Accounting I

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Accounting I

• How to Read a Financial Report
• January 25, 2007

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Today

• Quiz
• How to Read a Financial Report
• Apply what we have learned so far to
• Home Depot
• Pfizer
• Ebay
• Case Prep

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Quiz

• What is the difference between depreciation and
  amortization? Which is a cashless expense?
• Explain the difference between gross margin and
  net margin?
• In 2005, which company (Pfizer, Home Depot or
  Ebay) had the highest Return on Assets?

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The Basics

• The Balance Sheet.
• As if time stood still
• The Income Statement.
• does this company make money??

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The Balance Sheet

• Assets Liabilities Equity
• This is called the standard accounting model

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The Left Side of the Balance Sheet

• Assets Stuff the company needs to run the
  business day to day. Like
• -Cash
• -Marketable Securities
• -Accounts Receivable
• -Inventories
• -Prepaid Expenses
• These are called Current Assets and are often
  referred to as working assets

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The Left of the Balance Sheet
(contd)

• Assets But the company may also needs things
  like
• Land
• Buildings
• Machinery/Computer Networks
• less accumulated depreciation
• This is called Net Property, Plant Equipment

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The Left Side of the Balance Sheet (contd)

• Assets And, finally we add
• - Intangibles (goodwill, patents, etc) less
  accumulated amortization
• - Investment Securities, at cost
• To get
• TOTAL ASSETS

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What is Your Favorite Asset?

• Cash (and cash equivalents)?
• Marketable Securities?
• Accounts Receivables?
• Inventory?
• Prepaid expenses?
• Property Plant and Equipment?
• Intangibles?
• Investment Securities?

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The Right Side of the Balance Sheet

• Liabilities What the company owes
• - Accounts Payable
• - Accrued Expenses
• - Taxes Payable
• - Current Portion of Long Term Debt
• These are called Current Liabilities and
  are usually due in less than a year.
  

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The Right Side of the Balance Sheet (contd)

• Liabilities What the company can pay back in
  more than a year.
• Long term Debt (loans, bonds,etc)
• Deferred Income Taxes
• These are called Long Term Liabilities

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The Right Side of the Balance Sheet (contd)

• Shareholders Equity What the owners
  (shareholders) own
• - Preferred Stock
• - Common Stock
• - Additional Paid in Capital
• - Retained Earnings

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Historically, those who analyze and understand
what is behind the numbers in the Financial
Statements earn more than those who create
them.

• A simple picture is a good place to start.

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To analyze, you need some tools (Ratios
Valuations). These are the Balance Sheet basics

• Debt to Equity Liabilities / Equity
• Just how leveraged is this company ???
• Current Ratio Current Assets (CA)/Current
  Liabilities (CL)
• Will/Can this thing run out of money ???
• Quick Ratio Current Assets (less
  inventory)/Current Liabilities
• A better judge of the potential to run out of
  money
• Book Value Total Assets- intangible
  assets-liabilities-preferred stock
• What the company might be worth if liquidated

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The Income Statement

• Net Sales (what the company sold)
• less
• Cost of Sales (what did it cost the company to
  make/acquire the stuff it sold?)
• equals
• Gross Profit (what is left to pay everyone
  else)
• less
• Selling, general administrative expenses
• Depreciation and Amortization
• equals
• Operating Income
• plus
• Interest Income (what the company made on its
  cash securities)
• less
• Interest Expense (what the company is paying to
  borrow money)
• less
• Income Taxes (the governments cut of the
  companys success)
• equals
• Net Income (what the owners get to keep or
  reinvest back into the business)

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More tools to analyze the Income Statement

• Gross Margin (Net Sales- Cost of Sales)/Net
  Sales
• The most basic measure of a companys viability
• Operating Margin Operating Income/Net Sales
• Earnings before interest and taxes
• Net Profit Margin Net Income / Net Sales
• The true bottom line for shareholders
• Earnings per Fully Diluted Share Net Income /
  of diluted shares
• Very useful for year over year measurements
• Earnings Before Interest, Taxes, Depreciation,
  Amortization (EBITA) Net IncomeInterest
  ExpenseTaxes Depreciation Amortization
• A measure of Operating Cash Flow
• A very Wall Street thing to measure

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Statement of Cash Flow

• The Accrual Thing
• The key to understanding if cash is being
  produced or consumed by the activities and
  operations of the company.
• There are 3 basic activities of the company as it
  relates to Cash Flow
• Operating
• Investing
• Financing

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The Total Business

• What were sales for the past twelve months
• Are sales growing, declining, or flatwhy?
• What is the profit marginis it growing?
• How are the margins versus the competition? How
  does it compare with other industries?
• What is the asset velocity?
• How much cash is the company generating?
• What does the external environment look like?

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CasesMM 010

• Peter Bell
• John Clavin
• January 25, 2007

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Why

• Real world
• Tends to sticklearning not just remembering
• Help build oral (talking and listening)
  communication skills
• More personal experiencemore enjoyableand more
  powerful

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Keep in mind

• No right answer
• Each of you is responsible for the class
  discussion and what you learn/take away from the
  discussion
• Case prep take a lot of timeonly you will know
  when you are done

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What is it

• A true story
• Description of a management situation
• Vehicle for learning
• They are developed thru research, 200 hours or
  more per case
• There are a set of objectives that the case
  writer has before approaching a given company
  about writing a casethe case writer sets up the
  case to encourage second opinions.

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Preparation

• Read in once thru relative quickly to find major
  issues and who the protagonist is
• Re-read the case in more detail to understand and
  make note of the situation at hand and the role
  of the protagonist in that situation (put
  yourself in the shoes of the protagonist in the
  case)
• Focus your analysis on the major issue
• What is it?
• What are the alternatives in front of the
  protagonist?
• What is your recommendation of the action that
  should be taken?
• What is the desired outcome of this course of
  action?

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Prep (continued)

• Keep it real world
• Feel free to meet in small groups (3 to 5 people)
  to review, discuss, and prepare
• Make sure you understand the facts in the case
• Dont forget the language of business and your
  business acumeni.e.. the numbers in the case
  (often in the appendices) are key to
  understanding the story being told
• Use the prep questions as a guide