E145/STS173 Workshop A Basics of Accounting Professors Tom Byers and Randy Komisar Stanford University With special thanks...
Goals of the Workshop <ul><li>Review main accounting documents and financial analysis </li></ul><ul><ul><li>Balance Sheet ...
How Does It All Add Up Income Expenses Assets Liabilities When you buy something… When you get paid for a product or servi...
Some Accounting Principles <ul><li>Accounting items are classified into “accounts” according to their nature, translated i...
Accounting vs. Market Value <ul><li>Equity:  Ownership of a company is divided in certificates called common shares </li><...
Income Statement <ul><li>Reports the  economic results  of a company over a time period. It shows the derivation of earnin...
Income Statement - Analysis <ul><li>When does a transaction affect income?  -  When it changes the economic value of the c...
Income Statement - Example <ul><li>The following information was taken from the 2001 financial statements of Kellogg Compa...
Income Statement - Example <ul><li>KELLOG COMPANY </li></ul><ul><li>Income Statement </li></ul><ul><li>For the Year Ended ...
Balance Sheet <ul><li>It is a  financial snapshot  of a company at a  given point in time </li></ul>Current Assets (liquid...
Balance Sheet  - Analysis <ul><li>Working Capital :  measure of the amout of cash available in the short-term; Also, indic...
Balance Sheet - Example <ul><li>These financial statement items are for Tweeter Entertainment Group at year-end on Septemb...
Balance Sheet - Example Assets Current assets Cash $  3.3 Receivables   31.3 Inventories   129.2 Other current assets   7....
Statement of Cash Flows <ul><li>The Statement of Cash Flows  reports cash receipts and payments over a period, separating ...
Statement of Cash Flows - Analysis <ul><li>CFIMITYM !!! </li></ul><ul><li>(Cash Flow is More Important Than Your Mother!! ...
Statement of Cash Flows - Example <ul><li>SIERRA CORPORATION </li></ul><ul><li>Statement of Cash Flows </li></ul><ul><li>F...
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Slidedeck: The Basics of Accounting

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Slidedeck: The Basics of Accounting

  1. 1. E145/STS173 Workshop A Basics of Accounting Professors Tom Byers and Randy Komisar Stanford University With special thanks to: Roma Jhaveri, Ben Hallen, Filipe Santos, Yosem Companys Copyright © 2004 by the Board of Trustees of the Leland Stanford Junior University and Stanford Technology Ventures Program (STVP). This document may be reproduced for educational purposes only.
  2. 2. Goals of the Workshop <ul><li>Review main accounting documents and financial analysis </li></ul><ul><ul><li>Balance Sheet </li></ul></ul><ul><ul><li>Income Statement (Statement of Operations) </li></ul></ul><ul><ul><li>Statement of Cash Flows </li></ul></ul><ul><li>Please refer also to the handout: How to Read a Financial Report </li></ul>
  3. 3. How Does It All Add Up Income Expenses Assets Liabilities When you buy something… When you get paid for a product or service… The value of anything you own… The value of anything you borrow… Assets often generate income Liabilities often generate expenses
  4. 4. Some Accounting Principles <ul><li>Accounting items are classified into “accounts” according to their nature, translated into monetary units, and organized in statements </li></ul><ul><li>Basic Accounting formula: </li></ul><ul><li>Assets = Liabilities + Equity </li></ul>What the company owns How the ownership of assets was financed ( By third parties or by the owners)
  5. 5. Accounting vs. Market Value <ul><li>Equity: Ownership of a company is divided in certificates called common shares </li></ul><ul><li>Accounting Value (or Book Value) = Equity = Assets – Liabilities </li></ul><ul><li>Accounting Value is different from Market Value !!! </li></ul><ul><li>Market Value = Share Price * Number of Common Shares Outstanding </li></ul>
  6. 6. Income Statement <ul><li>Reports the economic results of a company over a time period. It shows the derivation of earnings or losses. </li></ul><ul><li>+ Revenues </li></ul><ul><li>- Cost of Revenue (product cost or COGS) </li></ul><ul><li>= Gross Margin </li></ul><ul><ul><li>Sales and Marketing </li></ul></ul><ul><ul><li>General and Administrative </li></ul></ul><ul><ul><li>Research & Development </li></ul></ul><ul><ul><li>Depreciation and Amortization </li></ul></ul><ul><li>= Operating Income (EBIT) </li></ul><ul><li>+ Interest Income(expense) net </li></ul><ul><li>= Net Income before Taxes </li></ul><ul><li>- Income Tax Provision </li></ul><ul><li>- Extraordinary Items </li></ul><ul><li>= Net Income </li></ul>Income Statement of XXX Corp. – year 2000 $ % Rev.
  7. 7. Income Statement - Analysis <ul><li>When does a transaction affect income? - When it changes the economic value of the company for the owners </li></ul><ul><li>Some Profitability Measures : </li></ul><ul><ul><li>Gross Margin (%) = Gross Profit / Sales </li></ul></ul><ul><ul><li>Operating Margin = Operating Income / Sales </li></ul></ul><ul><ul><li>Return on Sales = Net Income / Sales </li></ul></ul><ul><ul><li>Return on Equity = Net Income / Shareholders’ Equity </li></ul></ul><ul><li>Other Important Measures </li></ul><ul><ul><li>Earnings Per Common Share (EPS) = Net Income / Common Shares </li></ul></ul><ul><ul><li>Price Earnings Ratio (P/E) = Market Price / Earnings Per Share </li></ul></ul>
  8. 8. Income Statement - Example <ul><li>The following information was taken from the 2001 financial statements of Kellogg Company. Dollar amounts are in millions. </li></ul><ul><li>Cost of goods sold $ 4,128.5 </li></ul><ul><li>Selling & admin. expenses 3,523.6 </li></ul><ul><li>Interest expense 351.5 </li></ul><ul><li>Other expense 54.0 </li></ul><ul><li>Net sales 8,853.3 </li></ul><ul><li>Income tax expense 322.1 </li></ul>From Kimmel et. al. Financial Information For Decision Making
  9. 9. Income Statement - Example <ul><li>KELLOG COMPANY </li></ul><ul><li>Income Statement </li></ul><ul><li>For the Year Ended December 31, 2001 </li></ul><ul><li>Net sales $ 8,853.3 </li></ul><ul><li>Cost of goods sold 4,128.5 </li></ul><ul><li>Gross Profit 4,724.8 </li></ul><ul><li>Selling & admin. expense 3,523.6 </li></ul><ul><li>Income from Operations 1,201.2 </li></ul><ul><li>Interest expense 351.5 </li></ul><ul><li>Other expense 54.0 </li></ul><ul><li>Net Income Before Taxes 795.7 </li></ul><ul><li>Income tax expense 322.1 </li></ul><ul><li>Net Income $ 473.6 </li></ul>
  10. 10. Balance Sheet <ul><li>It is a financial snapshot of a company at a given point in time </li></ul>Current Assets (liquid in less than a year) Fixed Assets Other Assets Current Liabilities (payable in less than a year) Long-Term Liabilities (bonds issued, bank loans) Shareholders’ Equity Cash and Equivalents Accounts Receivable Inventories Property, plant and equipment (minus Depreciation) Intangibles (minus depreciation) Investment Securities Total Assets = Accounts Payable Accrued Expenses Short Term debt Common Stock Additional Paid-in Capital Retained Earnings Total Liabilities + Shareholder’s Equity Balance Sheet of XXX Corp. - 31 December of 2000 (in thousand $)
  11. 11. Balance Sheet - Analysis <ul><li>Working Capital : measure of the amout of cash available in the short-term; Also, indication of the funds needed operate within a given business size </li></ul><ul><li>= Current Assets – Current Liabilities </li></ul><ul><li>Liquidity ratios : measures of the ability to meet short term financial obligations </li></ul><ul><ul><li>Current Ratio: Current Assets / Current Liabilities </li></ul></ul><ul><ul><li>Acid-test: (Cash + Accounts receivable) / Current Liabilities </li></ul></ul><ul><li>Operational Efficiency Measures </li></ul><ul><ul><li>Inventory Turnover = Cost of Sales per year / Current Inventory </li></ul></ul><ul><ul><li>Accounts Receivable Collection Period = accounts receivable / sales </li></ul></ul><ul><ul><li>Accounts Payable Collection Period = accounts payable / cost of sales </li></ul></ul>
  12. 12. Balance Sheet - Example <ul><li>These financial statement items are for Tweeter Entertainment Group at year-end on September 30, 2001. (in millions) </li></ul><ul><li>Accounts payable $ 38.6 </li></ul><ul><li>Property, plant & equipment 109.1 </li></ul><ul><li>Receivables 31.3 </li></ul><ul><li>Other current liabilities 23.3 </li></ul><ul><li>Stockholders’ equity 332.4 </li></ul><ul><li>Cash 3.3 </li></ul><ul><li>Long-term debt 36.7 </li></ul><ul><li>Inventories 129.2 </li></ul><ul><li>Accrued expenses 38.9 </li></ul><ul><li>Other current assets 7.5 </li></ul><ul><li>Other liabilities 10.5 </li></ul><ul><li>Other assets 200.0 </li></ul>From Kimmel et. al. Financial Information For Decision Making
  13. 13. Balance Sheet - Example Assets Current assets Cash $ 3.3 Receivables 31.3 Inventories 129.2 Other current assets 7.5 Total current assets 171.3 Property, plant & equipment 109.1 Other assets 200.0 Total assets $ 480.4 Liabilities and Stockholders’ Equity Current liabilities Accounts payable $ 38.6 Accrued expenses 38.9 Other current liabilities 23.3 Total current liabilities 100.8 Long-term debt 36.7 Other liabilities 10.5 Total liabilities 148.0 Stockholders’ equity 332.4 Total liab. & stock. equity $ 480.4 TWEETER HOME ENTERTAINMENT GROUP Balance Sheet (in millions) September 30, 2001
  14. 14. Statement of Cash Flows <ul><li>The Statement of Cash Flows reports cash receipts and payments over a period, separating operational, investing and financing activities. </li></ul>+ Cash Flow from operating activities (reconciled from income statement) = income - net changes in working capital (except cash and equivalents) + depreciation and amortization + Cash Flow from investing activities + Cash Flow from financing activities = Net Change in Cash or Equivalents + Cash or Equivalents at beginning of period = Cash or Equivalents at end of period Statement of Cash Flows of XXX Corp. – 2000 $
  15. 15. Statement of Cash Flows - Analysis <ul><li>CFIMITYM !!! </li></ul><ul><li>(Cash Flow is More Important Than Your Mother!! ) </li></ul><ul><li>Especially for an entrepreneurial firm... </li></ul><ul><li>How is cash flow different from income? </li></ul><ul><ul><li>Income accrual is not necessarily linked to cash transactions (e.g., depreciation, sales by credit) </li></ul></ul><ul><ul><li>Some activities affect cash flows but not income (e.g., investments in fixed assets, additional capital from shareholders) </li></ul></ul><ul><li>Growth often absorbs cash flow because of a higher need for working capital and fixed investments (Entrepreneurial firms with negative income and high growth can have a very fast cash burn rate) </li></ul>
  16. 16. Statement of Cash Flows - Example <ul><li>SIERRA CORPORATION </li></ul><ul><li>Statement of Cash Flows </li></ul><ul><li>For the Month Ended October 31, 2004 </li></ul><ul><li>Cash flows from operating activities </li></ul><ul><li>Cash receipts from operating activities $ 11,200 </li></ul><ul><li>Cash payments for operating activities (5,500) </li></ul><ul><li>Net cash provided by operating activities $ 5,700 </li></ul><ul><li>Cash flows from investing activities </li></ul><ul><li>Purchased office equipment (5,000) </li></ul><ul><li>Net cash used by investing activities (5,000) </li></ul><ul><li>Cash flows from financing activities </li></ul><ul><li>Issuance of common stock 10,000 </li></ul><ul><li>Issued note payable 5,000 </li></ul><ul><li>Payment of dividend 500 </li></ul><ul><li>Net cash provided by financing activities 14,500 </li></ul><ul><li>Net increase in cash 15,200 </li></ul><ul><li>Cash at beginning of period 0 </li></ul><ul><li>Cash at end of period 15,200 </li></ul>From Kimmel et. al. Financial Information For Decision Making

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