BUAD 306 Business Finance Financial Statements Chapters 2 3 Balance Sheet Income Statement Cash Flow Ratio analysis telling a story with s Spring 2017 Julia Plotts Associate Professor of Clinical Finance and Business Economics plotts marshall usc edu Last class Overview of Corporate Finance Basic Busn i ess Decisions Investment Decision Whcih projects should the firm invest in Financing Decision How should the firm finance the chosen projects De bt Equit y Dividend Decision How muchof the profits should be paid out Pay Dividend s Reinvest the Profitsin These decisions are not independent of each otherFirm 2 Where are we headed We want to learn how to evaluate and nance investments projects What is the money they generate spend Where do we nd this information Outline Financial statements balance sheet and income statement What are cash ows Using Financial Statements to tell a story ratios 3 Chapters 2 3 Financial Statement Analysis The s tell the story for Finance and Strategic Analysis Valuation of assets and securities Capital budgeting and forecasting Credit decisions costs of debt capital risk Analysis of competitors Appraising managerial performance 4 Telling the Financial Story Why Focus on Financial Statement Analysis Lenders or Creditors Investors Board Management Employees Regulatory Agencies 5 The Role of Financial Statements Financial statements communicate speci c information to investors and help establish investor or donor expectations Three key nancial statements Balance Sheet snapshot of assets and nancial claims on those assets Income Statement performance over a period of time Cash Flow Statement sources and uses of cash over period of time Very useful 6 Accounting Review Balance Sheet Assets Liabilities Stockholders equity Income Statement or Pro t and Loss Statement P L Revenue Expenses Net Income Net Pro t GAAP Matching Principle Revenues matched with expenses The economic value of assets is connected to their future incremental cash ows 7 The Balance Sheet Snapshot at a point in time Strong vs Weak Strong liquid assets i e cash Weak illiquid assets high debt How much cash does a company need 8 The Current assets relatively highly liquid Balance Cash account receivables inventory which we hope to convert inSheet cash within the next 12 months Fixed assets relatively less liquid Tangible assets plants equipment Intangible assets trademarks patents Current liabilities due in less than 1 year Accounts payable short term debt Net Working Capital Current Assets Current Liabilities Long term debt bank loans bonds other debts 9 Income Statement A summary of the pro tability of the Revenues or sales rm over a period of time usually a cost of sales year gives info linking balance sheets Gross pro t SGA It presents revenues expenses and expense the resulting net earnings or pro ts Operation or net income pro t interest expense Taxable income tax Net Income Revenues Expenses Net Income or earnings Rolling performance income and expenses from business or operational model dividends Accrual accounting Retained earnings Match revenues and costs associated with a transaction Net income may be very di erent from cash ow 10 Income Statement Operating revenues from the activity of the rm Operating expenses from the activity of the rm Cost of goods sold COGS Depreciation of capital expenses Overhead costs employees administrative expenses EBIT Earnings Before Interest and Taxes Interest expenses from short and long term debt Taxes Net Income 11 Where to get nancial statements Directly from the corporation Company websites under investor relationship department From the SEC database Edgar http www sec gov cgi bin srch edgar Form 10K Previous year s balance sheet income statement statement of cash ow retained earnings Address state of incorporation etc Business description market products and competition sta information strategy and plans for the future accountant s report Google Yahoo Finance CapitalIQ 12 What are cash ows What do owners want to know How many have they put in How many are they getting back Cash Flow the di erence between the number of dollars that came in and the number that went out in a given period of time the actual timing of cash in ows and ouulows is critical in coming up with a reasonable estimate of market value 13 What are cash ows How to obtain information about Cash Flows Financial statements of a rm There is no statement that gives the needed information straight away including the CF statement 14 Value of a nancial asset versus accounting Income statement and balance sheet are based on GAAP Generally Accepted Accounting Principles the recognition or realization principle revenue is recognized when the earnings process is complete usually at the time of sale even if no cash has exchanged hands yet The matching principle revenues are always matched with the costs to producing them even if the expenses will occur at a di erent time Assets are shown at historical cost not current value GAAP rules o er a lot of latitude Still they are a crucial source of information and a tool for decision making Reported gains or losses ex due to changes in GAAP rules may be unrelated to fundamentals The value of a nancial asset depends on its riskiness and cash ows not accounting 15 Is Net Income Cash Flow NO the income statement may include items which are not related to cash in ows or ouulows Depreciation and items which are not related to day to day business operations Interest payments Spending on xed assets Spending on current assets Plus taxes must be considered 16 U S Corporation Balance Sheet 17 U S Corporation Income Statement 18 Three steps to get from Income to Cash Flow 1 Calculate Operating Cash Flow OCF Adjusting for taxes and depreciation 2 Calculate Net Capital Spending Adjusting for money reinvested for the long term 3 Calculate Change in Net Working Capital Adjusting for money reinvested for the short term 19 U S Corp Operating Cash Flow U S Corp Net Capital Spending We need to consider the long term assets in the rm s balance sheet over the income period If long term assets increase for example the rm purchased new equipment this increase corresponds to a cash ouulow If long term assets decrease for example the rm sold some buildings this decrease corresponds to a cash in ow Depreciation of assets is not a cash in ow 20 U S Corp Change in Net Working Capital Change in NWC Ending NWC Beginning NWC 21 U S Corp Cash Flow from Assets This 87 cash ow