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Seminar 6
 

Seminar 6

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Understanding financial statements (II)

Understanding financial statements (II)

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  • Ask yourself a question, “Why do you invest?” “ What is it you truly want to win?” Winning should be reaching your goals, having the financial capacity to achieve your life goals … … not anyone else’s. Remember, you want to build a financial house that won’t fall down in a strong wind. To do that, you need to start with a plan -- a blueprint. And one of the best plans around is asset allocation.
  • Ask yourself a question, “Why do you invest?” “ What is it you truly want to win?” Winning should be reaching your goals, having the financial capacity to achieve your life goals … … not anyone else’s. Remember, you want to build a financial house that won’t fall down in a strong wind. To do that, you need to start with a plan -- a blueprint. And one of the best plans around is asset allocation.
  • Ask yourself a question, “Why do you invest?” “ What is it you truly want to win?” Winning should be reaching your goals, having the financial capacity to achieve your life goals … … not anyone else’s. Remember, you want to build a financial house that won’t fall down in a strong wind. To do that, you need to start with a plan -- a blueprint. And one of the best plans around is asset allocation.
  • - Net losses will occur when expenses exceed revenues, common in new companies, esp. those that are capital intensive in the initial phases
  • Since this is a very dense class, perhaps we could just go quickly through cash flows, and just explain briefly what this might mean
  • Cash (or rather free cash flow – FCF) is also an indication of the cash the company has left behind after using cash required to maintain and/or expand asset base through improvements (capex)
  • - Non-current assets: PPE, long-term investments - Investing & financing activities can be a bit confusing for newcomers; financing strictly deals with the issuance of equity or debt, dividend payments and not the asset part of the B.S.
  • - Capital expenditures (capex) are necessary for the maintenance and/or improvement of the company’s long-term assets to ensure that they can still be utilized – think of them as similar to periodic tune-ups for a car (that can sometimes include replacement of parts)
  • - Repurchasing stock in the market is also referred to as Treasury Stock and often listed in the Equity section of the B.S.
  • - Net Operating Cash Flow: depreciation and amortization are added back to net income in calculating it because they are non-cash items, meaning that the company does not actually expend cash for them over the course of the year as companies will record D&A costs each year instead of putting one lump sum
  • - Net Operating Cash Flow: depreciation and amortization are added back to net income in calculating it because they are non-cash items, meaning that the company does not actually expend cash for them over the course of the year as companies will record D&A costs each year instead of putting one lump sum
  • - Net Operating Cash Flow: depreciation and amortization are added back to net income in calculating it because they are non-cash items, meaning that the company does not actually expend cash for them over the course of the year as companies will record D&A costs each year instead of putting one lump sum

Seminar 6  Seminar 6 Presentation Transcript

  • Understanding Financial Statements II Speaker Position Company smart woman securities © 2010 Smart Woman Securities. Materials are for SWS members’ use only. All rights reserved. Date
  • Announcements
    • Please enter any SWS related announcements here.
  • Last Seminar Recap
    • Financials paint a picture about a company and industry – they’re more than just numbers!
    • Use balance sheets to assess a company’s financial position at a point in time
    • Assets are what a company owns. Liabilities are what a company owes.
    • Accounts within each category help you understand more about the business operations.
  • Tonight’s Agenda
    • Income Statement
    • Statement of Cash Flows
  • This Week’s Seminar
    • After this, you should be able to:
      • Be familiar with the three financial statements (balance sheet, income statement, cash flow statement)
      • Understand why you look at each statement
      • Understand the income statement accounts, what they mean, and how to read them
      • Understand the three main sections of the cash flow statements and what they mean
  • Market Update
    • Have speaker comment on what happened in the markets for past week.
    • We encourage speakers to create a slide of important occurrences (see next slide for example).
  • Market Update Example Slide
    • There were mixed technology results as Apple & Microsoft posted solid positive third quarter earnings; raising concerns about semiconductor valuations
    • Merrill Lynch wrote down $7.9b in losses from subprime losses, which adds more wariness around the health of the housing market.
    • Bank of America announced 3,000 job cuts, which adds concern to the state of the economy.
    • Crude oil futures climbed above $92; analysts expect it to surpass $100, a strong sign for the economy.
    • S&P500 gained 2.3% on the week; DJIA was up 2.1% while the NASDAQ was up 2.9% as investors seemed less concerned about risks in the credit markets.
  • Review: Stock Picking
    • #1: Finding ideas through trends
      • Newspapers, TV, roommates, internet, everyday life
      • Wall Street Journal, New York Times
      • Come up with preliminary list of companies
    • #2: Research the company
      • What industry does it belong in? What trends impact that industry?
      • Company website, financial filings (MD&A section), talk to company mgmt, listen to conference calls
      • Porter’s 5 forces tell you if it’s a good business (customer power, supplier power, barriers to entry, threat of substitutes, rivalry)
    • #3: Determine how sustainable trends are (this is subjective, no easy answer)
      • Talk to company mgmt, think independently (what makes sense?)
      • Remember trends drive revenues, and revenues drive earnings (aka EPS)!
  • Next Up: Valuation
    • #4: Use valuation to determine if a trends are priced into the stock
    • #5: Use valuation to determine future stock price
    • But, before we can do this, we must learn about the financial statements
      • Balance Sheet
      • Income Statement
      • Statement of Cash Flows
  • Income Statement
  • Income Statement
    • Tells us about the profitability of a company over a 3-month or 1-year period vs. point in time (balance sheet)
    • Basic equation:
    • revenues – expenses = net income
      • Revenues: what the firm gets paid for selling goods (sometimes also called sales)
      • Expenses: costs firm incurs to create those goods
      • Analysis of net income (& other measures of profitability) tell us how profitable the firm is
    • Net Income = “earnings”
  • Revenues and Expenses
    • Revenues are typically = price x volume.
      • Price per widget x # of widgets
    • Expenses are the costs incurred in generating revenues
      • Cost of goods sold
      • Selling, general and administrative expenditures
      • Depreciation
      • Interest
      • Income taxes
      • Source: Intermediate Accounting; Spiceland., Sepe, Tomassini; 3rd edition; Irwin/McGraw-Hill Publishing Company, 2001
  • Income Statement Example
    • Revenues = # of loaves of bread sold x price per loaf
    • Cost of Good Sold = cost of ingredients & cost of using the plant to produce the bread, cost of labor
    • Gross Profit = amount of money left over after paying for the cost of the items sold
    • Selling General & Administrative Costs = costs to run your headquarters, your salaries
  • Income Statement Example
    • Operating Profit (also called Earnings Before Interest and Taxes (EBIT)) = the amount of profit you have left after paying for all of the operations of the business
    • Interest expense = cost of taking on debt
    • Taxes = what you owe the government
    • Net Income = the amount of profits you have left over
    • EPS = net income divided by shares outstanding
    • Diluted Shares Outstanding = number of shares (always use diluted!)
  • Earnings
    • From the income statement, we can determine the company’s earnings
      • The company can do three things with earnings
        • Pay dividends (returning money to shareholders)
        • Repurchase shares (returning money to shareholders)
        • Re-invest in the company (known as “retained earnings”)
    • Earnings per share (EPS)
      • How much a stock earned per share (or, net income divided by number of shares outstanding
      • During “earnings” season (4x a year), companies have to report how well they did in the previous quarter. Oftentimes you might hear about a company “missing earnings”… this means that the company reported EPS below consensus
  • Earnings
    • Quarterly earnings
      • How much profit a company made or lost during the past quarter
      • Given in EPS
        • Usually company also holds an earnings call where they discuss their earnings and company financial performance
    • Earnings seasons
      • Differ by company, but typically they come in the month after the end of the quarter
    • Earnings vs. consensus
      • Consensus from Wall Street analysts on what EPS will be
      • If the company beats estimates, the stock tends to go up
      • If the company falls short, the stock tends to go down
        • However, other aspects may also cause stock to move (management earnings call, announcement about part of the business, etc.)
  • Income Statement (CL)
  • Income Statement Detail (CL)
    • Usually companies give more detail regarding revenues, either by region or by product
  • How We Can Read Income Statements
    • Its usefulness
      • Summarizes sales and profits and losses (P&L) over a period of time – hence why it is often called a P&L statement!
      • Lets us look at changes in key line items and ratios across time to see whether operations have been changing and in what direction
    • Its limitations
      • Difficult to compare some ratios for companies in different industries
      • Management teams have lots of options for accounting practices
      • Revenues reported don’t always equal cash collected, and expenses reported aren’t always equal to cash paid, so income usually IS NOT EQUAL to the change in cash for the period
      • There are many components in income statements; make sure you read the footnotes so that you’re getting the whole story!
      • Source: ©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton
  • Statement of Cash Flows
  • Cash Flows
    • Statement of cash flows provides relevant information about a company’s cash inflows and outflows
    • Net Income ≠ Cash generated!!
      • Net income is a function of accrual accounting which smoothes cash flow
      • Cash can’t be manipulated
    • Cash flows help investors (and creditors) assess
      • Future funding needs
      • Liquidity (cash to run daily/annual operations)
      • Long-term solvency (ability to pay bills and service debt)
      • Sources: Intermediate Accounting; Spiceland., Sepe, Tomassini; 3rd edition; Irwin/McGraw-Hill Publishing Company, 2001
  • Income Statement vs. Cash Flows
    • Income statement uses accrual accounting to smooth cash flow, which tends to be lumpy.
      • Revenue recognition
        • Does a company recognize revenue when end product has been produced, when it’s shipped, when customer receives it? Orders often placed at end of the quarter.
      • Cost recognition
        • Does a company recognize cost when the end product has been produced, when it receives payment for the product?
      • There is a LOT of discretion by the CFO in terms of how s/he can account for items in the income statement
    • Cash flow is literally the cash being generated and used by the company over a certain period of time
  • Cash Flows
    • 3 sections of the cash flow statements
      • Operating Activities
        • How much cash do the firm’s core operations generate?
      • Investing Activities
        • How much cash firm is spending on long term assets to grow (capex) or on acquisitions
      • Financing Activities
        • How much cash firm is spending to finance its growth (debt borrowed & equity issued)
        • How much cash firm is returning to shareholders (dividends, share repurchases)
  • Cash Flows from Operating Activities
    • Inflows
      • Cash received from customers (remember accounts receivables)
    • Outflows
      • Buying inventory (remember accounts payables)
      • Paying salaries and wages
      • Paying suppliers (also accounts payable)
      • Sources: Intermediate Accounting; Spiceland., Sepe, Tomassini; 3rd edition; Irwin/McGraw-Hill Publishing Company, 2001
  • Net Income and Operating Cash Flow
    • Operating cash flow statement takes Net Income and makes adjustments so investors can see how much cash the business generated
  • Cash Flows from Operating Activities
  • Cash Flows from Investing Activities
    • Inflows
      • Cash received from sales of PP&E (selling an plant the firm doesn’t need anymore). Pretty infrequent.
    • Outflows
      • Purchasing long-term assets (PP&E) = capital expenditures (aka capex) (building a new plant)
      • Acquisitions of other companies
      • Sources: Intermediate Accounting; Spiceland., Sepe, Tomassini; 3rd edition; Irwin/McGraw-Hill Publishing Company, 2001
  • Cash Flows from Investing Activities
  • Cash Flows from Financing Activities
    • Inflows
      • Cash received from borrowing (i.e. firms borrow cash from banks to make acquisitions)
      • Cash received from issuing stock (i.e. firm issues shares to raise money)
    • Outflows
      • Repaying debt (i.e. firms eventually have to pay back what they borrowed from the bank)
      • Paying dividends to shareholders
      • Repurchasing stock
      • Sources: Intermediate Accounting; Spiceland., Sepe, Tomassini; 3rd edition; Irwin/McGraw-Hill Publishing Company, 2001
  • Cash Flows from Financing Activities
  • Cash Flows (CL)
  • How To Read Cash Flow Statements
    • Its usefulness
      • You can actually see where cash is going and how the company spends it
      • Changes in the B/S can be explained by looking at CF statement
      • Get a better understanding of a company’s investing and financing activities because these aren’t obvious in the I/S
    • Its limitations
      • When companies make acquisitions, it is often difficult to fully reconcile all of the cash inflows and outflows w/ the B/S
      • Source: ©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton
  • Free Cash Flow: Important Metric
    • Free Cash Flow (FCF) is the most important metric from the statement of cash flows
    • FCF represents the cash that a company has left over after paying money required to maintain/expand its asset base
    • It isn’t given to you, but it’s easy to calculate from the cash flow statement. The most basic way is:
      • Free Cash Flow =
      • Operating Cash Flow – Capital Expenditures
  • What is Free Cash Flow?
    • Free cash flow is what a company has left over at the end of the year - or quarter - after paying all its employees' salaries, its bills, its interest on debt, and its taxes, and after making capital expenditures to expand the business
    • Investors often refer to this as the “cash” that the company is producing. The company can decide what they want to do with the cash (expand, pay a dividend, pay down debt). Like with most things, the more cash you have, the more options you have.
  • Free Cash Flow Example
    • For our, CL example, you take 1,821.5 (cash from operations) and add 476.4 (capex) and you get 1,345.1in FCF.
    • So in 2006, CL had $1.3 billion in FCF. Now, that’s serious cash!
  • Seminar Recap
    • Income statements measure profitability over a certain time period
      • Revenues are what a company makes, expenses are its costs, and profit or earnings are what it takes home at the end.
    • Cash flow statements help to show you were cash has been used in the business and has three important parts:
      • Operating - cash going in/out for business operations
      • Investing - cash going in/out for growth and investment
      • Financing - cash going in/out to finance operations or growth or to return cash to shareholders /bondholders
    • Week 7:
    • Understanding important financial metrics
    • Calculating financial ratios
    • Analyzing what ratios mean about a company or industry
    • Week 8:
    • Understanding how an investment recommendation works
    • Putting it all together with an investment recommendation
    • Seeing a real world example of an investment recommendation
    • Weeks 9-10:
    • Guest lectures/presentations
    Coming Up