000 = $75,000.

The quarter-end balances are $114,000, $54,000,�and $75,000. The $9,000 decline in the liability�reconciles the year-to-date cash-versus-revenue�difference.

Why the other choices are wrong

A. Uses only the $24,000 of refunds as the�change in deferred revenue and as the collections�shortfall. It omits the $15,000 excess of gross�collections over recognized revenue.

C. Uses gross collections of $525,000 instead of�net collections of $501,000, omitting both�quarters of refunds.

D. Adds only Q3 net activity, $225,000 − $9,000�− $195,000 = $21,000, to the January opening�balance. It also substitutes the Q3 difference for�the requested year-to-date difference.

E. Adds the $24,000 of refunds to collections�instead of subtracting them, yielding $549,000 −�$510,000 = $39,000 and $84,000 + $39,000 =�$123,000.

Devon Coombs CPA, MBA | Santa Clara University | FIN143

32

W3-S031

143

Hard (6/8)

Cash flow and survival

Cash sources: What came from customers, asset sales, borrowing, or new equity?

Cash timing: When must the company pay, and when will it collect?

Cash obligations: What commitments remain after the current inflow?

FIN143 · Week 3

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Cash flow analysis

Revenue or profit can rise while the company runs short of cash.

The cash flow statement separates operating activity from investment and financing. It complements accrual financial statements and helps reconcile profit to cash.

Some startups initially keep cash-basis records. Funding, lending, or acquisition requirements may prompt accrual reporting. The timing varies.

Start with reconciled cash activity, then review receivables, payables, customer advances, and commitments. Cash receipts alone do not establish sustainable performance.

SEC: financial statements · Cash-basis bookkeeping and a GAAP cash flow statement are different things.

FIN143 · Week 3

34

Positive profit, negative operating cash flow

Illustrative quarter; amounts in $ thousands. Assume no other reconciling items.

The company earned $100,000 but operations used $20,000 of cash. Receivables and payables explain timing differences between profit and cash.

Illustrative reconciliation using the indirect method. Investing and financing cash flows are separate. SEC: financial statements

FIN143 · Week 3

35

Question: Operating cash flow

KNOWLEDGE CHECK

A SaaS company begins the year with $250,000 of cash and reports a�$450,000 net loss for the year. The net loss includes $120,000 of depreciation�and amortization and $90,000 of noncash stock-based compensation.

The following operating balances change during the year:

These changes arise only from ordinary operating transactions. The increase in�deferred revenue comes from customers paying in advance for future services.

The company also pays $210,000 for capital expenditures, receives $300,000�from new borrowing, and repays $60,000 of loan principal.

Assume no other noncash adjustments, working-capital changes, tax or�interest timing adjustments, or cash flows. Use the indirect method under U.S.�GAAP.

What are cash flow from operations and the total change in cash for the�year?

A. Operating cash flow:�−$330,000; total cash�change: −$300,000.

B. Operating cash flow:�$60,000; total cash�change: $90,000.

C. Operating cash flow:�$150,000; total cash�change: $180,000.

D. Operating cash flow:�$390,000; total cash�change: $180,000.

E. Operating cash flow:�$470,000; total cash�change: $500,000.

Devon Coombs CPA, MBA | Santa Clara University | FIN143

36

W3-S036

143

Hard (7/8)

Answer: Operating cash flow

KNOWLEDGE CHECK

C. Operating cash flow: $150,000; total cash change: $180,000.

Work the calculation

Operating cash flow = −$450,000 +�$120,000 + $90,000 − $160,000 + $70,000�+ $480,000 = $150,000.

Investing cash flow is −$210,000, and�financing cash flow is $300,000 − $60,000 =�$240,000. Total change in cash = $150,000 −�$210,000 + $240,000 = $180,000.

Ending cash would be $250,000 + $180,000�= $430,000, but the question asks for the�change.

Operating cash flow less CapEx is −$60,000,�so the increase in the bank balance depends�on financing.

Customer advances also contribute materially�to positive operating cash flow; they�accompany future service obligations.

Why the other choices are wrong

A. Omits the $480,000 increase in deferred revenue�from customer advances. Those cash receipts�precede revenue recognition and must be reflected in�operating cash flow.

B. Does not add back the $90,000 noncash�compensation expense already deducted in net loss.�This is an operating-cash-flow reconciliation, not a�claim that stock compensation has no economic cost.

D. Includes $240,000 of net borrowing in operating�cash flow. It can still reach the right total cash change�by misclassifying those financing flows and�subtracting CapEx, but the requested operating�subtotal is wrong.

E. Adds the $160,000 increase in receivables instead�of subtracting it. The resulting $320,000�overstatement carries into the total cash change.

Devon Coombs CPA, MBA | Santa Clara University | FIN143

37

W3-S036

143

Hard (7/8)

Risks a cash-only view can miss

Unpaid obligations: Vendor bills, earned compensation, and other commitments may not appear in cash records until payment.

Advance collections: Prepayments and deposits bring cash forward while leaving delivery or refund obligations.

Discounts: A 50% discount reduces revenue per sale. Whether the sale remains attractive depends on costs, retention, and the benefit of earlier collection.

Review contracts and payment schedules alongside margins. Faster collection and annual prepayment can be healthy when the underlying economics work.

Course diligence guidance. Future commitments and contingencies are not automatically recognized accounting liabilities.

FIN143 · Week 3

38

Discounted Cash Flow Refresh

Devon Coombs, CPA, MBA�Santa Clara University

FIN143 · Week 3

39

Cash-flow dates and time value

At a positive required return, earlier cash has greater value when risk and other terms are equal.

PV is value today. FV is value at a later date. r is the rate per period, and n is the number of periods.

Compound to move value forward. Discount to move value back. Mark payments negative and receipts positive.

40

Compounding over one and two years

One year

You invest $1,000 today at 5% per year, compounded annually, with no additional deposits or withdrawals. How much will you have at the end of one year?

Two years

Leave the same $1,000 invested for two years at 5%, with no deposits or withdrawals. Is the ending balance $1,100, or does compounding produce a different result? Explain before calculating.

41

Compounding: the worked answers

FV = PV × (1 + r)ⁿ.

Year 1: $1,000 × 1.05 = $1,050.

Year 2: $1,000 × 1.05² = $1,102.50.

Year 1 earns $50 of interest. Year 2 earns $52.50 because the first year’s interest also earns interest. That produces $2.50 more than simple interest over two years.

42

Present value of a future target

PV = FV / (1 + r)ⁿ.

Discounting expresses a future amount in today’s dollars at the stated rate.

You want $2,000 at the end of five years and can earn 5% per year, compounded annually. There will be no additional contributions or withdrawals.

How much must you invest today?

43

Present value: calculation and calculator check

PV = $2,000 / 1.05⁵ = $1,567.05. Interest grows the smaller contribution to the target over five years.

TI BA II Plus: Clear TVM and check P/Y = C/Y = 1.

Enter PMT = 0 explicitly. The negative PV marks money paid today.

44

Annuity timing and present value

An annuity has equal payments at equal intervals.

Ordinary-annuity PV = C × [1 − (1 + r)^(−n)] / r.

For three $100 year-end receipts at 8%, PV is $257.71. Each due payment occurs one period earlier and therefore has greater PV at a positive rate.

45

Beginning versus end: the deposit example

Make three $1,000 deposits at 10% annually, with no other cash flow. Value both accounts at time 3.

End: $1,000 × 1.10² + $1,000 × 1.10 + $1,000 = $3,310.

Beginning: $3,310 × 1.10 = $3,641.

Each beginning deposit earns one more year of interest. The difference is $331.

46

Investment cash flow and NPV

For an operating project, include incremental cash receipts, cash operating costs,�taxes, capital spending, and working-capital changes. Include any terminal�recovery at its actual date.

NPV = cash flow today + sum of later cash flows discounted to today.

Count each cash flow once. Identical costs under two payment options cancel in�an incremental comparison.

Match the discount rate to the cash-flow risk and the claim being valued. A�positive NPV means modeled benefits exceed costs at that required return; the�project may still need funding before receipts arrive.

Devon Coombs CPA, MBA | Santa Clara University | FIN143

47

Question: Discounted prepayments

KNOWLEDGE CHECK

A company lifted this quarter's cash by offering customers 50% discounts to prepay annually. On a cash-basis view, the inflow is best read as:

A. Cash arrives earlier, while future delivery obligations remain

B. A durable improvement in operating performance

C. Evidence of strong underlying unit economics

D. Irrelevant, since cash is always the best signal

E. A reduction in the company's deferred revenue

Devon Coombs CPA, MBA | Santa Clara University | FIN143

48

W3-S048

143

Easy (1/8)

Answer: Discounted prepayments

KNOWLEDGE CHECK

A. Cash arrives earlier, while future delivery obligations remain

Case: Customers receive a 50%�discount for annual prepayment.

Why: Annual prepayment�accelerates collection. The 50%�discount lowers the price per�period of service, but profitability�still depends on delivery costs and�customer behavior.

Key takeaway: Check collection�timing, discounted contribution,�and the remaining fulfillment costs�before treating the inflow as�sustainable performance.

Other choices: B/C infer durability�or economics without evidence; D�ignores timing; E reverses the usual�deferred-revenue effect.

Devon Coombs CPA, MBA | Santa Clara University | FIN143

49

W3-S048

143

Easy (1/8)

Question: Discounted prepayments

KNOWLEDGE CHECK

A company offers a three-year service contract under two payment options:

• Annual billing: The customer pays $140,000 at the end of each year for three years.

• Prepayment: The customer pays the full three-year contract price today and receives an 18%�discount from the total undiscounted price.

If the customer prepays, the company also incurs an $8,400 processing and�contract-administration cost today. This cost is not incurred under annual billing.

The company can immediately reinvest any cash it receives in another business line that is�expected to earn a 22% annual return over the next three years. The company incurs $28,000 of�service-delivery costs at the end of each year under either payment option.

Assume the service obligations are identical, all amounts are collected as scheduled, and there are�no taxes or other incremental cash flows. Treat 22% as the appropriate annual opportunity cost of�capital for this comparison.

What is the incremental NPV today to the company of accepting prepayment rather than annual�billing, rounded to the nearest $100?

A. −$84,000

B. −$12,800

C. −$7,100

D. +$50,100

E. +$58,500

Devon Coombs CPA, MBA | Santa Clara University | FIN143

50

W3-S050

143

Hard (7/8)

Answer: Discounted prepayments

KNOWLEDGE CHECK

D. +$50,100

Work the calculation

The nominal three-year price is 3 × $140,000 =�$420,000. Gross prepayment = $420,000 × 82%�= $344,400; net cash today = $344,400 −�$8,400 = $336,000.

Present value of annual receipts = $140,000/1.22�+ $140,000/1.22² + $140,000/1.22³ =�$285,913.80.

Incremental NPV = $336,000 − $285,913.80 =�+$50,086.20, or +$50,100 to the nearest $100.

The $28,000 delivery payments occur on identical�dates under both alternatives and cancel.

The positive incremental NPV supports�prepayment under the stated assumptions�despite the lower nominal price.

Why the other choices are wrong

A. Compares the $336,000 net upfront cash with�the $420,000 undiscounted annual receipts. It�ignores the value of receiving cash earlier.

B. Treats the annual payments as occurring at�signing and at the ends of years one and two.�They actually arrive at the ends of years one, two,�and three.

C. Subtracts the present value of the $28,000�annual delivery costs from only the prepayment�alternative. The same costs occur at the same�dates under annual billing, so they cancel in the�incremental comparison.

E. Uses the $344,400 discounted contract price�as net upfront cash, omitting the additional�$8,400 fee due today.

Devon Coombs CPA, MBA | Santa Clara University | FIN143

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Hard (7/8)

Positive unit economics do not guarantee survival

Positive customer contribution helps pay overhead, but acquiring customers may�consume cash before their payments arrive.

“Default alive” describes a company projected to reach profitability before existing�cash runs out, assuming constant expenses and continuation of recent revenue�growth.

For a cash-based decision, also model collection delays, capital spending, debt�payments, and the cash floor. Accounting profitability alone may arrive before�cash sustainability.

Test whether the full cash schedule reaches sustainable operations without an�uncommitted financing round. Faster growth can increase the near-term funding�gap.

Devon Coombs CPA, MBA | Santa Clara University | FIN143

52

Question: Growth and collection timing

A startup earns a positive contribution margin on every new customer. Customer acquisition spending is paid immediately, but customers pay invoices 60 days later. Sales are accelerating rapidly. Which conclusion is most accurate?

A. Positive contribution margin should reduce financing needs as sales grow because customer-level profit eventually offsets acquisition spending.

B. The 60-day collection lag matters mainly for working-capital presentation, while funding needs depend primarily on customer contribution margin.

C. Faster growth can increase short-term financing needs because acquisition cash is paid before the related customer cash is collected.

D. Faster growth should improve liquidity if the company maintains the same acquisition cost and contribution margin per customer.

E. The company is likely default alive if contribution margin remains positive, even when customer collections continue to lag acquisition spending.

Question FIN143

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Easy (1/8)

Answer: Growth and collection timing

A startup earns a positive contribution margin on every new customer. Customer acquisition spending is paid immediately, but customers pay invoices 60 days later. Sales are accelerating rapidly. Which conclusion is most accurate?

A. Positive contribution margin should reduce financing needs as sales grow because customer-level profit eventually offsets acquisition spending.

B. The 60-day collection lag matters mainly for working-capital presentation, while funding needs depend primarily on customer contribution margin.

C. Faster growth can increase short-term financing needs because acquisition cash is paid before the related customer cash is collected.

D. Faster growth should improve liquidity if the company maintains the same acquisition cost and contribution margin per customer.

E. The company is likely default alive if contribution margin remains positive, even when customer collections continue to lag acquisition spending.

Answer FIN143

Correct answer: C.

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Answer: Growth and collection timing — explanation

Case: Acquisition cash is paid immediately. Customer invoices are collected 60 days later. Each new customer has positive contribution margin.

Answer C: Faster growth adds more customers whose acquisition spending must be funded before their payments arrive.

A and D: Positive contribution and stable unit costs do not eliminate the collection gap.

B: The collection lag creates a real cash requirement.

E: Default alive depends on the full path to cash sustainability, including overhead, growth, and available cash.

Default alive: The company is projected to reach profitability before its existing cash runs out, assuming constant expenses and continued recent revenue growth.

Course interpretation of the collection-lag case. Paul Graham: Default Alive or Default Dead?

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Easy (1/8)

Question: Profit and delayed collections

KNOWLEDGE CHECK

A startup is preparing its first-quarter forecast. It begins January with $180,000 of�cash and no accounts receivable or accounts payable.

Each one-time order has the following terms:

• The company recognizes $1,200 of revenue when it delivers the order.

• Acquisition and delivery costs total $900, paid and expensed in the delivery month.

• The customer pays in full at the end of the second month after delivery. For�example, January orders are collected at the end of March.

Fixed operating costs are $15,000 per month, paid and expensed monthly. An�investor has mentioned a possible $500,000 investment in a nonbinding letter, but�the forecast includes no financing.

Assume all scheduled orders are delivered, with no taxes, noncash items, payment�deferrals, or other cash flows. A negative projected cash balance represents an�unfunded shortfall.

What are projected first-quarter operating profit and the March 31 cash balance�before financing?

A. Operating profit:�−$129,000; cash�before financing:�$75,000.

B. Operating profit:�$75,000; cash�before financing:�−$225,000.

C. Operating profit:�$75,000; cash�before financing:�−$129,000.

D. Operating profit:�$75,000; cash�before financing:�$255,000.

E. Operating profit:�$120,000; cash�before financing:�−$84,000.

Devon Coombs CPA, MBA | Santa Clara University | FIN143

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Answer: Profit and delayed collections

KNOWLEDGE CHECK

C. Operating profit: $75,000; cash before financing: −$129,000.

Work the calculation

There are 400 delivered orders. Revenue =�400 × $1,200 = $480,000. Variable costs�= 400 × $900 = $360,000, and fixed costs�= 3 × $15,000 = $45,000. Operating profit�= $75,000.

Only January's 80 orders are collected by�March 31: 80 × $1,200 = $96,000.�Unfinanced cash = $180,000 + $96,000 −�$360,000 − $45,000 = −$129,000.

The negative modeled balance identifies a�funding shortfall; it is not spendable cash.

Why the other choices are wrong

A. Confuses the operating-profit�result with the unfinanced cash�deficit.

B. Ignores the $96,000 collection�from January orders that arrives at�the end of March.

D. Treats all first-quarter sales as�collected: $180,000 + $480,000 −�$405,000 = $255,000.

E. Omits the $45,000 of fixed costs�from both profit and cash payments.

Devon Coombs CPA, MBA | Santa Clara University | FIN143

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Hard (7/8)

Cash needs and valuation cash flows

Operating working capital: Cash tied up between paying for operations and collecting from customers.

FCFF and FCFE: Cash flow after reinvestment, measured for different capital providers.

Burn and runway: The rate of cash use and the time available to fund the plan.

Valuation link: These cash flows supply inputs to the later valuation analysis.

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Working capital for liquidity and valuation

Balance-sheet working capital = current assets − current liabilities.

Net operating working capital (NOWC) = noncash operating current assets − nondebt operating current liabilities.

Receivables and inventory tie up cash. Payables and customer advances can finance operations. Under a consistent definition, an increase in NOWC reduces free cash flow.

Exclude cash and financing debt from the course’s FCFF/FCFE working-capital calculation.

In an acquisition, a working-capital “peg” is a negotiated target with transaction-specific definitions.

Damodaran: working capital in valuation · The purchase agreement governs the acquisition adjustment.

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The cash conversion cycle measures a timing gap

For a business that sells inventory, use consistent annual data and average�balances:

DSO = average receivables / annual credit sales × 365.�Inventory days = average inventory / annual cost of goods sold × 365.�DPO = average trade payables / annual credit purchases × 365. Cost of goods sold�is an approximation when purchases data are unavailable.�Cash conversion cycle = inventory days + DSO − DPO.

With 50 inventory days, 40 collection days, and 30 supplier-payment days, the�cycle is 60 days. It describes operating cash timing, not the cash balance or�runway. Subscription businesses may instead be funded partly by customer�advances.

Devon Coombs CPA, MBA | Santa Clara University | FIN143

60

Question: Collection timing and cash required

Annual credit sales are $3.65 million and average receivables are $500,000. Sales�occur evenly, bad debts are negligible, and inventory and supplier terms remain�unchanged. Management can reduce DSO to 35 days without affecting sales or�margins.

Using 365 days, what are current DSO and the one-time cash released when�receivables reach the target?

A. Current DSO: 35 days; cash released: $150,000.

B. Current DSO: 50 days; cash released: $350,000.

C. Current DSO: 50 days; cash released: $500,000.

D. Current DSO: 50 days; cash released: $150,000.

E. Current DSO: 73 days; cash released: $150,000.

Devon Coombs CPA, MBA | Santa Clara University | FIN143

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Medium (4/8)

Answer: Collection timing and cash required

D. Current DSO: 50 days; cash released: $150,000.

Daily credit sales = $3,650,000 / 365 = $10,000. Current DSO = $500,000 /�$10,000 = 50 days.

Target receivables = 35 × $10,000 = $350,000. The reduction releases $150,000�once; it is not additional recurring revenue or profit.

A confuses target with current DSO. B reports the target balance. C releases all�receivables. E reverses the timing calculation.

Devon Coombs CPA, MBA | Santa Clara University | FIN143

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Medium (4/8)

Free cash flow to the firm

FCFF = EBIT × (1 − tax rate) + D&A − CapEx − increase in NOWC

• EBIT is operating profit before interest and tax.
• D&A adds back depreciation and amortization already deducted from profit.
• CapEx and increased operating working capital represent reinvestment.

FCFF measures cash flow available to debt and equity capital before debt financing flows.

Net reinvestment = CapEx − D&A + increase in NOWC.

A loss does not automatically create a current cash tax refund. Model taxes and usable loss carryforwards explicitly.

Damodaran: free cash flows · Damodaran: taxes and operating losses · Simplified course formula. NOWC = net operating working capital.

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Free cash flow to equity

FCFE = net income + D&A − CapEx�− increase in NOWC + net borrowing

Net income is after interest and tax. Net borrowing equals new debt proceeds minus principal repayments.

FCFE measures cash potentially available to equity after operating needs, reinvestment, and debt cash flows. It is not automatically a dividend or the change in the bank balance.

With consistent operating, tax, and financing assumptions:

FCFE = FCFF − after-tax interest + net borrowing

Damodaran: free cash flows · Simplified formulas exclude additional adjustments such as other noncash or nonoperating items.

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Worked example: FCFF and FCFE

Illustrative annual amounts in $ millions. Assume no other noncash or nonoperating adjustments.

After-tax interest is $0.15M in this example. The bridge is $1.10M − $0.15M + $0.40M = $1.35M.

Illustrative annual example using consistent operating, tax, and financing assumptions. Damodaran: free cash flows

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Question: Working capital and FCFF

KNOWLEDGE CHECK

In the FCFF formula, how does an increase in net operating working capital, excluding cash and financing debt, affect free cash flow?

A. It increases FCFF, as a source of cash

B. It has no effect on FCFF either way

C. It increases FCFF only when debt rises

D. It decreases FCFF, as a use of cash

E. It reduces net income but not FCFF

Devon Coombs CPA, MBA | Santa Clara University | FIN143

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Easy (0/8)

Answer: Working capital and FCFF

KNOWLEDGE CHECK

D. It decreases FCFF, as a use of cash

Case: Net operating working�capital increases in an FCFF�calculation.

Why: More cash tied up in�receivables or inventory is a use�of cash, so FCFF falls.

Key takeaway: An increase in net�operating working capital is a use of�cash. It is subtracted in both FCFF and�FCFE under consistent definitions.

Other choices: A reverses the sign; B�ignores the cash use; C confuses debt�with operations; E confuses cash use�with expense recognition.

Damodaran: working capital in valuation

Devon Coombs CPA, MBA | Santa Clara University | FIN143

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Easy (0/8)

Question: Free cash flow to the firm

KNOWLEDGE CHECK

A profitable equipment-software company reports the following annual�results:

• EBIT: $6.40 million, after $0.90 million of depreciation and amortization.

• Capital expenditures: $1.70 million.

• Tax rate: 25%.

Its only operating working-capital accounts are shown below. All balances�are in millions of dollars.

During the year, the company also pays $0.40 million of interest, issues�$0.90 million of new debt, and repays $0.25 million of debt principal.

Assume no loss carryforwards, tax timing differences, or other noncash�adjustments.

What is the company's annual free cash flow to the firm (FCFF)?

A. $3.00 million.

B. $3.35 million.

C. $3.70 million.

D. $4.00 million.

E. $4.65 million.

Devon Coombs CPA, MBA | Santa Clara University | FIN143

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Answer: Free cash flow to the firm

KNOWLEDGE CHECK

B. $3.35 million.

Work the calculation

Beginning net operating working�capital = $1.20m + $0.65m − $0.80m�= $1.05m. Ending NOWC = $1.90m +�$0.95m − $1.15m = $1.70m, an�increase of $0.65m.

After-tax EBIT = $6.40m × 75% =�$4.80m. FCFF = EBIT × (1 − tax rate)�+ D&A − CapEx − increase in NOWC�= $4.80m + $0.90m − $1.70m −�$0.65m = $3.35m.

Interest, borrowing, and principal�repayment belong to the�financing/equity bridge rather than�this EBIT-based FCFF calculation.

Why the other choices are wrong

A. Subtracts the $1.00 million increase in receivables�and inventory without recognizing the $0.35 million�increase in payables as operating financing.

C. Computes FCFE instead: $3.35m − $0.40m × 75%�+ $0.90m − $0.25m = $3.70m. The question�requests cash flow to all capital providers before�debt financing flows.

D. Adds the $0.65 million net borrowing to FCFF.�Debt issuance and principal repayment are financing�flows, not components of FCFF.

E. Adds the $0.65 million increase in operating�working capital instead of subtracting it: $4.80m +�$0.90m − $1.70m + $0.65m = $4.65m.

Devon Coombs CPA, MBA | Santa Clara University | FIN143

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Cash burn and runway

Gross operating burn: Monthly operating cash outflows.

Net operating burn: Operating cash outflows minus operating cash inflows, excluding new financing.

Simple runway: Usable cash ÷ positive monthly net burn.

The shortcut assumes a stable burn rate and no additional cash requirements. A cash forecast must also include planned capital spending, debt payments, collection timing, and a minimum cash reserve.

If net burn is zero or negative, the shortcut does not provide a meaningful depletion date. Forecast the cash balance instead.

Course convention. State the scope of burn consistently and use cash available for the plan.

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Question: Runway

KNOWLEDGE CHECK

A pre-revenue startup holds $1.8 million in cash and burns $150,000 net per month. What is its runway?

A. 9 months

B. 18 months

C. 6 months

D. 15 months

E. 12 months

Devon Coombs CPA, MBA | Santa Clara University | FIN143

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Easy (2/8)

Answer: Runway

KNOWLEDGE CHECK

E. 12 months

Case: Usable cash is $1.8M and�constant monthly net burn is�$150,000.

Why: $1.8 million divided by�$150,000 per month equals 12�months.

Key takeaway: Runway estimates time�until usable cash is exhausted under�the assumed spending and collection�pattern. Accounting profit alone does�not establish cash sustainability.

Forecast limits: Collections, spending,�debt payments, and reserves can�change the result. Act before cash�runs out.

Devon Coombs CPA, MBA | Santa Clara University | FIN143

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Easy (2/8)

Question: Runway and the cash floor

KNOWLEDGE CHECK

A startup has $1.08 million in its bank accounts. Of that�amount, $180,000 is restricted and cannot be used for�operations. On day one, the company pays $120,000 for�equipment from its usable cash.

Its operating cash forecast is:

The equipment payment is additional to these outflows. Net�operating cash use occurs evenly within each month. The�company wants to maintain at least $180,000 of usable�cash and has no additional financing or other cash flows.

How many months after day one will usable cash first fall�to the $180,000 minimum?

A. 5.00 months.

B. 6.50 months.

C. 7.50 months.

D. 8.00 months.

E. 8.75 months.

Devon Coombs CPA, MBA | Santa Clara University | FIN143

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Hard (7/8)

Answer: Runway and the cash floor

KNOWLEDGE CHECK

B. 6.50 months.

Work the calculation

Usable opening cash = $1.08m −�$0.18m = $0.90m. After�equipment, $0.78m remains. The�first two months consume 2 ×�($0.21m − $0.09m) = $0.24m,�leaving $0.54m.

Cash available above the floor is�$0.54m − $0.18m = $0.36m.�Later burn is $0.08m per month,�giving 4.5 additional months.�Total = 2 + 4.5 = 6.5 months.

Why the other choices are wrong

A. Applies the initial $120,000 monthly burn�to the entire $600,000 spendable amount,�ignoring the reduction after month two.

C. Applies the later $80,000 monthly burn�from day one, ignoring the higher burn during�the first two months.

D. Omits the upfront $120,000 equipment�payment from the cash schedule.

E. Includes restricted cash as usable, or�equivalently ignores the $180,000 cash floor.�Either adds $180,000 of unavailable spending�capacity.

Devon Coombs CPA, MBA | Santa Clara University | FIN143

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Hard (7/8)

Operating metrics by business model

Different business models require different operating evidence.

Recurring revenue requires retention analysis. Marketplaces require transaction economics. Product businesses require inventory and warranty analysis. Services require capacity and project-margin analysis.

Use each metric to explain a financial-statement line or a cash requirement.

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Metrics by business model

Definitions, periods, and included costs must match before comparison.

ARR/MRR = annual/monthly recurring revenue. NRR/GRR = net/gross revenue retention. CAC = customer acquisition cost. LTV = customer lifetime value. GMV = gross merchandise value. Definitions of internal metrics vary.

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Net revenue retention and the customer base

NRR = ending recurring revenue from the starting customer base ÷ its starting recurring revenue.

Include expansion, contraction, and churn from that base. Exclude new customers. State the measurement period and reactivation policy.

• 120% NRR: The starting base produces 20% more recurring revenue.
• 85% NRR: The starting base produces 15% less recurring revenue.

New customer revenue can still make the 85% company grow overall. The same current ARR does not imply equal revenue durability.

ChartMogul: net revenue retention · NRR describes revenue retention, not customer-count retention or profitability.

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Question: Net revenue retention

KNOWLEDGE CHECK

Two SaaS companies each report $10 million ARR. One has 120% net revenue retention; the other has 85%. The difference tells you that:

A. The existing customer revenue base expands at 120% NRR and contracts at 85% NRR

B. The two firms are equivalent, since ARR is identical

C. The 85% firm has higher gross margins by definition

D. The 120% firm must be spending more to acquire users

E. Net revenue retention is a vanity metric here

Devon Coombs CPA, MBA | Santa Clara University | FIN143

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Easy (1/8)

Answer: Net revenue retention

KNOWLEDGE CHECK

A. The existing customer revenue base�expands at 120% NRR and contracts at 85% NRR

Case: Two companies have $10M�current ARR but 120% and 85% NRR.

Why: NRR compares recurring�revenue from the starting customer�base, including expansion, contraction,�and churn. It excludes new customer�revenue.

Key takeaway: Identical current ARR�can conceal different retention�patterns. New customer sales may still�grow the 85% NRR company overall.

Other choices: B ignores retention�differences; C/D infer margins or�acquisition spending; E dismisses�relevant retention evidence.

ChartMogul: net revenue retention

Devon Coombs CPA, MBA | Santa Clara University | FIN143

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Cohort analysis

Group customers by acquisition period and compare them at the same age.

Track customer retention, recurring revenue, usage, and contribution separately. Revenue can expand even if some customers leave.

A company can grow 30% overall while cohorts lose 40% of their revenue over 12 months. New customer revenue can mask deterioration in the existing base.

The desired pattern depends on purchase frequency and business model. A flattening curve alone does not prove attractive economics.

Missing cohort records create uncertainty. Reconstruct them where possible before judging durability.

ChartMogul: cohort retention · The 30%/40% scenario is illustrative, not a reported company result.

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Question: Cohort decay

KNOWLEDGE CHECK

A startup grows revenue 30% year over year, but each customer cohort loses 40% of its revenue within 12 months. The most accurate read is:

A. Retention is strong and the growth is durable

B. The business has clearly reached product-market fit

C. Aggregate growth understates true performance

D. New customer revenue must offset�substantial losses from earlier cohorts

E. Cohort decay does not matter while ARR rises

Devon Coombs CPA, MBA | Santa Clara University | FIN143

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Easy (1/8)

Answer: Cohort decay

KNOWLEDGE CHECK

D. New customer revenue must offset�substantial losses from earlier cohorts

Case: Overall revenue grows 30%, while�each cohort loses 40% over 12 months.

Why: Existing cohorts lose revenue, so�new customer revenue must offset that�erosion for total revenue to grow. Assess�acquisition costs and contribution to�judge whether that replacement is�economical.

Key takeaway: Aggregate growth�can mask weak retention. Cohort�revenue, customer retention, and�contribution answer different�questions.

Other choices: A/B overstate�retention or product-market fit;�C/E dismiss cohort losses.

ChartMogul: cohort retention

Devon Coombs CPA, MBA | Santa Clara University | FIN143

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Easy (1/8)

MARCS forecasting framework

Use MARCS to pressure-test each forecast assumption before it enters the model.

- Measurable: tied to observable metrics, not vague goals.

- Aspirational: reflects the plan the business is trying to achieve.

- Realistic: grounded in capacity, market evidence, and historical results.

- Controllable: linked to actions management can influence.

- Sequenced: timed in the order work, hiring, sales, and cash needs occur.

Better assumptions create better forecasts: clearer targets, fewer surprises, and stronger funding decisions.

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Market ratios need consistent earnings and share counts

Basic EPS = earnings available to common shareholders / weighted-average�common shares outstanding. Diluted EPS also reflects qualifying potential�common shares.

P/E = share price / EPS. Specify trailing or forecast earnings and use a consistent�definition across companies.

P/B = share price / common book value per share. Accounting book equity is not�the same as market value.

PEG = P/E / expected annual EPS growth in whole percentage units. Conventional�P/E and PEG are not useful positive-earnings comparisons when EPS is zero or�negative.

Devon Coombs CPA, MBA | Santa Clara University | FIN143

84

Valuation ratios and terminal value

P/E = share price ÷ earnings per share. It is not a useful positive-earnings multiple when earnings are zero or negative.

PEG = P/E ÷ expected annual EPS growth expressed as a whole percent. A P/E of 20 and 10% growth gives 2.0. Risk and growth durability still matter.

Terminal value estimates cash flows beyond the explicit forecast. It can dominate a startup DCF, making the maturity, margin, reinvestment, and growth assumptions consequential.

Week 5 develops the constant-growth mechanics. The perpetual growth rate must remain below the discount rate.

Damodaran: PEG ratios · Damodaran: stable growth · Valuation preview. EPS = earnings per share. DCF = discounted cash flow. PEG comparisons require a consistent earnings base and growth horizon. Match the P/E earnings denominator to the growth estimate.

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PEG needs an annual EPS growth rate

When EPS is forecast several years ahead, annualize its growth before using PEG:

Expected annual EPS growth = (future EPS / current EPS)^(1 / years) − 1.

Illustration: EPS grows from $2.00 to $2.88 over two years. Annual growth is (2.88�/ 2.00)^(1/2) − 1 = 20%, not the two-year total of 44%.

At a $48 share price, trailing P/E is 24× and PEG is 24 / 20 = 1.20. Use 20�percentage units, not 0.20.

State the earnings period and growth horizon. A lower PEG does not resolve�differences in risk, earnings quality, or reinvestment.

Devon Coombs CPA, MBA | Santa Clara University | FIN143

86

PEG Ratio Calculation

A company’s stock trades at $84 per share. Current EPS is $4.00, and analysts expect EPS to reach $6.91 in three years. Assume earnings grow at a constant annual rate.

What is the company’s approximate PEG ratio?

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Medium (4/8)

PEG Ratio Solution

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Medium (4/8)

Valuation Metrics Multiple Choice

A company has:

• Market capitalization: $3.9 billion
• Diluted shares outstanding: 50 million
• Current net income: $160 million
• Expected net income in three years: $280 million
• Expected diluted shares in three years: 52 million
• Peer median P/E: 25.0x
• Peer median PEG: 1.25x

Assume EPS grows at a constant annual rate. An investor considers the stock attractive only if both its P/E and PEG are below the peer medians. Which analysis is correct?

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Hard (7/8)

Valuation Metrics Solution

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Question: P/E versus PEG

KNOWLEDGE CHECK

An analyst is comparing two profitable technology companies:

For both companies, trailing earnings per share (EPS) covers�the same most recent 12 months, and forecast EPS covers the�following 12 months. Assume no stock splits or changes in the�share basis.

Use trailing P/E and the conventional PEG ratio based on�expected EPS growth from the trailing year to the forecast year.

Which answer gives the correct P/E and PEG for each�company, rounded to two decimal places?

A. Orion: P/E 23.33×,�PEG 1.17; Vega: P/E�16.07×, PEG 1.34.

B. Orion: P/E 28.00×,�PEG 0.80; Vega: P/E�18.00×, PEG 0.75.

C. Orion: P/E 28.00×,�PEG 1.17; Vega: P/E�18.00×, PEG 1.20.

D. Orion: P/E 28.00×,�PEG 1.40; Vega: P/E�18.00×, PEG 1.50.

E. Orion: P/E 28.00×,�PEG 1.68; Vega: P/E�18.00×, PEG 1.68.

Devon Coombs CPA, MBA | Santa Clara University | FIN143

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Answer: P/E versus PEG

KNOWLEDGE CHECK

D. Orion: P/E 28.00×, PEG 1.40; Vega: P/E 18.00×, PEG 1.50.

Work the calculation

Orion: trailing P/E = $84 ÷ $3 = 28.00×;�expected EPS growth = ($3.60 − $3.00) ÷�$3.00 = 20%; PEG = 28 ÷ 20 = 1.40.

Vega: trailing P/E = $90 ÷ $5 = 18.00×;�expected EPS growth = ($5.60 − $5.00)�÷ $5.00 = 12%; PEG = 18 ÷ 12 = 1.50. Use�the growth percentage as a whole�number in PEG.

Vega has the lower P/E, while Orion has�the lower PEG.

This ranking is a comparison of measures,�not proof that Orion is undervalued: risk,�reinvestment, and the durability of the�growth estimate still matter.

Why the other choices are wrong

A. Uses forecast EPS in P/E while still measuring�growth from trailing EPS. This changes the�requested earnings base and counts the coming�growth in both parts of the comparison.

B. Uses revenue growth, 35% and 24%, rather�than expected EPS growth, 20% and 12%.

C. Adds dividend yield to expected EPS growth,�giving denominators of 24 and 15. That is a�dividend-adjusted measure, not the requested�conventional PEG.

E. Divides the EPS increase by forecast EPS�instead of trailing EPS: growth becomes�16.6667% and 10.7143%, yielding PEG of 1.68 for�both.

Devon Coombs CPA, MBA | Santa Clara University | FIN143

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Hard (6/8)

Driver-based forecasting

Forecast from the business activities that actually drive financial results.

- Identify key drivers: volume, price, conversion, churn, headcount, utilization.

- Connect operations to financials: link drivers to revenue, expenses, working capital, and cash.

- Make assumptions testable: track actuals, update assumptions, and run scenarios.

A good forecast shows what must happen operationally, what resources are required, and when cash is needed.

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Sales capacity and the revenue forecast

Tie material line items to observable operating drivers and use history to test the assumptions.

Example: five fully productive salespeople × $200,000 of quarterly bookings�= $1 million in quarterly bookings capacity.

Three planned hires need explicit start dates, a two-quarter ramp, productivity assumptions, and compensation costs. They do not contribute full capacity immediately.

Translate bookings into delivery, recognized revenue, invoices, and collections using the contract terms.

Centralize assumptions and link them to the model. Test downside cases and whether cash funds the next milestone.

Illustrative bookings-capacity assumption. New-hire ramp percentages and contract timing must be specified in the forecast.

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AI-assisted financial modeling

Useful tasks: Draft a model structure, organize provided data, explain formulas, and generate scenarios.

Analyst responsibilities: Supply the assumptions, verify source data, and test whether the accounting and business logic fit the company.

Check formulas, signs, units, time periods, and statement reconciliations. Independently recalculate key outputs.

A coherent-looking model can still contain unsupported assumptions or incorrect formulas. Industry knowledge and judgment remain necessary.

Workflow guidance, not a claim about any particular AI product or a guarantee of accuracy.

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Due diligence

Financial diligence tests whether reported performance is repeatable and whether the company has recorded or disclosed its obligations.

Revenue quality, customer dependence, commitments, and founder dependence connect accounting results to business risk.

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Diligence risks and evidence

Three customers exceeding 50% of revenue is an example of concentration to investigate, not a universal cutoff.

Course diligence checklist. A concern may require investigation, recognition, disclosure, or forecast adjustment depending on its facts.

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Question: Customer concentration

KNOWLEDGE CHECK

In diligence, a startup's top three customers are 60% of revenue with no long-term contracts. In a quality-of-earnings review this most represents:

A. Customer concentration and durability risk

B. A working capital timing distortion to normalize

C. An unrecorded liability that should be accrued

D. A gross-versus-net revenue misstatement

E. A terminal value assumption that is too high

Devon Coombs CPA, MBA | Santa Clara University | FIN143

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Easy (1/8)

Answer: Customer concentration

KNOWLEDGE CHECK

A. Customer concentration and durability risk

Case: Three customers account for�60% of revenue without long-term�contracts.

Why: Heavy concentration with no�long-term contracts threatens�revenue durability and scalability if�a top account leaves.

Key takeaway: Concentration plus�no long-term contracts is a�durability red flag. One departure�can reset the revenue base.

Other choices: B concerns cash�timing; C liabilities; D revenue�presentation. E could be a valuation�consequence, but concentration is�the underlying risk.

Devon Coombs CPA, MBA | Santa Clara University | FIN143

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Capital structure and exit proceeds

The cap table identifies ownership. The contracts determine priority, conversion rights, and participation in exit proceeds.

The amount available to common shareholders can differ sharply from ownership percentage multiplied by a headline exit value.

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Debt, SAFEs, and equity claims

Read the contracts. Position in a conceptual debt-to-equity spectrum does not by itself establish the payout waterfall or accounting classification.

Y Combinator: SAFE terms · YC introduced the SAFE in 2013. Modified instruments may have different terms.

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One cap table, three exit outcomes

Assume $4M invested for 40% ownership on an as-converted basis. One preferred class, no dividends, and no participation cap. Exit amounts below are proceeds available to equity after debt and transaction costs.

Non-participating preferred converts when the common-equivalent payout is higher.

Illustrative course arithmetic. Carta: liquidation preferences

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Question: Participating preferred

KNOWLEDGE CHECK

A startup exit leaves $8 million available to equity after debt and transaction costs. An investor holds an uncapped 1x participating preferred on a $4 million investment. Versus a 1x non-participating investor, the participating investor generally receives:

A. Only the $4 million preference and nothing more

B. The $4 million back, then a share of the rest

C. Exactly the same amount under either structure

D. Nothing until common shareholders are paid

E. Three times the original amount invested

Devon Coombs CPA, MBA | Santa Clara University | FIN143

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Answer: Participating preferred

KNOWLEDGE CHECK

B. The $4 million back, then a share of the rest

Case: $8M is available to equity�after debt and costs; $4M was�invested in uncapped 1x�participating preferred.

Why: Participating preferred�takes its capital back and then�shares the remaining proceeds�pro rata with common.

Key takeaway: Non-participating:�preference OR convert. Participating:�preference AND a share of the rest.

Other choices: A omits participation;�C ignores it; D reverses priority; E has�no basis. The payout depends on�ownership, priority, and the contract’s�participation terms.

Carta: liquidation preferences

Devon Coombs CPA, MBA | Santa Clara University | FIN143

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The reconciliation test

Financial statements and cash: Do recognized revenue, receivables, customer advances, and cash movements reconcile?

Operating metrics: Do acquisition, retention, and delivery records support reported growth and margins?

Capital structure: Do the cap table and signed agreements support the modeled financing and exit claims?

Agreement improves confidence. Unexplained differences become the diligence agenda.

The three checks answer different questions. The cap table does not validate revenue or cash by itself.

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What a credible analysis establishes

1. The reported figures reconcile to independent records.
2. Revenue recognition and cash timing are explicit.
3. Free cash flow, burn, and runway use consistent definitions.
4. Customer evidence and operating capacity support the forecast.
5. The financing plan and contractual waterfall identify who funds the business and who receives the proceeds.

Remaining uncertainty should be visible in assumptions and scenarios.

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Optional practice and reference

The main sequence teaches the concepts and includes foundation questions�followed by applied challenges.

The following slides retain additional questions, worked answers, and deeper�reference for independent practice or extra class time.

Each question stays with its answer. Use the topic titles to select practice; the�appendix does not introduce a prerequisite needed for the main lesson.

Devon Coombs CPA, MBA | Santa Clara University | FIN143

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Investment cash flow and NPV

Lease cash flow = rental receipts − operating payments − capital spending − tenant improvements − leasing commissions.

Include acquisition costs at time 0 and net sale proceeds when the model includes a sale. Count each item once.

NPV = CF₀ + Σ [CFₜ / (1 + r)ᵗ], for t = 1 to n.

A positive NPV means modeled benefits exceed costs at the assumed required return. Match the rate to the cash-flow risk and financing basis.

108

Value Lease A’s level cash flows

Optional NPV practice

Lease A costs the landlord $20,000 today and produces net cash flow of $90,000 at each of the next three year-ends. At an 8% annual discount rate, the three-year ordinary-annuity present-value factor is 2.57709699.

Assume these are all relevant lease cash flows, with no terminal value. What is NPV, rounded to the nearest dollar?

A. $191,939

B. $211,939

C. $231,939

D. $250,000

E. $270,000

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Easy (2/8)

Value Lease A’s level cash flows: answer

Optional NPV practice

Correct answer: B. $211,939

PV of future receipts = $90,000 × 2.57709699 = $231,938.73.

NPV = −$20,000 + $231,938.73 = $211,938.73, or $211,939.

The time-0 outflow is already in today’s dollars. Deduct it once. Each future receipt is discounted; the sum of undiscounted receipts is not PV.

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Value Lease B’s unequal cash flows

Optional NPV practice

Lease B costs the landlord $45,000 today and produces net cash flow of $100,000, $102,000, and $104,000 at the ends of Years 1, 2, and 3, respectively. The annual discount rate is 8%. There is no terminal value or other relevant cash flow.

What is NPV, rounded to the nearest $100?

A. $217,600

B. $212,700

C. $238,600

D. $261,000

E. $262,600

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Value Lease B’s unequal cash flows: answer

Optional NPV practice

Correct answer: A. $217,600

NPV = −$45,000 + $100,000/1.08 + $102,000/1.08² + $104,000/1.08³ = $217,599.71.

The table rounds individual PVs to cents; the total uses unrounded values. To the nearest $100, NPV is $217,600.

Each receipt has its own amount and date. A single level-payment annuity cannot represent this growing cash-flow stream.

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Question: PEG ratio

KNOWLEDGE CHECK

A profitable technology company trades at $120 per share and reports current�EPS of $3.00. Analysts expect EPS of $4.50 next year. The company’s industry�average P/E is 28×, its dividend yield is 1.5%, and revenue grew 35% this year.

Using expected EPS growth, what is the company’s PEG ratio?

Convention: Use current EPS to calculate P/E.

A. 0.80

B. 0.9

C. 1.14

D. 1.33

E. 1.43

Devon Coombs CPA, MBA | Santa Clara University | FIN143

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Medium (4/8)

Answer: PEG ratio

KNOWLEDGE CHECK

A. 0.80

1. Current P/E

$120 ÷ $3.00 = 40×

2. Expected EPS growth

($4.50 ÷ $3.00 − 1) × 100 = 50%

3. PEG

40 ÷ 50 = 0.80�Use 50 for 50% growth, rather than�0.50.

Why the inputs matter

C. 1.14 uses 35% revenue growth in�place of EPS growth.

E. 1.43 divides 40 by the industry P/E�of 28. The denominator should be EPS�growth.

The dividend yield is not an input to�this PEG calculation.

Interpretation: A PEG below 1 does�not prove undervaluation. Growth�durability and risk still matter.

Devon Coombs CPA, MBA | Santa Clara University | FIN143

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Question: Analyst posture

KNOWLEDGE CHECK

A founder presents investor�materials showing $6.0 million�of “revenue” based largely on�contracts signed during the�year. Cash collections were�$3.8 million, customer-related�cash outflows were $2.9�million, and several contracts�require services to be�delivered over the next 12�months. The company does�not yet prepare audited�financial statements.

What is the most appropriate�analytical approach?

A. Use the $6.0 million figure because signed�contracts provide the clearest measure of current�operating performance.

B. Use the $3.8 million of collections as revenue�because cash receipts are more reliable than�management estimates.

C. Reconstruct revenue and cash flow using�contract terms, delivery obligations, collections, and�other verifiable information.

D. Exclude the company from analysis until audited�GAAP financial statements become available.

E. Focus primarily on net cash generation because�accounting revenue is less relevant for an�early-stage company.

Devon Coombs CPA, MBA | Santa Clara University | FIN143

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Answer: Analyst posture

KNOWLEDGE CHECK

C. Reconstruct revenue and cash flow using contract terms, delivery�obligations, collections, and other verifiable information.

Why C is right

Revenue depends on satisfying�delivery obligations. Verify contract�terms and work performed, then�reconcile collections and cash�outflows.

The information given does not�establish how much revenue the�company has earned.

Why the other choices fall short

A / B: Signing a contract or collecting�cash does not by itself establish�earned revenue.

D: An audit improves assurance, but its�absence does not prevent a supported�analysis.

E: $3.8m − $2.9m = $0.9m of customer�cash surplus. It omits other cash flows�and future delivery costs.

Devon Coombs CPA, MBA | Santa Clara University | FIN143

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Question: Deferred revenue

KNOWLEDGE CHECK

A SaaS startup reports a $1.2 million net�loss for the year. Its cash flow statement�includes $400,000 of depreciation and�amortization, $300,000 of stock-based�compensation, a $500,000 increase in�accounts receivable, and a $2.2 million�increase in deferred revenue. The�company also spent $1.5 million on�capital expenditures during the year.

Most of the increase in deferred revenue�resulted from customers paying annually�in advance for subscription services that�will be provided over the next 12 months.

The company reports positive�operating cash flow of $1.2 million.�Which interpretation is most accurate?

A. Advance collections increased revenue and�operating cash flow because customers had�already paid the company.

B. Deferred revenue increased operating cash�flow because cash was collected before the�related revenue was earned.

C. Deferred revenue did not affect operating cash�flow because it represents a noncash accounting�liability.

D. Positive operating cash flow shows the�underlying business generated cash�independently of customer prepayments.

E. Capital expenditures should reduce operating�cash flow because they support delivery of future�subscription services.

Devon Coombs CPA, MBA | Santa Clara University | FIN143

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Answer: Deferred revenue

KNOWLEDGE CHECK

B. Deferred revenue increased operating cash flow because cash was�collected before the related revenue was earned.

Reconcile operating cash flow ($m)

Net loss −1.2 + D&A 0.4�+ stock compensation 0.3�− receivables increase 0.5�+ deferred revenue increase 2.2�= $1.2m operating cash flow

Before the $2.2m deferred revenue�adjustment, the subtotal is −$1.0m.�Customers still have services due to�them.

Why the other choices are wrong

A / C: Advance cash can increase cash�and a liability before revenue is earned.

D: Positive operating cash flow does�not establish independence from�prepayments.

E: Capex is an investing outflow.�Operating cash flow less capex:�$1.2m − $1.5m = −$0.3m.

Devon Coombs CPA, MBA | Santa Clara University | FIN143

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Question: Deferred revenue

KNOWLEDGE CHECK

A SaaS company begins the year with $40,000 of deferred revenue. All customer consideration is collected before the related revenue is recognized. Assume there are no refunds or other contract liability adjustments.

At September 30, which statement is correct?

A. Deferred revenue is $25,000 because cash collections exceeded revenue by $25,000 year to date

B. Deferred revenue remains $40,000 because cash collections do not affect revenue recognition

C. Deferred revenue is $65,000, and year-to-date cash collections exceed GAAP revenue by $25,000

D. Deferred revenue is $65,000, and year-to-date GAAP revenue exceeds cash collections by $25,000

E. Deferred revenue is $90,000 because only Q3 activity determines the September 30 balance

Devon Coombs CPA, MBA | Santa Clara University | FIN143

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Answer: Deferred revenue

KNOWLEDGE CHECK

Correct answer: C

​

Calculation:

Beginning deferred revenue $40,000

- Cash collected $270,000

− Revenue recognized $245,000

= Ending deferred revenue $65,000

​

Deferred revenue increased by $25,000, which means cash collections exceeded recognized revenue by $25,000 year to date.

Devon Coombs CPA, MBA | Santa Clara University | FIN143

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Question: Discounted prepayments

A company normally charges $100,000 per year for three years, payable at the end of each year. It offers a customer a 20% discount to prepay the entire three-year contract at signing, resulting in an immediate cash payment of $240,000.

The company can reinvest available cash in a business unit expected to earn 25% annually. Assume 25% represents the appropriate opportunity cost of capital. Ignore taxes and operating costs.

What is the approximate incremental NPV of accepting the prepaid contract rather than collecting $100,000 annually?

A. $(60,000)

B. $0

C. $15,000

D. $44,800

E. $87,500

Devon Coombs CPA, MBA | Santa Clara University | FIN143

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Hard (6/8)

Answer: Discounted prepayments

Devon Coombs CPA, MBA | Santa Clara University | FIN143

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Answer: $44,800 incremental NPV

Present value of annual payments: $100,000 / 1.25 + $100,000 / 1.25² + $100,000 / 1.25³ = $195,200

Value of prepaid option: $240,000 received today

Incremental NPV: $240,000 - $195,200 = $44,800

The discounted prepayment creates more value because the company can reinvest the upfront cash at a 25% return.

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Hard (6/8)

Question: Free cash flow to the firm

KNOWLEDGE CHECK

A company reports EBIT of $5.0 million, a 25% tax rate, $700,000 of depreciation�and amortization, and $1.4 million of capital expenditures. During the year,�accounts receivable increased by $900,000, inventory increased by $400,000,�and accounts payable increased by $500,000.

Assume these are the only changes in operating working capital. What is the�company’s FCFF?

A. $3.85 million

B. $3.05 million

C. $2.25 million

D. $1.75 million

E. $1.25 million

Devon Coombs CPA, MBA | Santa Clara University | FIN143

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Answer: Free cash flow to the firm

KNOWLEDGE CHECK

C. $2.25 million

Working capital uses cash ($m)

Increase = receivables + inventory�− payables�= 0.9 + 0.4 − 0.5 = $0.8m

FCFF = EBIT × (1 − tax rate)�+ D&A − capex − increase in�operating working capital

= 5.0 × 0.75 + 0.7 − 1.4 − 0.8�= $2.25m

What each distractor misses

A. $3.85m: Adds the $0.8m working�capital increase instead of subtracting�it.

B. $3.05m: Ignores working capital.

D. $1.75m: Omits the cash benefit of�the $0.5m increase in payables.

E. $1.25m: Treats the increase in�payables as a cash use.

Devon Coombs CPA, MBA | Santa Clara University | FIN143

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