FIN 300 1st Edition Lecture 3Introduction to Financial Statement AnalysisChapter OverviewFinancial statements are the tools financial managers use to assess the success of a firm and to compare it to competitors. It is also the tool they use to make the correct decisions that maximize stockholder wealth.Therefore, it is absolutely imperative that students have a thorough grasp of the story each statement tells about the company and how it fits in with the other statements. Chapter 2 covers both national and international accounting standards, as well as the different types of financial statements. Most students arefamiliar with balance sheets and income statements, but the statement of cash flows is often overlooked. Its importance, implications, and use to the financial manager are explored thoroughly. This discussion is followed by an introduction to other sources of financial statement information that are rarely discussed inan introductory text: the management discussion and analysis, statement of stockholders’ equity, and the notes to financial statements. The chapter concludes with a look at the realities of financial reporting, including the Enron and WorldCom scandals and ensuing legislation, and a look at the role of the auditor.What’s to come:- Accounting Regulations- Financial Statementso Balance Sheet, Income Statement, Statement of Cash Flows, & Statement of Stockholder’s Equity- Financial Ratios Accounting Regulations:_Generally Accepted Accounting Principles (GAAP)___:- Provide a common set of rules and a standard format for public companies’ financial reports- Requires that financial statements are audited by an independent auditor. This aids with ____Trust & Comparability____._International Financing Reporting Standards (IFRS)___________:- Adopted by over 120 jurisdictions internationally- An attempt at international convergence of accounting standards- Criticisms include the lack of clear guidance and the vast customizable nature of IFRSThese notes represent a detailed interpretation of the professor’s lecture. GradeBuddy is best used as a supplement to your own notes, not as a substitute.- Arent very clear, have a lot of lee-way_Sarbanes-Oxley (SOX) 2002___________:- In response to the Enron scandal of 2001- Limits non-audit fees to auditor- Requires rotation of audit partners every 5 years;- Audit committees must be dominated by outside directors and at least one of theseoutside directors must have a financial background- Institutes larger penalties for providing false info to shareholders: $5 million and 20 years imprisonment- CEO & CFO must personally attest to accuracy of financial statements- CEOs & CFOs must return bonuses and/or profits from the sale of stock or the exerciseof stock options during any period covered by restated statements- Section 404 - Senior management and boards must attest to the validity of its entirefinancial control systemo Costly to implement especially for small firms, up to 3% of revenues_Dodd Frank (2010)_______________________:- Exempted smallest companies from Section 404 of SOX- Broadened whistleblower provisions – an individual who provides information related toa possible violation of the federal securities laws that results in penalties by the SEC is eligible to receive from 10 to 30% of that penalty.Financial StatementsThe purpose of financial statements is to provide a means for interested outside parties, such as creditors and investors, to obtain information about a firm with an overview of the short- and long-term financial condition of a business.1. The Balance Sheet___: provides a snapshot of a firm’s financial position (assets and liabilities) at a given point in timeSource: http://galleryhip.com/simple-balance-sheet-template.html___ ___ _____Assets__ include cash, inventory, Property, Plant & Equipment (PP&E), and other investments a company has made. (Assets= Liabilities + Stockholder Equity)- ____Current Assets_____ are cash or assets that can be converted into cash within one year. (I.e. cash, inventory, short term marketable securities, accounts receivable, and prepaid expenses)- ____Long-Term Assets_____ produce tangible benefits for more than one year. (I.e. PP&E and long-term investments)- ___Depreciation______ is the yearly deduction made from the value of a fixed asset over time according to its life span.- ___Book Value of Asset_____ is the acquisition cost less the accumulated depreciation for that asset.____Liabilities_____ are a firm’s obligations to its creditors.__Current Liabilities____ will be satisfied within one year. (I.e. accounts payable, short-term debt, current maturities of long-term debt, accrued salaries, and unearned revenue)- _____Long-Term Liabilities_____ extend beyond one year. (I.e. long-term loans)__Stockholder’s Equity____ is a firm’s net worth from an accounting perspective.- SE = ____Assets________ - _____Liabilities_______This is why the left and right sides of the BS must be equal. The assets must equal liabilities plus stockholders’ equity because stockholders’ equity is the difference between assets and liabilities.- SE = __Common Stock____ + ___Retained Earnings__Stockholders’ equity is also called the _Book Value of Equity___ or the _Book Value of the Firm_.Because assets are listed at book value (historical cost) rather than at market value, this measure generallyisn’t likely to provide an accurate assessment of the true value of the firm’s equity.- Also, many valuable, intangible assets aren’t included. These include items like the potential for growth,employee expertise, firm reputation, relationships with clients & suppliers, and the quality of management.- Sometimes, stockholders’ equity is used as an estimate of Liquidation Value, the value of the firm after all its assets are sold and liabilities are paid.Recall, the _Market Value of Equity_ is what investors are willing to pay for the firm.MVE = __Number of Shares__ x _Price/Share__ = market capitalizationRather than being based on the historical cost of the firm’s assets, MVE is dependent on what investors expect those assets to produce in the future.2. __Income Statement____: provides details about a firm’s revenues and expenses over a period of time (generated by the assets and liabilities covered in the balance statement).Sales- Cost of SalesGross Profit- Operating ExpensesOperating Income + Other IncomeEarnings Before Interest & Taxes (EBIT) - Interest