Accounting-Financial-Statement-Analysis-Course-Notes.pdf
- 1. Accounting & Financial Statement Analysis Ned Krastev Course Notes
- 2. WHAT IS ACCOUNTING? Accounting is an information science that is used to collect and organize financial data for organizations and individuals WHAT TYPE OF INFORMATION? Accounting organizes financial information. Accounting isn’t an abstract science – it is much more practical than theoretical. It’s one of those things that you’ll learn best by doing
- 3. TYPES OF ACCOUNTING • BOOKKEEPING: Ensures that financial information has been gathered systematically • FINANCIAL ACCOUNTING: Prepared for the company’s ownership, its lenders, financial analysts, and for other external stakeholders • MANAGERIAL ACCOUNTING: Looks into topics like pricing, competition, marginality, budgeting • TAX ACCOUNTING: Determines the amount of taxes that a company has to pay
- 4. Income Statement/ P&L/ Statement of Earnings Balance Sheet/ Statement of Financial Position C ash Flow Statement THE THREE CORE FINANCIAL STATEMENTS
- 5. Income Statement/ P&L/ Statement of Earnings PURPOSE • How did the company perform throughout the period under consideration? • Did it generate a profit or a loss? THE THREE CORE FINANCIAL STATEMENTS
- 6. PURPOSE • What does a company owe and own at a certain date? • What is the company’s financial position? Balance Sheet/ Statement of Financial Position THE THREE CORE FINANCIAL STATEMENTS
- 7. PURPOSE • How much cash did the company make during the period under consideration? • Where did the cash come from? C ash Flow Statement THE THREE CORE FINANCIAL STATEMENTS
- 8. THE MAIN INCOME STATEMENT ITEMS Income Statement/ P&L/ Statement of Earnings REV ENUE: An inflow of economic resources. Usually, the main type of revenue for a given firm are its day-to-day sales – customers buying the goods that the firm sells. OT HER REV ENUE: Earnings generated by performing activities that are outside the core area of operations C OST OF G OODS SOLD (C OG S): Expenses that are sustained in order to produce the goods that the firm sells and are directly attributable to the production process
- 9. Income Statement/ P&L/ Statement of Earnings SELLING , G ENERAL AND ADMINIST RAT IV E (SG &A): A large category of costs that includes many items that are not directly related to the production process (for ex. Salaries of non-production personnel, management compensation, rent, general expenses, etc.) DEPREC IAT ION & AMORT IZAT ION (D&A): Two accounts that reflect the “using up” of tangible and intangible assets. Depreciation refers to assets of a physical nature, while amortization is the term that is used for intangible assets (goodwill, licenses, copyrights, etc.). INT EREST EXPENSES: The finance expense that a company bears for receiving external financing THE MAIN INCOME STATEMENT ITEMS
- 10. THE MAIN BALANCE SHEET ITEMS Assets C ASH AND C ASH EQUIV ALENT S: One of the most important drivers for a business. It shows how much of a firm’s assets are cash or can easily be converted into cash. It gives us an idea of the liquidity of the company AC C OUNT S REC EIV ABLE: When customers buy a firm’s products they have to pay for them. And until they do, the firm will register this amount in accounts receivable, which indicates the money owed by customers. The firm registers that it has earned a payment from these customers but has not yet received the payment. Balance Sheet/ Statement of Financial Position
- 11. THE MAIN BALANCE SHEET ITEMS Assets INV ENT ORY: Inventory is the account that shows the value of raw materials, goods that are in the process of elaboration and finished goods that are ready to be sold to customers. PROPERT Y, PLANT & EQUIPMENT (PP&E): A group of assets that are vital to business operations. Imagine a production company – it certainly needs plants and equipment in order to transform raw materials into finished products. Usually, this is a hefty investment that cannot be easily liquidated. Balance Sheet/ Statement of Financial Position
- 12. THE MAIN BALANCE SHEET ITEMS Liabilities AC C OUNT S PAYABLE: When a company buys goods from suppliers and does not pay at the time of the purchase, it registers the amount in accounts payable until the actual payment has been made. FINANC IAL LIABILIT IES: A financial liability appears on the Balance Sheet of a company when it receives external financing – which is usually a bank loan. Balance Sheet/ Statement of Financial Position
- 13. THE MAIN BALANCE SHEET ITEMS Owners’ Equity EQUIT Y: The firm’s capital that it technically “owes” to its owners. This capital would not be repaid to the shareholders, but the company will try to pay them a decent amount of dividends if its business is successful Balance Sheet/ Statement of Financial Position
- 14. THE BASIC ACCOUNTING EQUATION The reason it is called a “Balance Sheet” is because assets must equal liabilities and equity. The two sides have to be equal at all times. This principle is known as the Accounting equation and is one of the core principles around which Accounting has been built. ASSETS ARE EQUAL TO LIABILITIES PLUS EQUITY. Assets Liabilities Equity = +
- 15. T-ACCOUNTS, CREDITS AND DEBITS Cash Accounts Receivable Trade Payables Financial Liabilities BALANC E SHEET Assets Liabilities & Equity
- 16. T-Account DEBIT MEANS “LEFT”, CREDIT MEANS “RIGHT” Credit Debit T-ACCOUNTS, CREDITS AND DEBITS
- 17. Asset T-Account DEBIT MEANS “LEFT”, CREDIT MEANS “RIGHT” Credit Debit Assets increase to the left Increase Decrease T-ACCOUNTS, CREDITS AND DEBITS
- 18. Liability T-Account DEBIT MEANS “LEFT”, CREDIT MEANS “RIGHT” Credit Debit Liabilities and Equity increase to the right Increase Decrease Equity T-Account Credit Debit Increase Decrease T-ACCOUNTS, CREDITS AND DEBITS
- 19. BALANC E SHEET Assets Liabilities & Equity Asset T-Account Credit Debit Increase Decrease Liability T-Account Credit Debit Increase Decrease Credit = Right Debit = Left T-ACCOUNTS, CREDITS AND DEBITS
- 20. INCOME STATEMENT T-ACCOUNTS P&L T-Account DEBITS ARE ON THE LEFT, WHILE CREDITS ARE ON THE RIGHT SIDE Credit Debit Income Statement/ P&L/ Statement of Earnings
- 21. INC OME ST AT EMENT Expenses Revenue Expense T-Account Credit Debit Increase Decrease Revenue T-Account Credit Debit Increase Decrease Credit = Right Debit = Left T-ACCOUNTS, CREDITS AND DEBITS
- 22. WHEN A FIRM MAKES PROFITS… COMPANY Revenue – Costs = Profit Shareholders BALANCE SHEET Liabilities Assets Equity
- 23. REVENUE T HE HIG HER A C OMPANY’S REV ENUE, T HE HIG HER IT S PROFIT S AND EQUIT Y Revenue behaves like Liabilities & Equity REV ENUE PROFIT S EQUIT Y
- 24. Revenue behaves like Liabilities & Equity Revenue T-Account Credit Debit Increase Decrease REVENUE
- 25. COSTS Costs behave like Assets Costs T-Account Credit Debit Increase Decrease
- 26. A USEFUL SCHEME EXPENSE? INCOME? OR Increase? Decrease? Debit Credit Increase? Decrease? Credit Debit OR OR
- 27. DOUBLE ENTRY BOOKKEEPING A firm owns one asset $1,000,000 Cash BALANC E SHEET Assets Liabilities & Equity Cash $1,000,000
- 28. DOUBLE ENTRY BOOKKEEPING A firm owns one asset $1,000,000 Cash 100% Equity Financing $1,000,000 Equity BALANC E SHEET Assets Liabilities & Equity Equity $1,000,000 Cash $1,000,000
- 29. DOUBLE ENTRY BOOKKEEPING A firm owns one asset $1,000,000 Cash 100% Equity Financing $1,000,000 Equity BALANC E SHEET Assets Liabilities & Equity Equity $1,000,000 Cash $1,000,000 Acquisition of Real Estate $1,000,000 $1,000,000 Cash(Asset) Real Estate (Asset) Real Estate $1,000,000
- 30. DOUBLE ENTRY BOOKKEEPING A firm owns one asset $1,000,000 Cash 100% Equity Financing $1,000,000 Equity BALANC E SHEET Assets Liabilities & Equity Equity $1,000,000 Cash $1,000,000 Acquisition of Real Estate Real Estate $1,000,000 Bank Loans $500,000 The firm receives a bank loan $500,000 Bank Loan
- 31. TIMING OF REVENUES A company sells office equipment COMPANY CLIENT FIRM ORDER FOR $10,000
- 32. The company delivers the products TODAY COMPANY CLIENT FIRM TIMING OF REVENUES
- 33. PAYMENT OF $10,000 COMPANY CLIENT FIRM The company delivers the products A payment is made AT delivery A payment is made BEFORE delivery A payment is made AFTER delivery TIMING OF REVENUES
- 34. TIMING OF REVENUES PAYMENT AT DELIVERY The client pays for the office supplies at delivery Cash(BS) $10,000 Revenue (IS) $10,000 Trade Receivables (BS)
- 35. TIMING OF REVENUES PAYMENT AFTER DELIVERY The client pays for the office supplies 60 days after delivery Cash(BS) Revenue (IS) $10,000 Trade Receivables (BS) $10,000
- 36. TIMING OF REVENUES PAYMENT AFTER DELIVERY The client pays for the office supplies 60 days after delivery Cash(BS) Revenue (IS) $10,000 Trade Receivables (BS) $10,000 $10,000 $10,000
- 37. TIMING OF REVENUES PAYMENT AFTER DELIVERY The client pays for the office supplies 60 days after delivery Cash(BS) Revenue (IS) $10,000 Trade Receivables (BS) $10,000 $10,000 $10,000
- 38. TIMING OF REVENUES PAYMENT BEFORE DELIVERY The client pays in advance Cash(BS) Revenue (IS) Trade Receivables (BS) $10,000 PrepaidRevenue (BS) $10,000
- 39. TIMING OF REVENUES PAYMENT BEFORE DELIVERY The client pays in advance Cash(BS) Revenue (IS) Trade Receivables (BS) $10,000 PrepaidRevenue (BS) $10,000 $10,000 $10,000
- 40. TIMING OF EXPENSES INVOICE $1,000 COMPANY LANDLORD A company has to pay rent A payment is made AT the date of the invoice A payment is made AFTER the date of the invoice A payment is made BEFORE the date of the invoice
- 41. PAYMENT AT THE INVOICE DATE Paying rent at the date of the invoice TIMING OF EXPENSES Cash(BS) Rent (IS) $1,000 Trade Receivables (BS) $1,000
- 42. PAYMENT AFTER THE INVOICE DATE The company pays its rent 60 days after the invoice is issued TIMING OF EXPENSES Cash(BS) Rent (IS) $1,000 Trade Receivables (BS) $1,000 $1,000 $1,000
- 43. PAYMENT BEFORE THE INVOICE DATE The company pays its rent in advance TIMING OF EXPENSES Cash(BS) Rent (IS) Trade Payables (BS) $1,000 PrepaidExpenses (BS) $1,000 $1,000 $1,000
- 44. FINANCIAL RATIOS LIQUIDITY A firm’s ability to pay its short- term obligations PROFITABILITY A firm’s ability to generate profits SOLVENCY The ability to meet long-term liabilities ACTIVITY/EFFIC IENC Y The ability to effectively employ resources into business operations VALUATION A firm’s capability to pay its short- term obligations
- 45. FINANCIAL RATIOS LIQUIDITY C urrent Ra tio = Current Assets Current Liabilities Quick Ra tio = Current Assets - Inventory Current Liabilities
- 46. FINANCIAL RATIOS SOLVENCY Debt Ra tio = Total Liabilities Total Assets Interest C overa ge Ra tio = EBIT Interest Expenses
- 47. FINANCIAL RATIOS PROFITABILITY ROA = Net Income Total Assets ROE = Net Income Shareholders’ Equity ROE = Net Income Revenue Revenue Shareholders’ Equity x ROE = Net Profit Margin x Equity Turnover
- 48. FINANCIAL RATIOS ACTIVITY/EFFIC IENC Y DSO = Accounts Receivable Revenue DPO = Accounts Payable Cost of Goods Sold x 360 x 360 DIO = Inventory Cost of Goods Sold x 360 Net T ra ding C ycle = DSO + DIO - DPO
- 49. FINANCIAL RATIOS VALUATION EPS = Net Income – Preferred Dividends Weighted average number of common shares outstanding DEPS = Adjusted income available for common shares Weighted average number of common shares outstanding P/ E Ra tio = Share price EPS Dividend Yield = Dividend per share Current share price