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Daniel Fotinich Andy Zhao

Berkeley Investment Group: Financial Statements and Modeling Workshop. Daniel Fotinich Andy Zhao. Importance of Financial Statements. Supplement our qualitative judgments about a company Predict future financial performance Calculate what we believe is the firm’s fair value.

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Daniel Fotinich Andy Zhao

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  1. Berkeley Investment Group: Financial Statements and Modeling Workshop Daniel Fotinich Andy Zhao

  2. Importance of Financial Statements Supplement our qualitative judgments about a company Predict future financial performance Calculate what we believe is the firm’s fair value

  3. Financial Statements What are the three financial statements? • Income Statement • Balance Sheet • Statement of Cash Flows Where do we find them? • Yahoo/ Google/ Morningstar • http://www.sec.gov/edgar.shtml • Company’s investor relations webpage Which is the most important? • All of them are useful for analysis 10-k, 10-Q

  4. Case Study: Chipotle

  5. The Income Statement

  6. A Bare-bones Income Statement “topline” “bottom line”

  7. Actual Income Statement

  8. Revenue, Cost of Goods Sold, Gross Profit Revenue – money generated from sales of products and/or services within a given time frame COGS – cost of materials directly related to goods/services sold Gross Profit– profit directly related to producing the good/service Gross margins: Gross profit/Revenue

  9. Operating Expenses & Operating Income Gross Profit OpEx – Indirect costs of operating the business Operating Income –profit received from company’s core operations Operating margins: Operating Profit/Revenue

  10. Interest, Taxes, Net Income Operating Income Interest Payments – interest on company debt Taxes – Tax rate * (Income Before Taxes) Net Income – “earnings”, how much total profit a company makes Net Margins: Net Income/Revenue

  11. Fixed vs. Variable Cost Costs Variable Cost Fixed Cost Production

  12. Operating Leverage Op. Income Revenue % of costs as fixed 50% 0% • Total expenses increase at a rate less than that of revenue • Occurs when there are fixed costs in the business • The greater the % of costs as fixed costs, the greater the operating leverage

  13. Understanding Gross Profit A B How do these two businesses differ from one another? Company A has 16% GMs, Company B has 81% GMs

  14. Understanding Gross Profit Certain types of businesses have far lower gross margins than others, and it is important to recognize these

  15. Operating costs: The Great Equalizer Ford has 2x the revenue of Pfizer, but 2x less “operating costs”

  16. Analyzing Income Statement Trends (I) What trends do you notice in this income statement?

  17. Analyzing Income Statement Trends (I) • Steep sales decline from 2011 • 40% decline in 2013 • Huge decline in gross and operating margins • GMs: 44% → 31% in 2 years • OMs: 23% → -11% • R&D spending flat in 2013, even as sales collapse • Due to the BlackBerry 10 • Net loss in 2013

  18. Analyzing Income Statement Trends (II) What trends do you notice in this income statement?

  19. Analyzing Income Statement Trends (II) • Annual revenue growth has averaged 17% since 2009 • SG&A has increased far less than revenue has in 2012-13 • Lots of operating leverage! • Net income up 103% since 2009 • Restaurant count has increased by ~100 per year • “Same-store sales” up 4%

  20. The Balance Sheet

  21. A Bare-bones Balance Sheet

  22. How to Think about the B/S LIABILITY ASSET What are the two methods for paying for a house? EQUITY

  23. Therefore… ASSETS = LIABILITIES + EQUITY The “balance sheet equation”

  24. Assets Cash and Cash Equiv. Receivables– IOUs from customers Inventory – goods that have been produced but not sold PP&E– capital goods used to make products

  25. Liabilities Accounts Payable– IOUs to suppliers Long-term Debt – debt to be paid off in more than a year (bonds)

  26. Equity Additional paid-in capital– total value of all issued stock Retained earnings – the sum of all the earnings of the business since day 1

  27. What’s the point? • The balance sheet is useful to investors in two ways: • How efficiently the company is using its capital • Solvency of the company (whether or not it’ll be able to pay back debt Return on Assets: Net Earnings / Total Assets • An indicator for how efficiently the firm uses its assets • Generally the higher the better • Why do airlines have lower ROAs than biotechnology companies? Debt/EBITDA • A higher D/EBITDA means more aggressive financing and is different for every industry • Companies with significant debt usually trade at a discount to companies with less debt

  28. One Type of Business What do you notice on this balance sheet? $20 Billion in PP&E!

  29. One Type of Business The Venetian is “necessary capital” for Las Vegas Sands to provide its product

  30. Another Type of Business What do you notice on this balance sheet?

  31. Another Type of Business “NIKE, Inc., together with its subsidiaries, engages in the design, development, marketing, and sale of athletic footwear, apparel, equipment, and accessories”

  32. The Cash Flow Statement

  33. What happens when the company makes money? • ↓ LT-Liabilities by 100k • ↓ Cash by 100k Pay back $100k debt Cash flow from financing Assume the company makes $1MM earnings in 2013 (all cash) Distribute $200k to Shareholders • ↓ cash by $200k Cash Flow from investing Reinvest rest in co • ↑ cash by $1MM • Capital expenditures • Keep cash on balance sheet Remaining cash flow

  34. Statement of Cash Flows • From Operating Activities • See appendix for detailed explanation From Investing Activities • From Financing Activities • Dividends • Debt paydowns

  35. Why does Cash Flow matter? • As investors, we are entitled to the assets of the company and cash is the most liquid asset • Not all of a company’s earnings are in cash • Chronically negative cash flow could result in increased leverage or eventual default What’s the problem here?

  36. Appendix

  37. “Cash Rules Everything Around Me”-Wu Tang Clan • Not all financial statements are created equal • IS tells us the earnings and costs of doing business • BS tells us the financial health of the company • CS tells us how much CASH is coming in every year and ties together the two • Cash is what investors want the most (cash = value) • High income doesn’t necessarily = High cash flow • The cash flow statement tells us how much value the company is generating Investors Lenders

  38. Non-Cash Items and Adjustments • Non-cash items are line items included in earnings but don’t represent cash inflows or outflows for the company. • Expenses (additions to earnings): • Depreciation and Amortization – Accounting method for recognizing capitalized expenses over time (non-cash) • Change in Accounts Payable – IOUs to suppliers (didn’t spend the cash) • Revenue (deduction from earnings): • Change in Accounts Receivable – IOUs from customers (didn’t give you cash) But you did spend cash on something else… Capital expenditures Capex is not recognized on the income statement, but is a major use of cash

  39. Free Cash Flow Free Cash Flow: cash the company generates in a given year to pay off lenders and give value to investors Proxy for FCF: • EBITDA (EBIT + D&A) The Equation… Free Cash Flow = Operating Cash Flow – Capex Strong free cash flow is a good indicator of a firm’s value

  40. The Beauty of the Statements CS BS IS Change in Cash Net Income (becomes retained earnings) NWC, Issued Debt Net Income, D&A

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