FINANCIAL STATEMENTSKey concepts fromObjectives• Goal:—Quick overview of financial statement concepts that are most important for corporate finance—(This is not an accounting course)• These concepts will be important for—Capital budgeting: Project cash flows• Capital budgeting often starts with financial statement data• Better understand the effects of working capital, depreciation, taxes—Valuation: Better understand where key ratios come from • e.g. Market‐to‐book, ROA, ROE, leverageBALANCE SHEET STATEMENTThe Balance Sheet• Lists the firm’s — Assets— Liabilities• Provides a snapshot of the firm’s financial position at a given point in time• The Balance Sheet IdentityAssets = Liabilities + Stockholders’ EquityGlobal Corporation Balance Sheet for 2010 and 2009Current Assets• Cash and other marketable securities—short‐term, low‐risk investments— easily sold and converted to cash• Accounts receivable—amounts owed to the firm by customers who have purchased on credit• Inventories—raw materials, work‐in‐progress, finished goods• Other current assets— includes items such as prepaid expensesLong‐Term Assets• Assets that produce benefits for more than one year—E.g. buildings, machinery, etc• Many of these assets’ value is reduced yearly through a deduction called depreciation• Depreciation is not a cash expense, but a wa y of recognizing that fixed assets wear out and become less valuable as they get olderLiabilities• Current Liabilities—Accounts payable• Amounts owed to suppliers for purchases made on credit—Notes payable• Short‐term loans that must be repaid within a year• The part of repayment of long‐term debt that will occur within the year— Accrual items • Items such as salary or taxes that are ow ed but have not yet been paid, and deferred or unearned revenue • Long‐Term Liabilities —Long‐term debt • a loan or debt obligation maturing in more than a yearWorking Capital• Measures of short term capital for running the business and pay billsNet Working Capital = Current Assets –Current LiabilitiesCurrent AssetsCurrent Ratio = Current LiabilitiesCurrent Assets - InventoryQuick Ratio = Current LiabilitiesBook Value vs. Market Capitalization• Book value of equityo Net worth from an accounting perspective o Assets – Liabilities = Equityo True economic value of assets may be different from book value• Market value of equity (“market capitalization”)o Market share price * number of shareso Is not directly tied to anything in the financial statementsExample: Market capitalization• Global has 3.6 million shares outstanding, and these shares are trading for a price of $10 per share• What is Global’s market capitalization? • How does the market capitalization compare to Global’s book value of equity?• What could drive any difference between these values?• Global’s market capitalization is: (3.6 million shares)  ($10/share) = $36 million • Market capitalization is significantly higher than Global’s book value of equity:$22.2 millionExamples of Balance Sheet RatiosINCOME STATEMENTThe Income Statement• Lists the firm’s revenues and expenses over a period of time• Provides information regarding the profitability of a firm’s businessGlobal Corporation’s Income Statement Sheet for 2010 and 2009• The “top” line shows net sales (or “revenues”)• The “bottom” line shows net income (or “earnings”)Earnings per share (EPS)• Net income reported on a per‐share basis:• “Fully diluted” EPS increases number of shares by:—Stock options issued to employees—Shares issued due to conversion of convertible bondsNet Income $2.0 millionEPS $0.556 per shareShares Outstanding 3.6 million sharesEBITDA• Financial analysts often compute a firm’s earnings before interest, taxes, depreciation, and amortization, or EBITDA• Because depreciation and amortization are not cash flows, this subtotal reflects the cash a firm has earned from operations.• The EBITDA for Global Corporation is 10.4+1.2=11.6Examples of Income Statement RatiosTHE STATEMENT OF CASH FLOWSThe Statement of Cash Flows• The firm’s statement of cash flows uses information from the income statement and balance sheet to determine:—how much cash the firm has generated—how that cash has been allocated• Divided into three sections (“activities”):— Operating activities— Investment activities—Financing activities • The last line of the Statement of Cash Flows combines the cash flows from these three activities to calculate the overall change in the firm’s cash balance over the time periodGlobal Corporation’s Statement of Cash Flows for 2007 and 2006Operating activities’ effect on cash flows• Accounts receivable: —A sale has been recorded as part of net income, but the cash has not yet been received from the customer, so we adjust the cash flows by deducting the increases in accounts receivable. —An increase in A/R represents additional lending by the firm to its customers and it reduces the cash available to the firm• Accounts payable: — Similarly, we add