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Slides_Higgins_12e_Ch_1.pptxInterpreting Financial Statements
Chapter One
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1
Key Points
Accounting is the scorecard of business.
Managers who understand accounting can diagnose ills and prescribe remedies.
Chapter 1 reviews accounting concepts that are essential for financial management.
Ch. 1 2
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Higgins, Analysis for Financial Management, 12e
2
The Cash Flow Cycle
Finance and operations are integrally connected.
Company operations and strategy affect financing.
Financial decisions affect company operations.
The cash flow–production cycle demonstrates this.
Where is production (operations) in this cycle?
Ch. 1 3
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Figure 1.1 The Cash Flow–Production Cycle
Ch. 1 4
Higgins, Analysis for Financial Management, 12e
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Questions about the Cash Flow–Production Cycle
What is depreciation, and how does it affect the cycle?
Did we miss accounts payable? If so, where does it fit in?
Where does the initial cash come from?
Where is the operating (working capital) cycle?
Are profits and cash flow the same?
Does depreciation have anything to do with this?
Ch. 1 5
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Principles demonstrated in the Cash Flow–Production Cycle
1. Financial statements are an important window on reality.
2. Profits do not equal cash flow.
Ch. 1 6
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Higgins, Analysis for Financial Management, 12e
6
The Balance Sheet
The balance sheet is a financial snapshot.
Assets = Liabilities + Shareholders’ Equity
What do these three items measure?
What is double-entry bookkeeping?
What happens to the balance sheet when a company:
pays $1 million in wages?
borrows $100,000 from a bank?
Receives a $10,000 payment from a customer?
Ch. 1 7
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7
TABLE 1.1 Worldwide Sports Financial Transactions 2017 ($ thousands)
Ch. 1 8
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Questions about Table 1.1
How much did WWS sell?
What was the value of WWS merchandise purchases?
How much did WWS borrow, and what rate of interest did they pay?
Are assets equal to the sum of liabilities and owners’ equity?
Ch. 1 9
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From snapshots to videos
If the balance sheet is a snapshot, the income statement and cash flow statement are videos.
The income statement shows how revenues and expenses determine changes in owners’ equity over a period of time.
The cash flow statement provides details of the change in cash balances over time.
Ch. 1 10
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FIGURE 1.2 Ties among Financial Statements
Ch. 1 11
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Hasbro is used as an example throughout the text.
Toy and game products
Monopoly, Nerf, Play-Doh, Mr. Potato Head, etc.
Headquartered in Pawtucket, Rhode Island
Annual sales of $5 billion
Listed on Nasdaq
Member of S&P 500
Ch. 1 12
Introduction to Hasbro, Inc.
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Higgins, Analysis for Financial Management, 12e
12
TABLE 1.2 Hasbro Balance Sheets ($ millions)
Ch. 1 13
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TABLE 1.3 Hasbro Income Statements ($ millions)
Ch. 1 14
Higgins, Analysis for Financial Management, 12e
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Other Key Balance Sheet Points
Current assets and liabilities
“Current” means it is expected to turn into cash within one year.
Shareholders’ equity
Don’t worry too much about the different categories of equity (common stock, paid-in capital, retained earnings, treasury stock).
Net income (less any dividends paid) goes into retained earnings.
Ch. 1 15
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15
The Income Statement
Basic relation: Revenues – Expenses = Net Income
Distinction between operating and nonoperating expenses
Ch. 1 16
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Higgins, Analysis for Financial Management, 12e
16
Measuring Earnings
Accrual accounting and the matching principle
Depreciation
Straight-line vs. accelerated
Taxes
2 sets of books: one to report financial condition of company to investors and the second to compute taxes
Research and marketing
Expense it all! (Why?)
Ch. 1 17
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17
Tax Arithmetic
Provision for income taxes on income statement
+ increase in prepaid income taxes on asset side of balance sheet
− increase in income taxes payable and deferred income taxes on liabilities side of balance sheet
= Taxes paid
Ch. 1 18
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Example of Taxes Paid: TARGET
From Target’s income statement, 2016
Provision for Income Taxes = $1,296 million
From Target’s balance sheet, 2015 to 2016
Increase in Taxes Payable = $38 (2015=823; 2016=861)
(No Deferred Taxes or Prepaid Taxes are listed)
Taxes Target paid
1,296 − 38 = $1,258 million
Ch. 1 19
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Ch. 1 20
You try it.
Calculate Home Depot’s taxes paid in year ended Jan 2017.
Excerpt from Balance Sheet
Excerpt from Income Statement
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Higgins, Analysis for Financial Management, 12e
Taxes paid=Prov. for taxes (4,534) - increase in payable (-9) – increase in deferred (-83) = $4,626 million (they had no prepaid inc. taxes)
20
Sources & Uses Statements
The income statement does not accurately show the movement of cash.
It includes items that are not cash flows.
It only lists cash flows pertaining to sales during the period.
For cash flows, we need something else.
Where does a company get its cash, and where does it spend its cash?
Ch. 1 21
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Sources & Uses of Cash
| Sources | Uses |
| Decreases in assets | Increases in assets |
| Increases in liabilities & equity | Decreases in liabilities & equity |
Ch. 1 22
These can be determined by placing two balance sheets side by side.
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22
Examples from Hasbro’s Balance Sheet
Why is an increase in cash a use?
Ch. 1 23
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TABLE 1.4 Hasbro, Sources and Uses Statement, 2016 ($ millions)
Ch. 1 24
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You try it. Identify the sources and uses.
Ch. 1 25
Higgins, Analysis for Financial Management, 12e
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Sources: Cash 20, Inv. 10, AP 10, LTD 25, Stock 5, PIC 25, RE 30, TOTAL=125
Uses: AR 20, NFA 90, STD 15, TOTAL=125
25
Statement of Cash Flows
Expansion and rearrangement of sources and uses
Divides cash flows into 3 categories
Operations
Investing
Financing
Typically reports additional categories, such as dividends, repurchases, capital expenditures
Highlights the solvency of the firm
Ch. 1 26
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Cash Flow and Net Income
Which is the better measure of performance?
Net income includes estimates, allocations, and approximations.
Cash flow from operations is actual cash.
Low or negative cash flow does not necessarily imply poor performance.
Cash flow statements can record items such as AR and employee stock options differently from sources and uses.
Ch. 1 27
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TABLE 1.5 Hasbro, Cash Flow Statement, 2016 ($ millions)
Ch. 1 28
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Market Value vs. Book Value
The financial statements are a mix of historical amounts and mark-to-market amounts.
Book values are historical.
Market values are forward-looking.
Intangible assets not appearing in the financial statements include patents, brand reputation, superior technology, human capital of workforce, etc.
Ch. 1 29
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Fair Value Accounting
Some quirks revealed by financial crisis of 2008
Drop in market value of debt
Fair value accounting required firms to record this change as a gain, because they were able to repurchase the debt at a lower price than they originally issued (sold it).
Effect reversed when market rebounded
Ch. 1 30
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Calculating market value of equity
On Dec. 31, 2016, Hasbro’s book value of equity was $1,863 million (see Table 1.2).
What was Hasbro’s market value of equity on Dec. 31, 2016?
Hasbro’s stock price was $77.79.
Hasbro had 124.5 million shares outstanding.
Is book value or market value a better indicator of Hasbro’s worth to investors? Why?
Ch. 1 31
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$77.79 × 124.5 million = $9,685 million
31
TABLE 1.6 The Book Value of Equity is a Poor Surrogate for the Market Value of Equity, December 31, 2016
Ch. 1 32
Higgins, Analysis for Financial Management, 12e
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Goodwill
Intangible on the balance sheet
Goodwill is the difference between acquisition price and the fair value of the asset acquired.
Fair value corresponds to either the book value or the replacement value of the target, whichever is more appropriate.
For Hasbro, how important is goodwill (see Table 1.2)?
Ch. 1 33
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Economic Income and Accounting Income
Realized vs. unrealized income
Marketable securities are marked to market, but not others.
Imputed costs: economic income recognizes the cost of equity as well as the cost of debt, while accounting income does not.
Ch. 1 34
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Adjusted earnings
Reported by over 70% of companies in the S&P 500
Common adjustments
Restructuring charges
Litigation expenses
Acquisitions
SEC regulates use of adjusted earnings
Are adjusted earnings informative for investors or simply an effort by managers to hide problems?
Ch. 1 35
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International Financial Reporting Standards
2005, Europe adopts IFRS
120+ countries have adopted
What about Japan and U.S.?
Effect of Enron and WorldCom accounting scandals?
Principles vs. rules
Ch. 1 36
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Change in
20152016Account
Assets
Cash and cash equivalents977$ 1,282$ 306$ Use
Accounts receivable, less reserve for possible losses1,218 1,320 102 Use
Inventories384 388 3 Use
Gross property, plant, and equipment601 651 50 Use
Liabilities and Shareholders' Equity
Accounts payable241 320 79 Source
Long-term debt1,547 1,199 (348) Use
Total shareholders' equity1,664 1,863 199 Source
December 31
20162017SourcesUses
Cash & Securities7555
Inventory8070
Accounts receivable7090
Total current assets225215
Net fixed assets720810
Total assets9451025
Accounts payable7585
Short-term debt205190
Total current liabilities280275
Long-term debt325350
Common stock5055
Paid-in capital150175
Retained earnings140170
Total shareholders equity340400
Total liabilities and equity9451025
TOTAL
Albany Enterprises
Year-end Balance Sheets ($ millions)
