Week 1: Financial Accounting
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Transcript of Week 1: Financial Accounting
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Week 1: Financial Accounting
Sept. 8, 2010
Mutual Investment Club of Cornell
Announcement
Get your junior analyst applications in by Friday at 11:59 PM.
JP Morgan Senior Speaker Event Monday, Sept. 13, 2010 Statler Hotel Fireside Chat: 5:00 – 6:00 p.m., Amphitheater Networking: 6:00 – 6:30 p.m., Yale/Princeton
Room For freshmen, sophomores and juniors
interested in summer opportunities in Investment Banking, IB Risk, Sales & Trading, and Research.
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Schedule
Week Topic1 Accounting2 Corporate Finance3 Financial System4 Macroeconomics5 Basic Excel Valuation6 Advanced Excel Valuation7 Research Methods8 Jobs in finance9 Financial Products
10 Resume Review/Interviewing11 Mock-pitch12 Pitch idea generation
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For today…
Introduction to accounting Three financial statements
Balance Sheet Income Statement Cash Flow Statement
Annual and Quarterly Reports
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What is Financial Accounting? Accounting is a system for recording
financial information about a business and reporting it to decision makers
Financial accounting refers specifically to accounting for external decision makers: creditors, investors, suppliers, etc. This is what we care about.
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The Balance Sheet
A list of the assets and liabilities of the firm at a particular time.
Can be thought of as a “snapshot” of the business at one point in time.
Three major components Assets: resources of the firm Liabilities: things the firm owes to others Stockholder’s equity: Everything else
Money investors put in or have reinvested from earnings.
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Balance Sheet: XOM
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The details
Current Assets are those that will be used up or can be sold within one year.
Current Liabilities have a maturity of less than one year.
Assets Investments: Money the firm has invested
in other companies (usually when it is sitting on a pile of cash)
Receivables: Money owed to the firm by others (usually customers)
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The details
Liabilities Accounts payable: money owed by the firm
to suppliers, usually Deferred Long-term liability charges: a
collection of future liabilities of the firm.’
Stockholder’s equity Common stock: money that investors have
invested in the business. Retained earnings: money that has been
reinvested in the business from its profits.
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Things to Notice
The Accounting Equation always holds Assets = Liabilities + Stockholder’s Equity Why?
Balance sheet items are recorded at the cost to acquire them, not at market value (for now).
The balance sheet is valid for a single date.
Note: All financial statements have notes accompanying them that explain some numbers.
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The Income Statement
Statement showing revenues and expenses over a period.
Can be thought of as a continuous video of the firm over time.
Revenue is NOT the same as cash inflow and expenses are NOT the same as cash outflow. More on that soon
Income Statement: XOM
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Amount paid for goods sold over the period (aka Cost of Goods Sold)
Op. expenses are those incurred in the normal operations of the business.
Calculating operating income or loss is important for determining income tax
Interest expense is not considered an operating expense: it does not relate to the normal operations of the business.
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Why distinguish operating income/loss?
When examining a business, we want to be able to determine how much profit it can make from the business itself.
Interest expense adds noise: it reflects how the firm is financed, not how it operates. If we bought the business, we might radically change its capital structure, so we want to see a picture of the business that is independent of that.
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Profit ≠ Cash Flow: example 1 The firm sells some inventory to a
customer on credit, due next month. Is that profit? Yes (assuming the
customer will pay). Is that cash flow? No.
In accounting, revenue is recorded when earned, not when cash is received.
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Profit ≠ Cash Flow: example 2
A firm uses its cash reserves of $10,000,000 to buy a plant, and uses the plant to generate $2,000,000 of cash per year for 10 years.
It would not be very useful to say the firm had a loss of $10 m in the first year, and $2 m profit thereafter, even though that is our cash flow.
Instead, we can classify the purchase as an investing activity and include the cost of the plant as an expense over time as it is used This is a process called “depreciation.”
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The Cash Flow Statement
Provides a summary of cash inflows and outflows over a specified period of time.
Like the income statement, it can be thought of as a continuous video over time.
This is the statement we care most about, as predicting future cash flows is the most important aspect of investing in stocks.
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Cash Flow Statement: XOM
Operating Cash Flow (OCF) is calculated by making adjustments to Net Income for non-cash items on the income statement and balance sheet.
Not that important exactly how this is done, but just know that OCF is calculated indirectly from Net Income
ICF includes purchase and sale of plant, equipment, land, etc. and other investments.
FCF includes inflows and outflows related to financing the business. Inflows from investors and loans, outflows from paying dividends and paying debt.
Net Change in cash balances
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Why distinguish O, I, and F?
As before, we are interested in seeing how much cash the business is capable of generating through its normal (operating) activities.
Cash flows from investing and financing activities are typically unrelated to this; that is, they generate noise around what we are really looking for.
By looking at operating activities, we get a feel for what kind of cash the business can generate even if we change its financing and investing cash flows
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Another word on Depreciation
Suppose a business spends $10 m on a plant that is used to generate $2 m in profit per year for 10 years.
The company might “depreciate” the plant by $1 m per year for 10 years.
This depreciation will count as an expense on the income statement, so the firm will show $1 m in profit per year.
In this way we spread the cost out over the useful life of the plant.
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Reports
Released annually and quarterly Mandated by the Securities & Exchange
Commission (SEC).
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Reports
Annual report includes: Non-financial section
Discusses the company and its operations Financial section
The main financial statements Financial history for 5 or 10 years Management’s discussion Other minor things
Quarterly report Less rigorous than annual report Unaudited
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SEC Filings
Form 10-K: annual Everything in the annual report More detailed description of the business Etc.
Form 10-Q: Quarterly Everything in the quarterly report More detailed description of the business Etc.
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Why do reports and filings matter? They are an excellent first source when
evaluating a company. They contain detailed information
about the company’s financial and non-financial history, operations, management, etc.
If you want to learn more about a company, pull up its annual report and see what you find.
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Further Information
Books Financial Accounting by Libby, Libby &
Short Courses at Cornell
AEM 2210 (I’m a TA for that) HADM 2210 ORIE 3150
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See you next week!
Don’t forget to apply for a Junior Analyst position. www.cornell-micc.com