finance week 2

Financial statements definition

Firm issued accounting reports with past performance information

Financial statement filing in US and UK

Filed with US Securities and Exchange commission (SEC) or Financial conduct authority in uk - FCA

Must also be sent to equity owners

Prep of fin statements companies go through

Generally Accepted Accounting Principles - GAAP

• common set of rules and standard format for public companies

International financial reporting standards - IFRS

• international effort to harmonise accounting standards

Auditors - neutral third party that checks statements

Type of financial statements

Balance sheet

Income statement

Statements of cash flow

Statements of shareholders equity

Stock vs flow definition

Stock - measured at specific time, represents quantity existing at point in time

Flow - measured over interval of time

Balance sheet type of measurement, definition

Stock

Balance sheet identity: assets = liabilities + equity

Definition of assets, liabilities and equity

Assets - what company owns

Liabilities - what company owes

Equity - difference between assets and liabilities

Asset types and definition, and what is the book value of assets

Current assets - cash or expected cash in the next year, eg shares

Long term assets - provides long term benefits

Book value = acquisition cost - accumulated depreciation

Liability types

Current liabilities - pay off in the next year eg short term debts

Long term - long term debt that can be offset in books

Working capital definition

Current assets - current liabilities

Equity value in market

Market value: market price (share) x number of shares

• often different from book value

• Can’t be negative every

Equity value in books

Net worth of company according to balance sheets

• can be negative

• Many valuable assets may not be captured

Market to book ratio/ price to book ratio

MBR: (market value of equity) / (book value of equity)

Use of MBR ratio

Value stocks - low MBR

Growth stocks - high MBR

Enterprise value and market capitalisation definition

Market cap. Measures market value of equity

EV - market value of equity + debt - cash

EV is how firms get valued for potential takeovers

Income statement type of measurement and definition

Flow

Lists firms revenue and expenses over time period

Net income def and where to find

Measures firms profit - bottom line of income statement

Gross profit calculation

Total sales - cost of sales

Operating expenses calculation

Selling/general/admin expenses + R/D + depreciation and amortisation costs

Amortisation definition

Spreading initial costs of assets over time to offset in books

Operating income equation

Gross profit - operating expenses

Earnings before interest and taxes (EBIT) calculation

Operating income + other income - other expenses

Pre tax income calculation

EBIT + interest income - interest expenses

Next income calculation from tax, and sales

= Pre tax income - tax

= total sales - cost of sales - expenses - R and D - Deprecation and amortisation costs

Use of net income

Paying dividends to shareholders

Retained profit

Revinvestment into firm

Earnings per share calculation

Net income / shares outstanding

Statement of cash flows uses

Net income =/ cash earned

• accounting profit, not change in cash

Where is the difference in accounting profit to cash earned

Non cash items eg depreciation lowering accounting

Use of cash not on income statement eg investment

3 sections of cash flow statement

Operating activity

Investment activity

Financing activity

Operating activity definition

Adjusts net income by all non cash items related to operating activity and changes in net working capital

• depreciation - add the amount of deprecation

• Accounts receivable - deduct the increases

• accounts payable - add the increases

• Inventories - deduct the increases

Accounts receivable meaning

Money owed to a company by its debtors - for goods and services bought on credit

Accounts payable meaning

Money owed by a company to companies for goods and services bought on credit

Cash from operating activities full calculation

= net income + depreciation and amortisation + other non cash items - accounts receivable + accounts payable - inventories

Investment activity examples

Capital expenditure

Buying or selling marketable securities

Financing activity examples

Payment of dividends

• retained earnings = net income - dividends

Changes in borrowings

• interest expenses already deducted when calculating net income

Cash from investing activities calculation

= cash from asset sales - capital expenditure - acquisitions

Cash from financing activities equation

= sale of stocks - repurchasing of stock + increase in borrowing - dividends paid out

Change in cash and cash equivalents equation

= cash from operating activities + cash from investment activities + cash from financial activities

Statement of share holders equity equation (change in)

Change = retained earnings + net sale of stocks

= (net income - dividends) + (sale of stock - repurchasing of stock)

Financial statement analysis - uses

Can be used for:

• comparing firms

• Comparing firm to itself

Gross margin equation

= gross profit / sales

Operating margin equation

= (operating income) / sales

EBIT margin equation

= EBIT / sales

Net profit margin equation

= (net income) / sales

Current ratio equation

= current assets / current liabilities

Quick ratio equation

= (Cash + short term investments + accounts receivable) / current liabilities

Cash ratio equation

= cash / current liabilities

P/E ratio - price to earnings - equation

= market capitalisation / net income

= share price / earnings per share

Enterprise value to EBIT equation

= (Market value of equity + debt - cash) / EBIT

Enterprise value to sales equation

= (market value of equity + debt - cash) / sales

Enterprise value to EBITDA equation

= (market value of equity + debt - cash) / EBITDA

EBITDA

EBIT + Depreciation and amortization