Undergraduate Stock Trading Society USTS – SECOND MEETING FINANCIAL STATEMENTS & RATIOS
The Holy Equation of Accounting
Assets = Liabilities + Equity
Lightning Round – Financial Accounting Two types of accounting 1. Managerial Accounting: for internal users 2. Financial accounting: for external decision makers SEC Act of 1934 10-K: annual report (required & must be audited) 10-Q: quarterly report (not required & no auditing necessary) 8-K: Announce major events such as changes to the management, bankruptcy, major accounting changes, etc. US: Financial Accounting Standards Board –
Generally Accepted Accounting Principles International Financial Reporting Standards
Lightning Round – Balance Sheet Balance sheet shows the company’s position at the point
of time Assets: any resources that will yield future economic benefit
Current Assets: Can/will be used in 1 yr. Cash,
cash equivalents, A/R, Merchandise Inventory, Prepaid Expenses, supplies, etc.
Non-current assts Long-lived
assets (PPE), Intangibles (patent, trademark, etc.)
Liabilities: amounts owed by the company
Current Liabilities: Payables (accounts, taxes, notes, interest, dividends, etc.), Unearned Revenue Non-Current Liabilities: Bonds, Loans
Lightning Round – Balance Sheet Equity: Owner’s claim on the business assets Contributed Capital: Preferred & common stock, additional paid in capital (in excess of par), treasury stock Retained earnings: whatever income/earnings left after drawings/dividends. (cumulative)
Lightning Round – Balance Sheet Sample Balance Sheet Assets Cash A/R Inventory 150 PPE (Less) Acc. Dep. Total
100 50 500 100 900
Liabilities A/P Expenses Payable N/P Bonds Total
100 50 200 300 650
Owner’s Equity Common Stock Retained Earnings 50 Total
200 250
Lightning Round – Income Statement Revenue: income that has been “earned”
Accrual accounting: Revenue is recognized when products are sold or services are performed. Expenses are recognized according to the matching principle (expenses are matched to revenue earned). Does not track cash
Operating expenses: expenses for day to day
business COGS: cost of goods sold SG&A: Selling, General, and Administrative Depreciation: rational and systematic allocation of cost (matching). Just another way of spreading cost.
Interest expenses, tax expenses, gains &losses.
Sample Income Statement Revenues Sales
500
Expenses COGS SG&A Depreciation Operating Income Interest Expense 20 Tax Expense Gain (loss) from sales Net Income
200 100 50 150
39 (20) 71
Lightning Round – Statement of Cash Flow Does the business have sufficient cash at hand to
operate? Cash Flows from operations: $ changing hands from everyday business Cash Flows from investing activities: $ change due to purchase or sales of long term assets (not necessarily like the ones we are doing). Cash Flows from financing activities: $ change due to raising capital by issuing shares, bonds, getting loans, paying back loans, etc.
Sample Statement of Cash Flows Operating Activities Revenues providing cash Expenses paid with cash Cash Flow from operations
100 90 10
Investing activities Sales of noncurrent assets Purchase of noncurrent assets Cash Flow from Investing activities
0 200 (200)
Financing activities Cash from borrowing 150 Cash from issuing equity Cash used to repay debt Cash used to pay dividends Cash Flow from financing activities
Net change in cash Beginning Balance of Cash Ending Balance of Cash
100 10 0 240
50 100 150
Statement of Owner’s Equity & Notes to financial statements Statement of Owner’s Equity: refer to the balance
sheet Notes: the qualitative nature of the numbers in the previous four financial statements
Financial Statement Analysis Horizontal Analysis: AKA time-series analysis, looks
at trends
Yoy change = (Change this year/last year’s total) x 100% Absolute $ amount change
Vertical Analysis: Common size, what is the
percentage composition of each item?
Balance Sheet: percentage of each item (total asset = 500k, inventory = 100k, or 20%; cash= 400k, or 80%) Income statement: percentage of sales (sales = 100k, operating expenses = 80k, or 80% of sales)
Ratios Liquidity Ratios Current Ratio: measures company’s ability to pay current liabilities <CurrentRatio = Current assets / current liabilities>
Quick Ratio: measures company’s ability to pay current liabilities just like current ratio, but this is a much more stringent test QR = Quick Assets / Current Liabilities Quick
Assets = Cash +Cash equivalents + A/R + Short term investments ( <3 mo )
Ratios Profitability Ratios Net Profit Margin: percentage of sales that remain in net income after expenses <Net Income / Net Revenue>
Gross Profit Margin: NPM tells you the overall profit margin. If there’s an increase or decrease in NPM, is it due to +/- in revenue or is it due to +/- in cost? GPM tells you this <(Net Sales – COGS)/ Net Sales>
Operating profit margin: the two aforementioned ratios may be skewed due to one-time items. This ratio only looks at profitability of usual business <Operating profit / Net Sales>
Ratios More Probability Ratios Effective Tax Rate: The company’s stated jurisdictional tax rate may differ from real tax rate due to accounting factors, foreign factors, etc. This rate gives the effective rate. <Effective Tax Rate = Income Tax Expense / Pretax Income>
Return on Assets: How much income is generated in sales for each dollar invested. <ROA = Net Income / Avg. Total Assets>
Return on Equity: How much is earned as a percentage of each dollar contributed by stockholders and retained in business. <ROE = Net Income / Avg. Stock holder’s equity>
Ratios More Profitability Ratios
EPS: < (Net income – preferred dividends) / Avg. number of common shares> P/E: Stock price / EPS
Solvency Ratio
Debt to Assets: indicates the proportion of total assets to cover total liabilities <Tot. Liabilities / Tot. Assets> Free Cash Flow: company’s ability to make capital investments and pay dividends from its operating cash flows. <FCF=Net Cash flow from operating activities – purchase of PPE – Dividends paid> Times interest earned: how may times is the company’s interest expense is in terms of operating results (ability to pay interest) <TIE = (net income + interest expense + income tax expense) / Interest expense>