Financial Report Literacy Fall 2011


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Financial Report Literacy Fall 2011

  2. 2. PUBLIC COMPANIES MUST REPORT THEIR FINANCIAL CONDITION <ul><li>Government wants stable financial markets </li></ul><ul><ul><li>Securities and Exchange Commission </li></ul></ul><ul><li>Investors want accurate information </li></ul><ul><li>All financial reporting must conform with Generally Accepted Accounting Principles (GAAP) </li></ul>
  3. 3. ACCOUNTING <ul><li>Double entry system </li></ul><ul><ul><li>Designed as a double-check </li></ul></ul><ul><li>Double entries consist of debits and credits </li></ul><ul><li>Do not think that “debit” is always bad and “credit” always good </li></ul><ul><li>Depends on which side of the balance sheet you are on </li></ul>
  4. 4. Various Types of Accounting <ul><li>Financial accounting </li></ul><ul><ul><li>Cash </li></ul></ul><ul><ul><li>Accrual </li></ul></ul><ul><li>Cost </li></ul><ul><li>Tax </li></ul><ul><li>Managerial </li></ul>
  5. 5. Cash Accounting <ul><li>Record transactions as cash flows in or out. </li></ul><ul><li>Most individuals operate on cash accounting basis. </li></ul>
  6. 6. Accrual Accounting <ul><li>Record transactions as revenue and expenses accrue. </li></ul><ul><ul><li>Haven’t paid December bills. In cash accounting wouldn’t record expenses until paid, but in accrual accounting would. Expenses have accrued. </li></ul></ul>
  7. 7. May Also Choose Time Basis <ul><li>Calendar Year </li></ul><ul><li>Fiscal Year-- any twelve-month period </li></ul><ul><ul><li>July 1--June 30 </li></ul></ul><ul><ul><li>September 1--August 30 </li></ul></ul>
  8. 8. Types of Financial Reports <ul><li>Cash Flow Statement </li></ul><ul><li>Balance Sheet </li></ul><ul><li>Income Statement </li></ul><ul><li>Annual Report </li></ul>
  9. 9. Cash Flow Statement Net amount of cash taken into the business during a given period and the cash paid out during that same period.
  10. 10. Inflows & Outflows <ul><li>sales </li></ul><ul><li>borrowed funds </li></ul><ul><li>investment proceeds </li></ul><ul><li>from investors </li></ul><ul><li>purchases </li></ul><ul><li>operations </li></ul><ul><li>interest </li></ul><ul><li>taxes </li></ul><ul><li>dividends </li></ul>
  11. 11. Cash Flow Statement <ul><li>two things not told by cash flow statement: </li></ul><ul><ul><li>profit </li></ul></ul><ul><ul><li>financial condition or position of the business at the end of the year </li></ul></ul>
  12. 12. Balance Sheet Two sides must balance
  13. 13. Balance Sheet <ul><li>Assets </li></ul><ul><li>The “own” side </li></ul><ul><li>Liabilities + Equity </li></ul><ul><li>The “owe side” </li></ul>
  14. 14. Assets <ul><li>Current </li></ul><ul><li>Non-current </li></ul>
  15. 15. Current Assets <ul><li>Cash </li></ul><ul><li>Accounts Receivable </li></ul><ul><li>Inventory </li></ul><ul><ul><li>Anything likely to be converted into cash, sold exchanged or expenses (used and then charged as an expense) in the normal course of business -- usually a year </li></ul></ul>
  16. 16. Fixed Assets <ul><li>Leasehold improvements </li></ul><ul><li>Intangible assets </li></ul><ul><ul><li>Goodwill </li></ul></ul><ul><ul><li>Patents and trademarks </li></ul></ul><ul><li>Notes receivable after one year </li></ul><ul><li>Other investments </li></ul><ul><li>Misc. assets that are not current </li></ul>
  17. 17. Not everyone agrees on classifications <ul><li>Credit analysts view prepaid expenses as a noncurrent asset. </li></ul><ul><li>Accountants view prepaid expenses as a current asset. </li></ul><ul><li>Accountants and Internal Revenue auditors frequently disagree on classification of transactions. </li></ul>
  18. 18. Liabilities <ul><li>Current and Long-term </li></ul>
  19. 19. Current Liabilities <ul><li>Debts and obligations that are coming due within one year </li></ul><ul><ul><li>Credit card debt </li></ul></ul>
  20. 20. Long-Term Liabilities <ul><li>Debts and obligations that are not coming due within a year. </li></ul><ul><ul><li>Student loan </li></ul></ul><ul><ul><ul><li>The monthly payments for the year are current liabilities but the principal and interest due are not current. </li></ul></ul></ul>
  21. 21. Equity <ul><li>Shareholders’ equity. </li></ul><ul><li>Retained earnings. </li></ul>
  22. 22. Shareholders’ equity Interest of shareholders in the company.
  23. 23. Retained earnings Money the company keeps for itself rather than being paid out in dividends to the shareholders.
  24. 24. If a company is insolvent and owes more than it owns . . . Equity will be a negative amount. Negative amounts are shown in ( )
  25. 25. Income Statement
  26. 26. Other names for an income statement: <ul><li>Profit and loss statement </li></ul><ul><li>Operating statement </li></ul><ul><li>Earning statement </li></ul>
  27. 27. Income statement Reports the results of operations over a specified period of time.
  28. 28. Income statement Summary of how much the business has taken in and paid out -- its profits.
  29. 29. Income statement <ul><li>Revenues </li></ul><ul><li>Costs and expenses </li></ul><ul><li>Operating income </li></ul><ul><li>Income before taxes </li></ul><ul><li>Income taxes </li></ul><ul><li>Net income </li></ul><ul><li>Earnings per share </li></ul>
  30. 30. Non-operating Income or Expenses <ul><li>Incomes, gains or losses from other investments </li></ul><ul><li>Gains or losses on the sale of fixed assets </li></ul><ul><li>Special payments to employees </li></ul><ul><li>Interest expense is a non-operating expense </li></ul>
  31. 31. Net income after taxes The bottom line
  32. 32. Dividend Distribution of earnings to shareholders.
  33. 33. Dividends <ul><li>Prorated by class of security </li></ul><ul><ul><li>Preferred stock </li></ul></ul><ul><ul><li>Common stock </li></ul></ul><ul><li>May be paid in money, stock, scrip or, rarely, company products or property </li></ul>
  34. 34. Depreciation <ul><li>Bookkeeping entry that reduces income without reducing cash. </li></ul><ul><li>May be combined with cost of goods sold. </li></ul><ul><li>Non-cash expense. </li></ul><ul><li>Added back to net income to determine company’s cash earnings. </li></ul>
  35. 35. Cash flow from operations Net income + depreciation
  36. 36. Amortization conversion of intangible long-lived assets into expenses over a number of accounting periods
  37. 37. Don’t be Fooled <ul><li>Revenues ≠ Profit </li></ul><ul><li>Profit not only concern </li></ul><ul><li>Management has three tasks: </li></ul><ul><ul><li>earning profit </li></ul></ul><ul><ul><li>controlling company’s financial condition </li></ul></ul><ul><ul><li>cash flow, preventing “cashouts” </li></ul></ul>
  38. 38. Basic Financial Ratios (Balance Sheet Ratios) Percentages that provide understanding.
  39. 39. Vital Signs Or How to tell if a company is healthy. (Fundamental Analysis)
  40. 40. Ratios to evaluate . . . <ul><li>Short Term Stability (Liquidity) </li></ul><ul><li>Long Term Stability </li></ul><ul><li>Management Performance </li></ul><ul><li>Profitability </li></ul><ul><li>Stock Prices </li></ul>
  41. 41. Evaluating Short Term Stability (Liquidity) <ul><li>Current ratio </li></ul><ul><ul><li>Current assets / current liabilities </li></ul></ul><ul><li>Quick ratio </li></ul><ul><ul><li>(Current assets - inventory) / current liabilities </li></ul></ul>
  42. 42. Current ratio <ul><li>Current assets divided by current liabilities. </li></ul><ul><li>Indication firm is sufficiently liquid </li></ul><ul><ul><li>Enough working capital to ensure that firm can meet its current obligations and operate comfortably </li></ul></ul><ul><li>Short-term solvency </li></ul>
  43. 43. <ul><li>Extra liquidity can held in a recession </li></ul><ul><ul><li>Receivables might be slow </li></ul></ul><ul><ul><li>Inventory can lose value </li></ul></ul><ul><li>Businesses do make mistakes in purchasing or marketing </li></ul>
  44. 44. Too much liquidity not good <ul><li>Want to be lean and mean </li></ul><ul><li>Want to use cash resources efficiently </li></ul><ul><li>Could indicate shrinking operations </li></ul><ul><li>May be vulnerable to a take-over attempt </li></ul>
  45. 45. Current ratio <ul><li>Manufacturing -- 1.5 to 1 to 2 to 1 </li></ul>
  46. 46. Quick ratio <ul><li>Also known as the acid-test ratio </li></ul><ul><li>Current ratio excluding inventory </li></ul><ul><li>Cash, Receivables / current liabilities </li></ul><ul><li>Test: what if sales stopped </li></ul>
  47. 47. Quick ratio <ul><li>Assuming no negative trends in year to year comparison </li></ul><ul><li>Ratio of .50 to 1 or 1 to 1 </li></ul>
  48. 48. Evaluating Long Term Stability (measuring capitalization) <ul><li>Debt to equity </li></ul><ul><ul><li>Total liabilities / total stockholders’ equity </li></ul></ul><ul><li>Debt to total assets </li></ul><ul><ul><li>Total liabilities / total assets </li></ul></ul><ul><li>Long-term debt to total capitalization </li></ul><ul><ul><li>Long-term debt / (long-term debt + stockholders’ equity) </li></ul></ul>
  49. 49. <ul><li>Times interest earned </li></ul><ul><ul><li>(earnings before taxes + interest charges) / interest charges </li></ul></ul><ul><li>Fixed charge coverage </li></ul><ul><ul><li>(earnings before taxes + interest charges) / (interest charges + lease payments) </li></ul></ul>
  50. 50. Evaluating Management Performance (measuring activity) <ul><li>Inventory </li></ul><ul><ul><li>Cost of goods sold / inventory </li></ul></ul><ul><li>Average collection period </li></ul><ul><ul><li>Accounts receivable / (annual credit sales/360 days) </li></ul></ul><ul><li>Fixed assets turnover </li></ul><ul><ul><li>Net sales / net fixed assets </li></ul></ul><ul><li>Asset turnover </li></ul><ul><ul><li>Net sales / total assets </li></ul></ul><ul><li>Operating profit margin </li></ul><ul><ul><li>Net operating profit / net sales </li></ul></ul>
  51. 51. Evaluating Profitability <ul><li>Net profit margin </li></ul><ul><ul><li>Net income / net sales </li></ul></ul><ul><li>Return on equity </li></ul><ul><ul><li>Net income / total stockholders’ equity </li></ul></ul><ul><li>Operating profit margin </li></ul><ul><ul><li>Net operating profit / net sales </li></ul></ul>
  52. 52. Net Profit Margin <ul><li>Net income / net sales </li></ul><ul><li>Measures overall efficiency </li></ul><ul><ul><li>Success in managing operations </li></ul></ul><ul><ul><ul><li>Borrowing money at a favorable rate </li></ul></ul></ul><ul><ul><ul><li>Investing idle cash to produce extra income </li></ul></ul></ul><ul><ul><ul><li>Taking advantage of tax benefits </li></ul></ul></ul>
  53. 53. Return on Equity <ul><li>Net income / total stockholders’ equity </li></ul><ul><li>The bottom line measured against the money shareholders have invested </li></ul>
  54. 54. Operating profit margin <ul><li>Net operating profit / net sales </li></ul><ul><li>Measures firm’s operating efficiency </li></ul>
  55. 55. Evaluating Stock Prices <ul><li>Price-earnings ratio </li></ul><ul><ul><li>Market price of common share / earnings per common share </li></ul></ul><ul><li>Market-to-book ratio </li></ul><ul><ul><li>Market price of common share / book value per share </li></ul></ul><ul><li>Dividend pay-out ratio </li></ul><ul><ul><li>Dividends per common share / earnings per common share </li></ul></ul>
  56. 56. Price/Earnings Ratio <ul><li>current market price / earnings per share </li></ul><ul><li>earnings per share (EPS) </li></ul><ul><ul><li>net income for year / number of shares of stock </li></ul></ul>
  57. 57. A few helpful terms.
  58. 58. EBITDA <ul><li>Earnings Before Interest, Taxes, Depreciation and Amortization </li></ul><ul><li>EBITDA is not a measure of cash flow. </li></ul><ul><li>Is an indicator of company’s financial performance (revenues - expenses). </li></ul>
  59. 59. Trailing Twelve Months <ul><li>Previous 12 months </li></ul><ul><ul><li>As opposed to the past calendar year </li></ul></ul>
  61. 61. Two Types of Analysis <ul><li>Fundamental </li></ul><ul><li>Technical </li></ul>
  62. 62. Fundamental Analysis <ul><li>Sales (revenues) </li></ul><ul><li>Profitability </li></ul><ul><ul><li>Earnings per share (higher is better) </li></ul></ul><ul><ul><li>Return on Equity (higher is better) </li></ul></ul><ul><li>Stock is reasonably priced </li></ul><ul><ul><li>P/E ratio (lower is better) </li></ul></ul><ul><li>New or unique </li></ul><ul><li>Leader in some aspect </li></ul><ul><li>Superior in some way </li></ul>
  63. 63. Technical Analysis <ul><li>Chart the stock price </li></ul>
  64. 64. Most Important Rule to Know <ul><li>diversify </li></ul>