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ITP Fall 2014: Financial Statements
September 28, 2014
What are financial statements?
Definition:
A formal record of the financial activities of a business
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Remember the SEC?
Primary agency for regulating the securities industry and enforcing securities law
Insider trading, fraud (Madoff) etc.
Financial Reporting
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Financial Reporting
U.S. GAAP
Generally Accepted Accounting Principles
The rules that all companies must follow
SEC Reporting
Public companies are required to disclose their financial statements
Most common: Form 10-K and Form 10-Q
EDGAR Database
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Accounting
Definition:
The process of communicating financial information about a business to shareholders, investors, managers etc., generally through the use of financial statements
Financial Auditing:
The verification, by accountants, of the financial statements of a company. Designed to provide a reasonable assure that the financial statements are presented fairly in all material respects
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The Big Four Accounting Firms
PricewaterhouseCoopers
Deloitte Touche Tohmatsu
Ernst & Young
KPMG
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SEC Form 10-K
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The Three Statements
Balance Sheet
A snapshot at a moment in time
What the company owns (assets)
What the company owes to others (liabilities)
What remains accrues to owners (equity)
Income Statement
A report of flows
How much money the company brings in (revenues)
How much it costs to bring that money in (expenses)
How much money is left over (profit)
Statement of Cash Flows
A report of flows
What cash has come in or out, and for what purposes
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Balance Sheet
Assets = Liabilities + Shareholders Equity
Assets:
A resource with economic value that an individual, corporation, or country owns or controls with the expectation that it will provide future benefit
Liabilities:
A companys legal debts or obligations that arise during the course of business operations. Liabilities are settled over time through the transfer of economic benefits including money, goods, or services
Shareholders Equity:
A firms total assets minus its total liabilities; the money left over to the owners of a company
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Examples
Assets:
Cash
Buildings
Inventory
Accounts Receivable
Liabilities:
Debt
Accounts Payable
Rent Payable
Salary Payable
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Balance Sheet
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Assets Liabilities & Equity($mm) 2012 ($mm) 2012
Cash & Equivalents 250.4 Accounts Payable 147.5
Accounts Receivable 183.2 Short Term Debt 33.0
Inventory 59.0 Accrued Interest Payable 12.9
Other Current Assets 14.1 Other Current Liabilities 88.8
TOTAL CURRENT ASSETS 506.7 TOTAL CURRENT LIABILITIES 282.2
PP&E 934.6 Long Term Debt 766.6
Other Long Term Assets 25.0 Other Long Term Liabilities 14.3
TOTAL LONG TERM ASSETS 959.6 TOTAL LONG TERM LIABILITIES 780.9
TOTAL ASSETS 1,466.3 TOTAL LIABILITIES 1063.1
Stockholder's Equity 403.2
TOTAL LIABILITIES & EQUITY 1,466.3
Balance Sheet
Assets:
The Asset side of the balance sheet reflects the operations of the firm
Note the distinction between current assets (some of which can be liquidated immediately) and longer-term, fixed, and intangible assets. Why is this distinction important?
Liabilities:
Liabilities and equity reflect the financing aspect of the firm
What type of financial instrument might be included in long-term debt?
Note that these are book values, and may not equal the firms market value
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Balance Sheet
Its usefulness:
Gives us information about the liquidity of the company
Tells us how asset intensive a company is or how many assets (buildings, machines, equipment) are necessary
Tells us about the ability of a company to meet its long-term fixed expenses and to accomplish long-term growth
Its limitations:
Assets are recorded at historical cost rather than at market value
What you paid, not what it is worth or the price at which you could sell the asset
Resources such as employee skills and firm reputation are NOT recorded
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Income Statement
A financial statement that measures a companys financial performance over a specific accounting period
Financial performance is assessed by giving a summary of how the business incurs its revenues and expenses through both operating and non-operating activities. It also shows the net profit or loss incurred over a specific accounting period, typically over a fiscal quarter or year
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Income Statement
Its usefulness:
Summarizes sales and profits and losses (P&L) over a period of time
Lets us look at changes in key line items and ratios across time to see whether operations have been changing and in what direction
Its limitations:
Difficult to compare some ratios for companies in different industries
Management teams have lots of options for accounting practices within the income statement
Revenues reported dont always equal cash collected, and expenses reported dont always equal cash paid, so net income is not the same as cash flow for the period
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Income Statement and Simple Cash Flow Calculation
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Income Statement($mm) 2012
Revenues 938.5
COGS 334.0
Gross Profit 604.5
SG&A Expense 234.4
EBITDA 370.1
D&A 25.0
EBIT 345.1
Interest Expense 6.9
Pre-Tax Income 338.2
Taxes 118.4
NET INCOME 219.8
Cash Flow Reconciliation($mm) 2012
NET INCOME 219.8
D&A 25.0
in Working Capital (16.3)
CapEx (45.8)
FCF 182.7
Statement of Cash Flows
Provides aggregate data regarding all cash inflows a company receives from both its ongoing operations and external investment sources, as well as all cash outflows that pay for business activities and investments during a given quarter or year
Note:
Differences between income and cash
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Statement of Cash Flows
Operating:
Cash from what the company actually does
Sell widgets
Financing:
Cash brought in from financing sources
Take out a loan
Investing:
Cash from investments
Store excess cash in U.S. Treasury bonds
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Statement of Cash Flows
Free cash flow is what a company has left over at the end of the year or the quarter after paying all of its employees salaries, its bills, its interest on its debt, and its taxes, and after making capital expenditures to expand the business
Investors often refer to this as the cash that the company is producing. The company can then decide what to do with the cash (expand, pay down debt, pay a dividend etc.)
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Statement of Cash Flows
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Statement of Cash Flows($mm) 2012
Operating Activities
Cash recevied from customers 721.9
Cash paid to suppliers 324.1
Interest Paid (6.9)
Taxes Paid (118.4)
Net Cash from Operating Activities 920.7
Investing Activities
Proceeds from sale of building 120.5
Returns on Treasury investments 43.7
Net Cash from Operating Activities 164.2
Financing Activities
Dividends paid (100.0)
Loan from bank 200.0Net Cash from Operating Activities 100.0
Attendance
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Attendance Quiz URL
http://tinyurl.com/rForrestr
Which is the most important?
Classic interview questions:
If you could only have access to one of the three statements, which would it be and why?
If you could only have access to two of the three statements, which ones would they be and why?
Walk me through how a 10 dollar rise in depreciation flows through the three financial statements.
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Why do we care about accounting and financial statements?
Complete diagnostic of a company
Warren Buffet looks at the same statements we do
Foundation of fundamental research
Source for vast majority of valuation inputs
Historical data
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Want to learn more?
Econ 174: Financial Accounting
Professor C.J. Skender
Learn how the three statements work and fit together
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Unofficial Homework
Go look up any companys 10-K on the SEC EDGAR database or the companys Investor Relations website
Example: Microsoft (MSFT)
http://www.microsoft.com/investor/SEC/default.aspx
http://www.sec.gov/Archives/edgar/data/789019/000119312513310206/d527745d10k.htm
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