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  1. 1. Financial Statement Basics Fin 341 Prepared by Keldon Bauer
  2. 2. Financial Statement Fundamentals <ul><li>Publicly traded companies must file an annual (10-K) report with the SEC. </li></ul><ul><li>The purpose of the 10-K is to report to owners on the status of their investment. </li></ul><ul><li>The 10-K report contains both verbal and quantitative information about the performance of the firm. </li></ul>
  3. 3. Financial Statement Fundamentals <ul><li>Income Statement (usually 3 years) </li></ul><ul><li>Balance Sheet (usually 2 years) </li></ul><ul><li>Statement of Retained Earnings </li></ul><ul><li>Statement of Cash Flows </li></ul><ul><li>Key operating statistics for 5-10 years </li></ul><ul><li>The purpose is both informative and marketing </li></ul>Financial Sections Include:
  4. 4. Financial Misrepresentation <ul><li>Some firms go far in misrepresenting their financial statements. </li></ul><ul><li>If they become fiction, then shareholders can sue. </li></ul><ul><ul><li>Stanford Law School maintains a clearinghouse website for securities class actions, most of which involve managers allegedly misrepresenting their financial statements. </li></ul></ul>
  5. 5. Financial Misrepresentation <ul><li>Trust is a very important asset in the financial market. </li></ul><ul><li>Those playing games with their financial credibility may never regain market value that they once had. </li></ul><ul><ul><li>Typically, new leadership is required to reestablish it – the CEO must go! </li></ul></ul>
  6. 6. Importing Financial Statements <ul><li>The Securities and Exchange Commission (SEC) posts firms’ financial filings online on EDGAR. </li></ul><ul><li>To access these filings go to this link and type in the company’s name. </li></ul><ul><ul><li>Then click find companies . </li></ul></ul><ul><li>Filings are listed chronologically from most recent to most ancient. </li></ul>
  7. 7. Importing Financial Statements <ul><li>Annual income statements are usually found in the firm’s 10-k report (annual report). </li></ul><ul><li>The report type is listed on the left side of the screen. </li></ul><ul><ul><li>Most of these files have follow-up links. </li></ul></ul><ul><ul><li>Use the link to 10-k, annual report, or sometimes exhibit 13. </li></ul></ul>
  8. 8. Importing Financial Statements <ul><li>Once the annual report is loaded in the browser, the quickest way to the financials is usually under E dit and F ind ( or ctl-f ) . </li></ul><ul><ul><li>Then type in the words “balance sheet.” </li></ul></ul><ul><ul><ul><li>Balance sheet is a better term because it is found next to the income statement and not all firms call the income statement the same thing. </li></ul></ul></ul><ul><ul><li>You may have to hit find a couple of times to get to the actual balance sheet. </li></ul></ul>
  9. 9. Importing Financial Statements <ul><li>Click and drag over the whole income statement. </li></ul><ul><ul><li>Copy to the clip-board. </li></ul></ul><ul><li>Go to Excel and put the cell-pointer in the upper-left corner of where you want to put the statement. </li></ul><ul><ul><li>Then paste. </li></ul></ul>
  10. 10. Importing Financial Statements <ul><li>There are two general types of EDGAR filings. </li></ul><ul><ul><li>Those in HTML format. </li></ul></ul><ul><ul><li>Those in text format. </li></ul></ul><ul><li>If the numbers are mostly in their own cells, then you probably have one in HTML format. </li></ul><ul><ul><li>You will still have to clean it up. </li></ul></ul><ul><ul><ul><li>Reformat it to look nice. </li></ul></ul></ul><ul><ul><ul><li>Watch for negatives where only one bracket is in the right cell! </li></ul></ul></ul>
  11. 11. Importing Financial Statements <ul><li>If it was a text file, then Excel put all data from each line in the first column, and you need to break them into individual columns. </li></ul><ul><ul><li>Highlight all lines (just the column with the data). </li></ul></ul><ul><ul><li>D ata </li></ul></ul><ul><ul><ul><li>T ext to Columns </li></ul></ul></ul><ul><ul><ul><ul><li>Use the fixed widths option, and use the arrows to point to where the breaks should be. </li></ul></ul></ul></ul><ul><ul><ul><ul><ul><li>Double click an arrow to make it go away. </li></ul></ul></ul></ul></ul>
  12. 12. The Balance Sheet <ul><li>The balance sheet gives a conservative estimate of the current status of sources and uses of investment funds. </li></ul><ul><li>Each side of the balance sheet is organized in order of decreasing liquidity. </li></ul><ul><ul><li>The further a line is from the top, the less liquid, and the less likely it represents the current market value. </li></ul></ul><ul><ul><li>Liabilities do equal the current outstanding balance. </li></ul></ul>
  13. 13. Income Statement <ul><li>The income statement show the basis whereby equity is adjusted on the balance sheet over time. </li></ul><ul><ul><li>This is its primary function. </li></ul></ul><ul><li>The bottom-line income is then used to declare a dividend, or increase the equity on the balance sheet (retained earnings). </li></ul>
  14. 14. Creating Common Size Statements <ul><li>The key to creating common size financial statements is the use of relative versus absolute addresses. </li></ul><ul><ul><li>Excel interprets an address as relative (in position) to another address in a formula, unless you specify otherwise. </li></ul></ul><ul><ul><ul><li>A1 is a relative address. </li></ul></ul></ul><ul><ul><li>To specify an absolute address you simply use a $ in front of the absolute portion. </li></ul></ul><ul><ul><ul><li>$A$1 means always A1. </li></ul></ul></ul><ul><ul><ul><li>The F4 key allows you to cycle through all options. </li></ul></ul></ul>
  15. 15. Creating Common Size Statements <ul><li>The item that is the basis for the common size, then typically gets an absolute address. </li></ul><ul><ul><li>For example if sales are in C4, then creating a common size income statement would require you to punch in: </li></ul></ul><ul><ul><ul><li>C4/C$4. </li></ul></ul></ul><ul><ul><li>Then copying that formula down will create the common size income statement. </li></ul></ul>
  16. 16. Creating Custom Views <ul><li>You might want to, (but you don’t have to) use the custom view to create the common size statements. </li></ul><ul><li>To use a custom view, first get the spreadsheet to display what you want it to display. </li></ul><ul><ul><li>Then choose V iew and Custom V iews . </li></ul></ul><ul><ul><ul><li>Then just add the new view. </li></ul></ul></ul>
  17. 17. Cash Flow Statements <ul><li>There are two types of cash flow statements possible: </li></ul><ul><ul><li>Indirect </li></ul></ul><ul><ul><ul><li>Starts with net income a reconciles the change in cash position of the company by making adjustments. </li></ul></ul></ul><ul><ul><li>Direct </li></ul></ul><ul><ul><ul><li>Looks like an income statement, but deals only with cash items, and ends up showing the change in cash position of the company. </li></ul></ul></ul>
  18. 18. Cash Flow Statements <ul><li>Companies may disclose either type of cash flow statement as long as they disclose and indirect statement. </li></ul><ul><ul><li>If they choose to use a direct statement, they must also use an indirect. </li></ul></ul><ul><li>Therefore, only indirect statements are used. </li></ul>
  19. 19. Indirect Cash Flow Statement <ul><li>The indirect cash flow statement starts with net income disclosed on the income statement. </li></ul><ul><li>Cash adjustments are then made for operating revenues and expenses. </li></ul><ul><li>Then cash adjustments are made for assets and liabilities. </li></ul>
  20. 20. Indirect Cash Flow Statement <ul><li>Then categories are covered that don’t exist on the income statement. </li></ul><ul><ul><li>First, the cash income is adjusted for investing activities. </li></ul></ul><ul><ul><ul><li>Buying/selling subsidiaries, assets, etc. </li></ul></ul></ul><ul><ul><li>Second, the cash income is adjusted for financing activities. </li></ul></ul><ul><ul><ul><li>Both activities that bring in funds, or cost funds. </li></ul></ul></ul>
  21. 21. What is free cash flow (FCF)? Why is it important? <ul><li>FCF is the amount of cash available from operations for distribution to all investors (including stockholders and debtholders) after making the necessary investments to support operations. </li></ul><ul><li>A company’s value depends upon the amount of FCF it can generate. </li></ul>
  22. 22. What are the five uses of FCF? <ul><li>1. Pay interest on debt. </li></ul><ul><li>2. Pay back principal on debt. </li></ul><ul><li>3. Pay dividends. </li></ul><ul><li>4. Buy back stock. </li></ul><ul><li>5. Buy nonoperating assets (e.g., marketable securities, investments in other companies, etc.) </li></ul>
  23. 23. What are operating current assets? <ul><li>Operating current assets (OCA) are the current assets needed to support operations. </li></ul><ul><ul><li>Operating current assets include: cash, inventory, receivables. </li></ul></ul><ul><ul><li>Operating current assets exclude: short-term investments, because these are not a part of operations. </li></ul></ul>
  24. 24. What are operating current liabilities? <ul><li>Operating current liabilities (OCL) are the current liabilities resulting as a normal part of operations. </li></ul><ul><ul><li>Operating current liabilities include: accounts payable and accruals. </li></ul></ul><ul><ul><li>Operating current liabilities exclude: notes payable, because this is a source of financing, not a part of operations. </li></ul></ul>
  25. 25. Important Operating Measures <ul><li>Net Operating Working Capital (NOWC): </li></ul><ul><ul><li>NOWC = OCA - OCL </li></ul></ul><ul><li>Total Net Operating Capital (TNOC): </li></ul><ul><ul><li>TNOC = NOWC + Net Fixed Assets </li></ul></ul><ul><li>Net Operating Profit After Tax (NOPAT): </li></ul><ul><ul><li>NOPAT = EBIT(1-Tax Rate) </li></ul></ul><ul><ul><ul><li>EBIT = Earnings Before Interest and Taxes </li></ul></ul></ul>
  26. 26. Important Operating Measures <ul><li>Free Cash Flow (FCF): </li></ul><ul><ul><li>FCF = NOPAT - Net investment in operating capital </li></ul></ul><ul><li>Return on Invested Capital (ROIC): </li></ul><ul><ul><li>ROIC = NOPAT / TNOC </li></ul></ul><ul><li>Economic Value Added (EVA): </li></ul><ul><ul><li>EVA = NOPAT- (WACC)(TNOC) </li></ul></ul>
  27. 27. Market Value Added <ul><li>Market Value Added (MVA): </li></ul><ul><ul><li>Market Value of Firm - Book Value of Firm </li></ul></ul><ul><ul><li>If the market value of debt is close to the book value of debt, then MVA is: </li></ul></ul><ul><ul><ul><li>MVA = Market value of equity – book value of equity </li></ul></ul></ul>