Accounting And Balance Sheets
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Duke Investment Club Analyst Training Program
A n a l y s t T r a I n I n g P r o g r a m
When you come in •
Sign-‐in sheet is at the front – if there’s a grey box somewhere next to your name, make sure to fill in the info that I’m missing
•
Take a copy of Nike’s 1Q10 Balance Sheet, next to the sign in sheet
•
Find a seat, and login •
Username: “training”
•
Password: “perkins”
0
Duke Investment Club
SESSION 2: Fundamentals of Financial AccounSng 14 October 2009
Duke Investment Club Analyst Training Program
Agenda DefiniSons and examples of assets, liabiliSes, and shareholders’ equity
•
IntroducSon of the accounSng equaSon
•
Corporate financial statements: balance sheets
•
ApplicaSon to fundamental financial analysis
•
PracSce examples
A n a l y s t T r a I n I n g P r o g r a m
•
2
Duke Investment Club
Disclaimer and general comments
A n a l y s t T r a I n I n g P r o g r a m
We’re students, just like you •
We highly encourage you to challenge what we’re saying – if you see a mistake, tell us, even if it’s in front of the whole class. This is pracSce for us, too
•
We will be the first to acknowledge that we’re full of any four leYer word you’d like to subsStute in, but the reason we’ve started this class is because we find this stuff really interesSng. Hopefully, you do too
•
The people to your le\ and right may one day run the government, an investment bank, a consulSng firm, or become the next Warren Buffet (get to know him or her)
•
Addi(onal disclaimer: There’s a difference in learning how to read balance sheets from a finance viewpoint versus learning the same skill in an accounSng class. The accounSng version is harder to learn, but it teaches the right way to think about assets, liabiliSes, and equity. Take Econ182 if you want to know that side of it. This lecture is about a bunch of shortcuts
3
Duke Investment Club
The balance sheet
A n a l y s t T r a I n I n g P r o g r a m
Corporate financial statements, part I •
www.sec.gov
•
“Search for Company Filings”
•
“Company or fund name”
•
Enter company name or stock Scker
•
Find the most recent 10-‐K
•
Search (ctrl + f) for “consolidated balance sheet” and scroll through unSl you find the balance sheet
4
Duke Investment Club
The balance sheet
A n a l y s t T r a I n I n g P r o g r a m
Corporate financial statements, part I •
Summarizes a company’s assets, liabiliSes, and shareholder’s equity at a specific point in Sme, and it’s divided up into three secSons, one for each category listed above
•
A publically traded company will report the state of its balance sheet at the close of every quarter to the SEC
•
The three balance sheet segments give investors an idea as to what a company owns and owes, as well as the amount invested by shareholders
A s s e t s = L i a b i l i S e s + S h a r e h o l d e r s ’ E q u i t y
5
Duke Investment Club
The balance sheet Assets •
Defini*on: a resource that a company owns with the expectaSon that it will provide a future benefit
A n a l y s t T r a I n I n g P r o g r a m
•
•
•
An asset is a resource that a company owns with the expectaSon that it will provide a future benefit •
Tangible (physical) assets: machinery, buildings, and land
•
Intangible assets: patents, trademarks, copyrights
Assets can also be divided into two categories based on their liquidity •
Current assets: can be converted into cash within one year (cash, accounts receivable, inventory, marketable securiSes)
•
Long-‐term assets: assets that are expected to be usable for more than one year and are less liquid (machinery, property)
Physical assets (PP&E) versus assets as a measure of future benefit
6
Duke Investment Club
The balance sheet
A n a l y s t T r a I n I n g P r o g r a m
Assets
Common current assets
Common fixed assets
Cash and cash equivalents (CCE)
Plant, property, & equpiment (PP&E)
Accounts receivable (A/R)
Accumulated depreciaSon (contra-‐asset)
Short-‐term investments
Goodwill and other intangibles
Inventories Prepaid expenses
7
Duke Investment Club
A n a l y s t T r a I n I n g P r o g r a m
The balance sheet
Assets
Current assets
Fixed assets
8 Duke Investment Club
The balance sheet
A n a l y s t T r a I n I n g P r o g r a m
LiabiliSes •
Defini*on: LiabiliSes are a company’s legal debts or obligaSons that arise through the course of business
•
Vital to a company’s operaSons because they are used to finance operaSons and pay for large expansions
•
LiabiliSes include loans, accounts payable, mortgages, and accrued expenses
•
Like assets, there are both current and long-‐term liabiliSes •
Current Liability: a company’s debt or obligaSons that are due within one year (short term debt, accounts payable)
•
Long-‐Term Liability: debts that are payable over a longer period than one year (bond issue with a 10 year maturity)
9
Duke Investment Club
The balance sheet LiabiliSes
Common current liabiliSes
Common long-‐term liabiliSes
Accounts payable (A/P)
Long-‐term debt
Accrued liabiliSes
Deferred income taxes
A n a l y s t T r a I n I n g P r o g r a m
Current maturiSes of long-‐term debt (short-‐ term debt) Commercial paper
10
Duke Investment Club
The balance sheet LiabiliSes
A n a l y s t T r a I n I n g P r o g r a m
Current liabiliSes
Long-‐term liabiliSes
11
Duke Investment Club
Net working capital (NWC) •
Defini*on: NWC = current assets – current liabiliSes
•
NWC is a very important factor to debt-‐investors, and it is an important variable used in projecSng future performance in financial modeling
•
PosiSve net working capital indicates that a company is able to pay off its short-‐term debts, while negaSve net working capital indicates a company may be in trouble soon
A n a l y s t T r a I n I n g P r o g r a m
•
•
A declining working capital raSo over Sme could be a red flag for further analysis •
•
When used in conjuncSon with some of the financial raSos presented at the end of this presentaSon, NWC can give even inexperienced investors a decent grasp on the effects of debt on a company’s finances
Why would this be the case?
Also gives investors an idea of a company’s operaSonal efficiency (and thus managerial effecSveness) •
High working capital may imply that a company does a poor job at collecSng accounts receivable
12
Duke Investment Club
The balance sheet
A n a l y s t T r a I n I n g P r o g r a m
Equity •
Defini*on: shareholder’s equity represents the amount by which a company is financed through common and preferred shares
•
Comes from two main sources: •
The first and original source is the money that was originally invested in the company (IPO), along with any addiSonal investments made therea\er (new share offering)
•
Second comes from retained earnings which the company is able to accumulate over Sme through its operaSons (this porSon is typically the largest component)
A s s e t s = L i a b i l i S e s + S h a r e h o l d e r ’ s E q u i t y W h a t a c o m p a n y h a s = w h a t i t o w e s + w h a t i t o w n s
13
Duke Investment Club
The balance sheet Equity
Common components of equity
DefiniSon
Common stock
A n a l y s t T r a I n I n g P r o g r a m
Dividends Preferred stock
Like common stock, but has a higher claim on earnings in exchange for fewer voSng rights
Paid-‐in capital
The par value of shares of equity (typically $0.01/share)
AddiSonal paid-‐in capital
The premium that investors pay for shares of equity: APIC = (Issue price – par value) x shares issued
Retained earnings
The percentage of net income not paid out as dividends
14
Duke Investment Club
A n a l y s t T r a I n I n g P r o g r a m
The balance sheet
Equity
15 Duke Investment Club
Retained earnings Equity •
Retained earnings are the porSon of net earnings not paid out as dividends, but retained by the company
•
Can be reinvested into the business (buying new machinery, R&D) or be used to pay down debt
A n a l y s t T r a I n I n g P r o g r a m
Retained Earnings (RE) = Beginning RE + Net Income – Dividends •
Thus, a dividend is the porSon of a company’s earnings that is distributed to shareholders
•
High-‐growth companies rarely offer dividends because all of their profits are reinvested to help sustain above average growth
16
Duke Investment Club
Financial raSos
RaSos derived from balance sheet data, p. 1 RaSo
EquaSon current assets Current = current liabilities
Current raSo
Quick raSo €
A n a l y s t T r a I n I n g P r o g r a m
ExplanaSon [alternaSve names]
Quick =
CCE + A /R + ST Investments current liabilities
Total assets Leverage = Stockholders' equity
Leverage raSo €
Debt raSo €
DR =
[Liquidity ra(o] The CR shows a company’s ability to pay back ST debts; gives a sense of the ability of the company’s ability to turn its product into profit [Acid-‐test ra(o] Ability to repay ST debts without selling inventory; when compared with the working capital, investors can get a sense of how reliable a company’s assets are to the company’s inventory One method of determing how much leverage a company has taken on, or how much debt must be used to finance the company’s assets Another type of leverage raSo, the debt raSo can be indicaSve of unserviceable debt loads
Total debt Total assets
€
17
Duke Investment Club
Financial raSos
RaSos derived from balance sheet data, p. 2 RaSo
EquaSon
A n a l y s t T r a I n I n g P r o g r a m
Debt-‐to-‐equity raSo
LT debt-‐to-‐total € capital raSo
D/E =
D/E =
ExplanaSon
Total liabilities Total shareholders' equity
LT debt LT debt + total common stock + total pref stock
Pr ice /share P /B = Book value /share
Price-‐to-‐book € raSo
Another type of leverage raSo, the D/E raSo allows for the calculaSon of the raSos of debt and equity used to finance a company, a very important factor in investment banking and invesSng. Note that long-‐term debt is someSmes subsStuted for total liabiliSes in the numerator Similar to above When compared to the market value of equity (i.e., what the stock trades for on the market), the book value can indicate if a stock may be overvalued or undervalued
€
N.B.: some important raSos, such as return on equity (ROE), return on assets (ROA), inventory turnover, and receivables turnover have been omiYed unSl a more detailed study of the income statement is presented 18
Duke Investment Club
PracSce
Analyzing the balance sheet from Nike’s 1Q10 (FQE 5/31) Complete handout at front
A n a l y s t T r a I n I n g P r o g r a m
•
19
Duke Investment Club
A n a l y s t T r a I n I n g P r o g r a m
QuesSons, comments, & criSques
Duke Investment Club
A n a l y s t T r a I n I n g P r o g r a m
When you come in •
Sign-‐in sheet is at the front – if there’s a grey box somewhere next to your name, make sure to fill in the info that I’m missing
•
Take a copy of Nike’s 1Q10 Balance Sheet, next to the sign in sheet
•
Find a seat, and login •
Username: “training”
•
Password: “perkins”
0
Duke Investment Club
SESSION 2: Fundamentals of Financial AccounSng 14 October 2009
Duke Investment Club Analyst Training Program
Agenda DefiniSons and examples of assets, liabiliSes, and shareholders’ equity
•
IntroducSon of the accounSng equaSon
•
Corporate financial statements: balance sheets
•
ApplicaSon to fundamental financial analysis
•
PracSce examples
A n a l y s t T r a I n I n g P r o g r a m
•
2
Duke Investment Club
Disclaimer and general comments
A n a l y s t T r a I n I n g P r o g r a m
We’re students, just like you •
We highly encourage you to challenge what we’re saying – if you see a mistake, tell us, even if it’s in front of the whole class. This is pracSce for us, too
•
We will be the first to acknowledge that we’re full of any four leYer word you’d like to subsStute in, but the reason we’ve started this class is because we find this stuff really interesSng. Hopefully, you do too
•
The people to your le\ and right may one day run the government, an investment bank, a consulSng firm, or become the next Warren Buffet (get to know him or her)
•
Addi(onal disclaimer: There’s a difference in learning how to read balance sheets from a finance viewpoint versus learning the same skill in an accounSng class. The accounSng version is harder to learn, but it teaches the right way to think about assets, liabiliSes, and equity. Take Econ182 if you want to know that side of it. This lecture is about a bunch of shortcuts
3
Duke Investment Club
The balance sheet
A n a l y s t T r a I n I n g P r o g r a m
Corporate financial statements, part I •
www.sec.gov
•
“Search for Company Filings”
•
“Company or fund name”
•
Enter company name or stock Scker
•
Find the most recent 10-‐K
•
Search (ctrl + f) for “consolidated balance sheet” and scroll through unSl you find the balance sheet
4
Duke Investment Club
The balance sheet
A n a l y s t T r a I n I n g P r o g r a m
Corporate financial statements, part I •
Summarizes a company’s assets, liabiliSes, and shareholder’s equity at a specific point in Sme, and it’s divided up into three secSons, one for each category listed above
•
A publically traded company will report the state of its balance sheet at the close of every quarter to the SEC
•
The three balance sheet segments give investors an idea as to what a company owns and owes, as well as the amount invested by shareholders
A s s e t s = L i a b i l i S e s + S h a r e h o l d e r s ’ E q u i t y
5
Duke Investment Club
The balance sheet Assets •
Defini*on: a resource that a company owns with the expectaSon that it will provide a future benefit
A n a l y s t T r a I n I n g P r o g r a m
•
•
•
An asset is a resource that a company owns with the expectaSon that it will provide a future benefit •
Tangible (physical) assets: machinery, buildings, and land
•
Intangible assets: patents, trademarks, copyrights
Assets can also be divided into two categories based on their liquidity •
Current assets: can be converted into cash within one year (cash, accounts receivable, inventory, marketable securiSes)
•
Long-‐term assets: assets that are expected to be usable for more than one year and are less liquid (machinery, property)
Physical assets (PP&E) versus assets as a measure of future benefit
6
Duke Investment Club
The balance sheet
A n a l y s t T r a I n I n g P r o g r a m
Assets
Common current assets
Common fixed assets
Cash and cash equivalents (CCE)
Plant, property, & equpiment (PP&E)
Accounts receivable (A/R)
Accumulated depreciaSon (contra-‐asset)
Short-‐term investments
Goodwill and other intangibles
Inventories Prepaid expenses
7
Duke Investment Club
A n a l y s t T r a I n I n g P r o g r a m
The balance sheet
Assets
Current assets
Fixed assets
8 Duke Investment Club
The balance sheet
A n a l y s t T r a I n I n g P r o g r a m
LiabiliSes •
Defini*on: LiabiliSes are a company’s legal debts or obligaSons that arise through the course of business
•
Vital to a company’s operaSons because they are used to finance operaSons and pay for large expansions
•
LiabiliSes include loans, accounts payable, mortgages, and accrued expenses
•
Like assets, there are both current and long-‐term liabiliSes •
Current Liability: a company’s debt or obligaSons that are due within one year (short term debt, accounts payable)
•
Long-‐Term Liability: debts that are payable over a longer period than one year (bond issue with a 10 year maturity)
9
Duke Investment Club
The balance sheet LiabiliSes
Common current liabiliSes
Common long-‐term liabiliSes
Accounts payable (A/P)
Long-‐term debt
Accrued liabiliSes
Deferred income taxes
A n a l y s t T r a I n I n g P r o g r a m
Current maturiSes of long-‐term debt (short-‐ term debt) Commercial paper
10
Duke Investment Club
The balance sheet LiabiliSes
A n a l y s t T r a I n I n g P r o g r a m
Current liabiliSes
Long-‐term liabiliSes
11
Duke Investment Club
Net working capital (NWC) •
Defini*on: NWC = current assets – current liabiliSes
•
NWC is a very important factor to debt-‐investors, and it is an important variable used in projecSng future performance in financial modeling
•
PosiSve net working capital indicates that a company is able to pay off its short-‐term debts, while negaSve net working capital indicates a company may be in trouble soon
A n a l y s t T r a I n I n g P r o g r a m
•
•
A declining working capital raSo over Sme could be a red flag for further analysis •
•
When used in conjuncSon with some of the financial raSos presented at the end of this presentaSon, NWC can give even inexperienced investors a decent grasp on the effects of debt on a company’s finances
Why would this be the case?
Also gives investors an idea of a company’s operaSonal efficiency (and thus managerial effecSveness) •
High working capital may imply that a company does a poor job at collecSng accounts receivable
12
Duke Investment Club
The balance sheet
A n a l y s t T r a I n I n g P r o g r a m
Equity •
Defini*on: shareholder’s equity represents the amount by which a company is financed through common and preferred shares
•
Comes from two main sources: •
The first and original source is the money that was originally invested in the company (IPO), along with any addiSonal investments made therea\er (new share offering)
•
Second comes from retained earnings which the company is able to accumulate over Sme through its operaSons (this porSon is typically the largest component)
A s s e t s = L i a b i l i S e s + S h a r e h o l d e r ’ s E q u i t y W h a t a c o m p a n y h a s = w h a t i t o w e s + w h a t i t o w n s
13
Duke Investment Club
The balance sheet Equity
Common components of equity
DefiniSon
Common stock
A n a l y s t T r a I n I n g P r o g r a m
Dividends Preferred stock
Like common stock, but has a higher claim on earnings in exchange for fewer voSng rights
Paid-‐in capital
The par value of shares of equity (typically $0.01/share)
AddiSonal paid-‐in capital
The premium that investors pay for shares of equity: APIC = (Issue price – par value) x shares issued
Retained earnings
The percentage of net income not paid out as dividends
14
Duke Investment Club
A n a l y s t T r a I n I n g P r o g r a m
The balance sheet
Equity
15 Duke Investment Club
Retained earnings Equity •
Retained earnings are the porSon of net earnings not paid out as dividends, but retained by the company
•
Can be reinvested into the business (buying new machinery, R&D) or be used to pay down debt
A n a l y s t T r a I n I n g P r o g r a m
Retained Earnings (RE) = Beginning RE + Net Income – Dividends •
Thus, a dividend is the porSon of a company’s earnings that is distributed to shareholders
•
High-‐growth companies rarely offer dividends because all of their profits are reinvested to help sustain above average growth
16
Duke Investment Club
Financial raSos
RaSos derived from balance sheet data, p. 1 RaSo
EquaSon current assets Current = current liabilities
Current raSo
Quick raSo €
A n a l y s t T r a I n I n g P r o g r a m
ExplanaSon [alternaSve names]
Quick =
CCE + A /R + ST Investments current liabilities
Total assets Leverage = Stockholders' equity
Leverage raSo €
Debt raSo €
DR =
[Liquidity ra(o] The CR shows a company’s ability to pay back ST debts; gives a sense of the ability of the company’s ability to turn its product into profit [Acid-‐test ra(o] Ability to repay ST debts without selling inventory; when compared with the working capital, investors can get a sense of how reliable a company’s assets are to the company’s inventory One method of determing how much leverage a company has taken on, or how much debt must be used to finance the company’s assets Another type of leverage raSo, the debt raSo can be indicaSve of unserviceable debt loads
Total debt Total assets
€
17
Duke Investment Club
Financial raSos
RaSos derived from balance sheet data, p. 2 RaSo
EquaSon
A n a l y s t T r a I n I n g P r o g r a m
Debt-‐to-‐equity raSo
LT debt-‐to-‐total € capital raSo
D/E =
D/E =
ExplanaSon
Total liabilities Total shareholders' equity
LT debt LT debt + total common stock + total pref stock
Pr ice /share P /B = Book value /share
Price-‐to-‐book € raSo
Another type of leverage raSo, the D/E raSo allows for the calculaSon of the raSos of debt and equity used to finance a company, a very important factor in investment banking and invesSng. Note that long-‐term debt is someSmes subsStuted for total liabiliSes in the numerator Similar to above When compared to the market value of equity (i.e., what the stock trades for on the market), the book value can indicate if a stock may be overvalued or undervalued
€
N.B.: some important raSos, such as return on equity (ROE), return on assets (ROA), inventory turnover, and receivables turnover have been omiYed unSl a more detailed study of the income statement is presented 18
Duke Investment Club
PracSce
Analyzing the balance sheet from Nike’s 1Q10 (FQE 5/31) Complete handout at front
A n a l y s t T r a I n I n g P r o g r a m
•
19
Duke Investment Club
A n a l y s t T r a I n I n g P r o g r a m
QuesSons, comments, & criSques
Duke Investment Club
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