Risk Committee Educational Program. By Carlos Roa (CRO)
Education Session 2: Introduction to Financial Statements Understanding the Fundamentals Financial Statements Required by law as elements of reporting Used to assist investors/shareholders in achieving sets of comparable information Without consistent reporting and accounting standards, it would be difficult to perform valuation Accounting terms are necessary to understand later forms of ratio analysis and discounted cash flow (DCF) modeling Types of Financial Statements US Version [International] Securities & Exchange Commission (SEC) 10K [Annual report] 10Q [Quarterly report] S-1 [Prospectus for IPO] S-3 [Prospectus for follow-on offering] International Accounting Standards FASB (Financial Accounting Standards Board) GAAP (Generally Accepted Accounting Principles) IASB (International Accounting Standards Board) Set uniform standards for accounting practices US GAAP to conform to IASB practices within a few years Financial Statements Income Statement Balance Sheet Statement of Cash Flows Income Statement Charts a companys revenue Subtracts expenses to achieve a net income figure Revenues Expenses Net Income Income Statement + Revenues (sales) - Cost of Goods Sold (the production costs) Gross Profit - Selling, General, & Administrative Expense (SG&A) (Salaries, Advertising, Supplies) EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) - Depreciation EBIT (Operating Income) - Interest Expense (the interest on debt) Taxable Income - Income Taxes Net Income
Balance Sheet A snapshot in time of the company, taking account of all its properties, cash, debt, etc. Used to calculate a number of key investment ratios Total assets, liabilities, and ownership Indicator of debt vs. equity mix The Accounting Equation
Assets = Liabilities + Shareholders Equity Assets Liabilities Shareholders Equity Assets Asset: Something that provides a future benefit Current Assets: Assets expected to be converted to value within 1 year Cash Accounts Receivable Money owed from completed sales, expected to be collected Inventory Expected to be sold during the current year; products on shelves Prepaid Expenses Prepaid benefits are theoretically assets set aside to be used Supplies Office supplies: pens, paper and such expected to be used Long-term Assets: Assets expected to be converted to value within >1 year Property, Plant, and Equipment (PPE) Goodwill Money paid in excess of fair value for an acquisition (Google/YouTube) Liabilities Liabilities: Claims by creditors (others) against the company Current Liabilities: Obligations due in <1 year Accounts Payable Money owed to suppliers Short-term Debt Bank debt or bonds to be paid back in the current year Current Portion of a Long-Term Debt The piece of a long-term bond or loan due in the current year Accrued Expenses Expenses not yet paid for (such as power bills, rent, debt interest) Unearned Revenue A liability as the company must deliver a product or service Long-term Liabilities: Obligations due in >1 year Long-term Debt Shareholders Equity What the stockholders are to receive, or currently own, as a part of the company Paid in Capital The seed money given by investors to start the company Also includes stock shares at book value Retained Earnings The cash savings of a company not yet disbursed to shareholders or reinvested in production Book Value Measurement Accounting statements are done at book value Aims to provide a common definition and concrete value towards financial concepts Assesses the value of items at historical cost The cost paid for the item when acquired Book Value per Share = Total Common Equity/Shares Outstanding Book vs. Market Value Market value is more important than book value Market value takes into account Companys earnings potential, market share, etc. Comparable, real-time valuation versus other firms The time value of money Book value and accounting terms are essential to understand market valuation Analysis of how market reacts to companies with specific book characteristics allow investors perceive over/under-valuation Statement of Cash Flows Measures how free cash changes during the year (the cash register drawer) End of previous year cash balance (Net Income) Changes in Cash Flow from: Operations Financing Investing Statement of Cash Flows (Cont.)