SCG Workshop #3: More FSA and some TVM

AgendaReview of Fin Statements

The BS and IS

The Statement of Cash Flows

The

Looking at health and profitability

BS AccountsWe have 3 types of accounts in the

balance sheet:

Assets: Resources of the business we will use to generate revenues

Liabilities: Money we owe to creditors or “debt-holders” that have funded our business

Equity: Money we got from people who bought stock from the company in return for voting power and a share of the profits

Assets = Liabilities + Owner’s Equity

Value of resources in the business = Money we got from creditors + money we got from shareholders

In other words, everything in the business was either bought with money from shareholders or creditors.

The Accounts Within: AssetsCash

Accounts Receivable(Short term IOU’S)

Investments

Land

Buildings

Equipment

“Property, Plant, and Equipment” or PP&EInventory

The Accounts Within: Liabilities

Accounts Payable (short term debt to

suppliers)

Bank Loans

Bonds Payable

Unearned Revenue (prepaid sandwiches)

The Accounts Within: Equity

Common Stock

Preferred Shares

Retained Earnings

Additional Paid-In Capital

Treasury Stock

Exercise

Assets Liabilities Equity

Companies have a lot of funky names for their accounts, so based on your

knowledge of the base accounts and what each category is, what is each account

classified under?

Cash and Cash Equivalents

Certificates of Deposit (CD’s)

Raw MaterialsConstruction in Progress

Intangible Assets (Patents)

Short Term Borrowings

Dividends PayableTrade

Receivables

Earnings Employed in the business

Common Stock Held in

Treasury

The Income Statement

Tells us the revenue generating and expense generating activities of the

business over the course of the reporting period (year or quarter)

Two Classifications to Know

Revenues: Dollar value of sales a company generates

Expenses: Costs associated with generating the revenue.

After all expenses have been taken out of our pool of revenue, what’s left is taxed.

Stepping to the side:

Depreciation and Amortization, what are they?When you buy a car for $50,000 and try to sell it a year later, you can’t get the same value you paid for it, you get less.

Accountants adjust the value of the long term assets the company is holding at the end of every period to reflect what they believe is the new value.

We call this “depreciation” for physical assets and “amortization” for intangible assets (like patents)

The Uselessness of the Income Statement

• Typically, investors don’t use Operating income to a profit measurement, we have EBITDA, EBIT, EBT, and E.

Earnings Before Interest Taxes Depreciation and Amortization

How we get to Earnings

Revenue-Cost of Goods SoldGross Profit-Selling, General, and Admin Expense-Other Expenses+Depreciation and AmortizationEBITDA-Depreciation and AmortizationEBIT-InterestEBT-TaxesEarnings

Most of the time, this is the same as Operating Income

Most of the time D&A is already looped in with COGS or in Expenses

Statement of Cash Flows

Tell us about where we earned and spent cash during the reporting period, as well as our cash

balances.

Important because a company can earn billions of dollars in revenue but through the usage of

accounts receivable, never see a dollar. This can be a problem because you have to pay debts

with cash not another IOU.

This statement will be our best friend during DCF modeling in a few lessons.

Form of the Statement of Cash Flows

Beginning Cash$100

Net Income$437.50

+Net Cash Flows from Operations $550

+Net Cash Flows from Investing -$50

+Net Cash Flows from Financing $400

+Net Cash Flows$900

Ending Cash$1000

Idea Behind it:

We want to take our net income and add back any cash generating activities, then take back out any cash using activities to find how much

cash was generated by the business.

We like cash because finance people think accountants can manipulate numbers (they can)

so cash gives us the clearest picture of the reality of the business.

Cash Flows from Operating Activities

Cash generated or used up from the everyday activities of the business like:

Cash collections from Accounts ReceivablesCash SalesCash ExpendituresChanges in Current AssetsChanges in Current LiabilitiesAdd back Depreciation and Amortization

Depreciation and Amortization are already in Net income, so to get to cash, we need to add it back (remember, we don’t actually pay any cash on D&A), it’s an accounting gimmick.

Essentially how much cash you take in minus your bills.

Cash Flows from Investing ActivitiesCovers purchases and sales of long-term assets and investments.

What we see in the statement:

Buying a building is a cash outflowSelling land is a cash inflow

Buying Investments is a cash outflowSelling investments is a cash inflow

Important to remember that you’re dealing with cash, so buying assets will decrease your cash and vice versa

We refer to the acquisition of long-term assets as “Capital Expenditures”

Cash Flows from FinancingCovers cash flows that are related to raising capital for the business, both by

debt and equity.

Paying interest is a cash outflowPaying back principal of a loan is a cash outflow

Receiving a loan’s funds is a cash inflowReceiving funds from a issuance of stock is a cash inflow

Having a positive number in cash flows from financing means you are taking on more debt or issuing stock faster than you are paying it back.

So if we go back…Beginning Cash

$100

Net Income$437.50

+Net Cash Flows from Operations $550

+Net Cash Flows from Investing -$50

+Net Cash Flows from Financing $400

+Net Cash Flows$900

Ending Cash$1000

Cash in - Bills

Buying/Selling LT Assets

Taking in/paying off capital from investors and creditors

How does all this apply to picking better stocks and valuation?

Eyes on the prize: This is all leads to DCF modeling and valuation.

Although balance sheets and cash flow statements alone can’t tell you how much a

company is worth, we can look at it to see if the company is “healthy”.

An Introduction to Present Value

Would you rather have $100 today or $110 dollars a year from now?

We have a choice…

Today

$100

1-Year from Now

$110

What if there was a way to figure out how much money in the future is worth in

today’s terms…

5% Interest Rate

Future Value = Present Value(1+Interest Rate)^(Number of Years)FV= PV*(1+i)^nFV= 100*(1+.05)^(1)FV= $105

How about now?

Today

$100

5-Years from Now

$105

FV=PV*(1+i)^nFV=100*(1+.0067)^(5)FV=$103.39

Going back to the futureWe can also do the opposite of calculating future value. We can

discount a future value back to the present value to make direct

comparisons:

FV = PV * (1 + i) ^ n

(1 + i) ^ n(1 + i) ^ n

FV

(1 + i) ^ n = PV

We also refer to this as the “discount rate”

The previous example:

Today

$100

5-Years from Now

$105

FV

(1 + i) ^ nPV =

105

(1 + .0067) ^ 5PV =

PV = $101.55

So…

A dollar today is worth more than a dollar in the future because we can invest the dollar today and get interest by the time the future comes around. We refer to this as the time-value of

money.

But…

When will a stranger ever offer me the choice of having $100 now or $105 later? What use do I have for this

stuff?

We use present value to calculate terminal value and cash flow value of a

company in order to form a DCF, and can use it to calculate internal rate of return.