ITP Fall 2014: Financial Statements
September 28, 2014
What are financial statements?
Definition:
A formal record of the financial activities of a business
Remember the SEC?
Primary agency for regulating the securities industry and enforcing
securities law
Insider trading, fraud (Madoff) etc.
Financial Reporting
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
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
The Big Four Accounting Firms
PricewaterhouseCoopers
Deloitte Touche Tohmatsu
Ernst & Young
KPMG
SEC Form 10-K
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
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
Examples
Assets:
Cash
Buildings
Inventory
Accounts Receivable
Liabilities:
Debt
Accounts Payable
Rent Payable
Salary Payable
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Balance Sheet
Assets
Liabilities & Equity
($mm)
2012
($mm)
2012
Cash & Equivalents
Accounts Receivable
Inventory
Other Current Assets
TOTAL CURRENT ASSETS
250.4
183.2
59.0
14.1
506.7
Accounts Payable
Short Term Debt
Accrued Interest Payable
Other Current Liabilities
TOTAL CURRENT LIABILITIES
147.5
33.0
12.9
88.8
282.2
PP&E
Other Long Term Assets
TOTAL LONG TERM ASSETS
934.6
25.0
959.6
Long Term Debt
Other Long Term Liabilities
TOTAL LONG TERM LIABILITIES
766.6
14.3
780.9
TOTAL ASSETS
1,466.3
TOTAL LIABILITIES
1063.1
Stockholder's Equity
403.2
TOTAL LIABILITIES & EQUITY
1,466.3
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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
Income Statement
Cash Flow Reconciliation
($mm)
2012
($mm)
Revenues
COGS
Gross Profit
SG&A Expense
EBITDA
D&A
EBIT
Interest Expense
Pre-Tax Income
Taxes
NET INCOME
938.5
334.0
604.5
234.4
370.1
25.0
345.1
6.9
338.2
118.4
219.8
NET INCOME
D&A
in Working Capital
CapEx
FCF
2012
219.8
25.0
(16.3)
(45.8)
182.7
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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
Statement of Cash Flows
($mm)
2012
Operating Activities
Cash recevied from customers
Cash paid to suppliers
Interest Paid
Taxes Paid
721.9
324.1
(6.9)
(118.4)
Net Cash from Operating Activities
920.7
Investing Activities
Proceeds from sale of building
Returns on Treasury investments
120.5
43.7
Net Cash from Operating Activities
164.2
Financing Activities
Dividends paid
Loan from bank
Net Cash from Operating Activities
(100.0)
200.0
100.0
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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/d
527745d10k.htm
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