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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