The document provides an overview of key accounting and finance concepts for an introduction course, including:
1) It outlines the three main financial statements - the balance sheet, income statement, and cash flow statement - and provides high-level explanations of what each shows.
2) The balance sheet presentation shows assets on the left, liabilities and equity on the right, and the key equation that assets must equal liabilities plus equity.
3) The income statement captures a company's revenues and expenses over a period to determine net income.
4) The cash flow statement reconciles net income to cash provided or used by operating, investing, and financing activities.
The document provides an overview of key accounting and finance concepts for an introduction course, including:
1) It outlines the three main financial statements - the balance sheet, income statement, and cash flow statement - and provides high-level explanations of what each shows.
2) The balance sheet presentation shows assets on the left, liabilities and equity on the right, and the key equation that assets must equal liabilities plus equity.
3) The income statement captures a company's revenues and expenses over a period to determine net income.
4) The cash flow statement reconciles net income to cash provided or used by operating, investing, and financing activities.
Original Description:
Brief introduction to accounting and finance for investment banking
The document provides an overview of key accounting and finance concepts for an introduction course, including:
1) It outlines the three main financial statements - the balance sheet, income statement, and cash flow statement - and provides high-level explanations of what each shows.
2) The balance sheet presentation shows assets on the left, liabilities and equity on the right, and the key equation that assets must equal liabilities plus equity.
3) The income statement captures a company's revenues and expenses over a period to determine net income.
4) The cash flow statement reconciles net income to cash provided or used by operating, investing, and financing activities.
The document provides an overview of key accounting and finance concepts for an introduction course, including:
1) It outlines the three main financial statements - the balance sheet, income statement, and cash flow statement - and provides high-level explanations of what each shows.
2) The balance sheet presentation shows assets on the left, liabilities and equity on the right, and the key equation that assets must equal liabilities plus equity.
3) The income statement captures a company's revenues and expenses over a period to determine net income.
4) The cash flow statement reconciles net income to cash provided or used by operating, investing, and financing activities.
Presents the financial position of a firm at a particular moment in time
Contain three main sections: assets, liabilities and equity Assets economic resources available that provide future economic benefit Liabilities creditors claims on the assets of the firm Shareholders Equity residual owners claim on the assets of the firm
The balancing equation:
Series of journal entries can adjust these accounts but Assets = Liabilities + Owners Equity This equation must always hold true, hence the balance sheet
Investment Banking Academy
Balance Sheet Example
Assets - economic resources
Liabilities creditors claims
Shareholders Equity residual owner claims
Investment Banking Academy
Assets Recognition of Assets
Valuation of Assets
Recognition of Assets if:
Acquired rights to future use as a result of a
past transaction or exchange
Firm can measure or quantify future benefits
with a reasonable degree of precision
Accountants continuously assign and evaluate
the monetary amount to each asset in the balance sheet
Methodologies:
While all assets represent future benefits, not
all future benefits are assets (i.e. human capital) Current Assets mature within one year (cash, marketable securities, accounts receivable, prepaid expenses)
Non-current takes over a year to mature
(PP&E, Investments, Other Assets)
Acquisition or Historical Cost: represents
the amount of cash paid in acquiring the asset
Current Replacement Cost: amount to
currently replace the asset
Current Net Realizable Value: cash received
if asset was sold minus any transaction costs
Present Value of Future Net Cash Flows:
future benefits of asset discounted back at the appropriate discount rate
Checkpoint: What if the NPV of the asset is
less than the current book value?
Investment Banking Academy
Long-term Assets Recognition of Long-term Assets
Long-term or noncurrent assets are assets that
firms expect to hold or use for longer than one year
Given the longer useful life, they are not
recorded as an expense, but instead capitalized on the balance sheet
Asset Depreciation
Since long-term term assets are capitalized,
expenses are slowly incurred on the income statement in the form of depreciation (PP&E) or amortization (Intangibles)
CAN expense:
Examples include:
Property, Plant & Equipment (PP&E)
Land
Buildings
Machinery
Intangible Assets
Patents
Trademarks
Goodwill
Building
Machinery
Patents
CANT expense:
Land
Goodwill
Investment Banking Academy
Liabilities Classification of Liabilities
Liabilities are economic obligations and categorized as either:
Current matures in less than a year
Noncurrent takes more than a year to mature
Liabilities commonly include short-term and long-term debt
Obligations that require specific amounts of cash due in more than one year appear at the present value of the future cash flows
Current Liabilities
Non-current
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Net Working Capital (NWC)
Net Working Capital = Current Operating Assets Current Operating Liabilities
What is net working capital?
Working capital is a key concept derived from the balance sheet and an important measure of the firms shortterm financial health
Factors into the free cash flow of a company
Current operating assets minus current operating liabilities
Current operating assets = current assets cash & cash equivalents
Current operating liabilities = current liabilities short-term debt
Current Assets Current Liabilities = NWC
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Shareholders Equity Contributed Capital
Retained Earnings
Contributed capital represents the funds
invested by shareholders for an ownership stake
Par Value value assigned to the stock
Additional Paid-in Capital funds contributed
in excess of par
This equity account increases if companies
issue more stock and decreases if companies buy back stock
i.e. Apple just repurchased $14 billion worth
of stock, meaning the contributed capital decreased
Stock repurchases increase a contra-equity
account known as Treasury stock which is subtracted from contributed capital
Represents a firms earnings since its
formation less the dividends paid out to the shareholders since formation
Net Income from income statement directly
increases retained earnings
Checkpoint: Is it possible for a company to
have negative retained earnings?
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Income Statement Overview
Presents the results of the operating activities of a firm for a fiscal year (not always the same time period as a calendar year)
Basic equation is Revenues Expenses = Net Income
Revenues represent inflows of assets from selling goods and services
Expenses represent outflows of assets used in generating revenues
Cash vs. Accrual Accounting
Cash Accounting: firm recognizes revenue and expenses from providing goods when cash is received and paid out
Accrual Accounting: recognizes revenue in period that goods were sold and recognizes all relevant costs associated with selling the goods in the same period
Checkpoint: What methods do the income statement and cash flow statement represent?
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Revenue Revenue Recognition
Revenue is recognized when the following two conditions are met:
Firm performed all or most of the services expected to be provided
Received payment or payment is highly probable for the provided good or service
Checkpoint: What happens if cash is received before the firm performs the mandated service or delivers the product?
Revenue Adjustments
On financial statements, companies always report revenue as net revenue
Net Revenue = Gross Revenue sales discounts, allowances, or returns
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Expenses Expense Breakdown COGS: costs related to producing the good or performing the service SG&A: Advertising, Salaries, Office Expenses, Legal, & Accounting Net Interest = Interest on debt interest on cash Income Taxes: Corporate taxes at around 35% - 40%
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Earnings Earnings Breakdown Gross Profit: Net sales - COGS
Operating Income: Earnings before interest & taxes (EBIT)
EBT = Earnings before taxes Net Income: Final income after deducting all expenses (NI)
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Cash Flow Statement
Overview
The most important statement because CASH IS KING!
Represents the net cash flows relating to operating, investing and financing activities for a designated period of time
Follows the cash-basis convention for accounting
Cash Flow Segments
Cash from Operations: cash received from selling goods and services less cash paid for providing goods and services
Cash from Operations = Net Income + Depreciation & Amortization Changes in Net Working Capital
Cash from Investing: cash received from sales of investments and PP&E less cash paid for the acquisition of investments and PP&E (capex)
Cash from Financing: cash received from the issuance of debt or equity less cash paid for dividends and reacquisition of debt and equity
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Cash Flow Statement Example
Cash Flow Breakdown
Cash from Operations: Uses indirect
method by adjusting net income with D&A and changes in operating assets and liabilities
Cash from Investing: Subtract
investments in plant, property and equipment (sourced from capital expenditures) plus proceeds from selling long-term assets Cash from Financing: Changes to a firms capital structure in order to raise cash from debt/equity issuance or deplete cash from paying down debt or repurchasing stock
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Key Financial Statement Metrics
Balance Sheet Ratios
Balance Sheet ratios revolve around a companys capital structure and liquidity Current Ratio: Current Assets/Current Liabilities Popular measure for a firms liquidity
Another popular measure for a firms liquidity Checkpoint: Why does the quick ratio not include inventory?
Debt/Equity: (Long + Short Debt)/Total Equity
An index for a firms capital structure saying how many dollars of debt the company has for a dollar of equity investment
Market/Book: Market Capitalization/Book Value of Equity
Measures the publics perception of firms worth against the stated book value
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Key Financial Statement Metrics
Income Statement Ratios
Income Statement ratios revolve around a companys operational performance
Gross Profit Margin: Gross Profit/Total Sales Measure for a firms typical markup on products or services
Net Income Margin: Net Income/Total Sales
Measure for a firms typical profit on a dollar of sales
Return on Assets: Net Income/Total Assets
An index for how efficiently a company is using assets in order to generate profit
Return on Equity: Net Income/Total Equity
An index for how efficiently a company is using shareholders investments and retained earnings to generate profit Most commonly looked at financial ratio for investors
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Key Financial Statement Metrics
Additional Financial Metrics
Inventory Turnover: COGS/Inventory
How many times a company can turnover its entire inventory
Asset Turnover: Total Sales/Total Assets
How many times a company can turnover all of its assets
Days Payable Outstanding: Accounts Payable/COGS*365
Used as a metric for balance sheet projections to estimate future changes in net working capital
Days Receivable Outstanding: Accounts Receivable/Sales*365
Used as a metric for balance sheet projections to estimate future changes in net working capital
Breaks down a companys return on equity into operational profitability, asset use efficiency and financial leverage Investment Banking Academy
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Introduction to Finance
Finance
Net Present Value (NPV)
WACC
Net Present Value of a certain
number of cash flows projected out into the future
Weighted Average Cost of Capital
(i.e. the discount rate for companys future cash flows)
Net Present Value implies a
certain discount rate to apply to future cash flows
Represents the value of a dollar
today against the value of a dollar next year
A dollar today is WORTH
MORE than a dollar tomorrow
WACC is the bare minimum
return a company should make on an investment
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Net Present Value
Free Cash Flow
Discounting
Free cash flow is the amount of cash
generated in a year through a companys operations and investments
FCF = EBIT(1-T) + Depreciation &
Amortization Changes in Net Working Capital Capital Expenditures
EBITDA is often a proxy for a companys free
cash flow
Everyone demands a certain return on
investment and the same is true with companies
Like a bank account earning interest
Internal Rate of Return = discount rate that
makes the NPV of future free cash flows equal zero
Net Present Value
NPV = FCF1*(1+R)^1+FCF2*(1+R)^2+FCF3*(1+R)^3+
Accept a project if the NPV is greater than 0 and the IRR is greater than the discount rate
Checkpoint: Why do companies look at both NPV and IRR?
Checkpoint: Why would companies decline a project with an IRR greater than the discount rate?
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Weighted Average Cost of Capital
Cost of Capital
Companies raise capital to fund projects and investments through either debt or equity
WACC = proportion of debt funding * cost of debt + proportion of equity funding * cost of equity
In calculating the proportion of funding from debt or equity, divide by total capital funding which is the sum of total debt and the market capitalization
Cost of Debt
Cost of Equity
Incremental interest rate a company pays to a
lender for borrowing cash is the before-tax cost of debt
After-tax cost of debt = before-tax cost of
debt * (1-T)
Checkpoint: Why do you make the cost of
debt tax-effective?
Cost of equity derived from the Capital Asset
Pricing Model (CAPM)
Represents required return new equity
investors expect upon purchase of companys stock
RoE = Rf + B (RM RF)
Checkpoint: What are appropriate indices to
gauge Rf and RM?
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The Illinois Investment Banking Academy:
To Be Continued Introduction to Valuation & Modeling March 15, 2015
