Basic Finance - Balance sheet, Income statement, Shareholder's equity, Cash flow

JWI 530 Finance I, week3 summary, 1/27/13

What a fantastic week this was ! We took a deep dive and I found a door to the fascinating world of finance. I had a Alice in Wonderland moment many times over. To know that the four key statements - Balance sheet, income statement, shareholder's equity and cash flow - make the foundation of financial reporting itself is a revelation to me. This gives a neat structure with which to analyze financial health of firms. I will now be able to look at annual reports of firms in greater detail and see factors impacting the bottom line and top line.

The lectures held our hand and walked us step by step through finance statements, demystifying the meaning of the finance terms and explaining why each kind of statements are important, how to read them, how to evaluate them and what to look for when analyzing a firm in the context of time and environment.

Numerous take aways this week as given below. I have waited for a very long time to get these insights...thrilled to be in this class and learning with such a bright community
Dr DP

JWI 530 Financial Management I, week3 summary
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The four basic statements in an annual report are:
Balance sheet - assets & liabilities; what firm owns & owes; snapshot in time
Income statement - bottomline; results of operations over a period of time
Shareholder's equity or Stockholder's equity - retained earnings between balance sheet dates
Cash flow statement - cash flow from operating, investing, financing activities

1. BALANCE SHEET (Week3, Lecture1) - What firm owns/owes
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Balance Sheet - assets & liabilities; what firm owns, what firm owes;
snapshot of company's financial condition at a single moment in time;
in constant flux and evolution as cash comes in, debts are repaid, investments are made
Use this to assess firm's ability to generate profits, withstand bumps in the road
is the firm getting better ? how is the business changing ? Year over Year analysis, Quarter over Quarter analysis

Assess company's ability to collect on credit sales and manage inventories
Financial statements feed into or are derived from balance sheets

Gauge overall fiscal health of company
How much cash firm has ?
how much debt it maintains ?
how well it turns over inventory ?

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Assets = Equity + Liabilities
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Assets are ranked by liquidity
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Cash  equivalents
Accounts receivable (completed sales; must be collected from customers before they become cash)
inventory (value of merchandise yet to be sold, held in warehouses or stores; must be converted into goods and or sold to become cash)
other current assets (prepaid expenses, deferred tax expenses)
long lived assets eg plant, property,equipment, buildings, warehouses, forklifts, trademarks, prepaid leases for stores (net of accumulated depreciation)
Goodwill
Long term investments

Liabilities are ranked by due dates
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Short Term Liabilities = Current liabilities = Accounts payable bills due to suppliers within 15-90 days + income taxes to pay within 1 year
Other - gift cards to be redeemed
Portion of long term debt due within that period
Long term liabilities eg money borrowed from banks, bonds issued, taxes owed in future, rent due later on, long term debt, other financial obligations

Equity = book value = value of company once it pays off everything

How much cash does the firm hold? Cash + Cash equivalents + Short Term investments
Trends in last few years ? Rising or falling ? Comparison vs other businesses with similar operating needs ? Cash vs future strategy ?Is Cash position increasing over years ? Hoard => avoid short term funding problems

Stock holder's equity ie book value
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Amount left over for stockholders
Retained earnings = total value of money the firm has accumulated over years in the form of profits
Treasury stock - value of company stock that firm has at its disposal

Banks
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Assets = Loans given out
Liabilities = deposits owed to customers

2. INCOME STATEMENT - Business Operations (financial engine diagnostics)
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- how money trickles through a business eg revenues from sales, costs & charges, profits?
- how revenues and expenses are changing with time?
- how much profit is the firm making ?

I. Revenues
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Total revenue = Net sales

II. Cost of Revenue
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Cost of Goods Sold (COGS) = cost of producing the products or services sold
- cost of raw materials
- cost of manufacturing
- shipping & handling costs to receive raw materials and deliver finished goods

III. Gross Margin
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Gross Profit = Total Revenue - Cost of Revenue
Gross Margin = Gross Profit/Revenue
- how effective the business is at sourcing materials vs competitors & peers; what differentiates the leader ?
- For Bed Bath & Beyond, it gives the markup vs wholesale cost
- Highest gross margin does not always mean a superior business
WalMart & Costco gross margins lower 25% vs BBB 41%; but volumes and total revenues are higher


IV. Operating expenses
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overhead = R&D, depreciation, amortization
           SG&A selling/general/admin cost: commissions to sales people, mgmnt & support staff salaries, utility bills, advertising expenses,
Operating profit = Operating income = Gross profit - operating expenses
Operating margin = operating income/total revenues
- operational effectiveness of business
- ability to manage discretionary costs
- how disciplined with salaries, paying expensive trips, corporate meals
- evaluate with trends and economic context: trend going down - why?

V. Net income
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bottomline - how much of every dollar the firm keeps for itself
Net margin = net income/total revenue
- all non-operation items that take a toll on the firm's earning are listed here

VI. Margins - Gross, Operating, Net
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Check trends and vs competitors
Look for changes in revenues, SG&A expenses, COGS

- taxes, interest payments on debt, unusual items, currency fluctuations

VII. DQ1- compare balance sheets of 3 different firms
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The industry structure and the firm's position determines the balance sheet
Use percentage to compare across firms rather than absolute dollar value

VIII. DQ2 - SOX Title III effectiveness
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Sarbanes-Oxley Act of 2002 is a US law that is aimed at reducing corporate fraud by improving financial accounting through a mandate for higher standards in corporate governance. With 11 titles, also known as sections, the law sets standards for ethical behavior of CEOs, CFOs, Board of Directors, auditors, investment analysts and investment banks (Brigham &Ehrhardt 2011). Title III stipulates the following:
(i) BoD's audit committee must be composed of independent members
(ii) CEO & CFO - Must take personal responsibility to review the annual and quarterly financial reports and certify integrity, accuracy and completeness
(iii) Non-compliance Penalty - In the event of fraud, bonuses and equity based compensation earned by fraudulent executives can be clawed back
ie. must be reimbursed to the company. Such executives will face $5 million fine and/or 20 years in prison

IX. Other Finance metrics
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Net cash flow = net income + depreciation
Operating current assets = cash, inventory, accounts receivable (short term investments not included)
Operating current liabilities = accounts payables, accruals (short term debts not included)
Net operating working capital = investor supplied funds + working capital acquired
Operating long term assets = plant and equipment (long term investments that pay interest or dividends not included)
Total net operating capital = net operating working capital + operating long term assets
NOPAT = Net operating profit after taxes; measure of operating performance
Free cash flow (FCF) = cash flow amount remaining after a company makes asset investments necessary to support operations
Amount of cash flow available for distribution to investors
=> value of a company is directly tied to its ability to generate free cash flow
Market value added = market value of firm - investor supplied capital
Economic value added = after tax operating profit - cost of capital =>  value created by management during the year
Capital assets = stocks, bonds, real estate