Accounting Basics
Alex Apanovitch and Mikhail Stepanov
October 16, 2013
Accounting Basics
The Importance of Financial Statements
Importance to Managers
§  Shows a comprehensive financial picture of the company
§  Gives light to potential problems
§  Can be used to compare against projections and make projections for the
future
Importance to Users
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Could be lenders or investors
Allows analysts/potential users to project future performance
Helps to make investment recommendations/decisions
Helps to assess management’s efforts and performance
Note: A company’s statements may not accurately reflect actual performance in certain scenarios
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Accounting Basics
Market Value vs. Book Value
Book Value
Market Value
§  The value on the balance sheet
§  What the asset is currently worth
(in general)
today
§  Historical Cost
§  Provides a more accurate picture of
current value / worth
§  Useful to help track profits / losses
§  Market Capitalization: Stock Price
§  For most assets, accounting
x Total Shares Outstanding à what
standards require book value to be
does this tell us about a business?
recorded
Pop Quiz: When would market value equal book value?
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Accounting Basics
Enterprise Value vs. Equity Value
Enterprise Value
Equity Value
§  Market value of the firm’s
underlying assets
§  Attributable to both debt and
equity holders
§  Common synonyms: Firm Value,
Transaction Value, Aggregate
Value
§  Market Value attributed to
shareholders
§  Leads to valuation of common
shares
§  Common synonyms: Market value,
Offer Value, Market Capitalization
Enterprise Value = Market Capitalization + Preferred Equity + Minority Interest + Net Debt
Note:
§  Must be consistent when using multiples
§  Be sure to subtract the appropriate accounts to get from enterprise value to
equity value
Pop Quiz: Why do we add minority interest back to Enterprise Value?
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Accounting Basics
Components of Enterprise Value
(+) Equity Value
§  Market Capitalization (# shares outstanding x current share price) [Includes
dilutive securities]
(+) Preferred Equity
§  Part of the firm’s capitalization
(+) Net Debt = Total Debt – Cash and Cash Equivalents
§  Includes short-term and long-term debt (interest bearing), substantial offbalance sheet financing for certain industries
§  Cash includes cash and cash equivalents (i.e. marketable securities)
(+) Minority Interest
§  Represent claim on assets/earnings of non-controlling shareholders
(included in EV as it is part of a firm’s invested capital (important for use of
EV/EBITDA multiples))
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Accounting Basics
Overview of Statements
Income Statement
§  Captures revenues and expenses over a fiscal period
§  States the profit (loss) for an accounting period
§  “How well did we do over this period?”
Balance Sheet
§  “Snapshot” of a firm’s assets, liabilities & and shareholders’ equity
§  Shows our financial position as at a specific point in time
§  What we own versus what we owe leads to our net worth
Cash Flow Statement
§  Reports the cash inflow and outflow of a business
§  Broken down by operating, financing, and investing activities
§  Reconciles the income statement and balance sheet
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Accounting Basics
Starbucks
Let’s take a look at Starbucks’ 2011 Annual Report
Things To Look For
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Statements
Management Discussion & Analysis
Understand how the numbers link to their strategy
Key accounting policies
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Accounting Basics
Normalizing Financial Statements
Income Statement
§  A tool used to convert financial statement data into a format that is helpful
for financial analysis
§  Useful when comparing similar companies
Cash Flow Statement
§  One-time items
§  Anything that doesn’t reflect on-going business profitability and cash flows
Balance Sheet
§  Look for obvious items (restructuring, gain/(loss) on sale, legal settlements)
§  Cross check any items with the footnotes for more accuracy
§  Check with MD&A
Accounting Basics
A Flow Through Question
How does a $10 increase in depreciation affect all the statements?
Overview
§  Operating Income would decline by $10
§  Assuming a 40% tax rate, net income would decline by $6
What to Normalize
§  Net Income at the top goes down by $6
§  Add back the non-cash depreciation (-$6 + $10 = $4)
Some Steps To Follow
§  Fixed assets go down by $10, but cash is up by $4 (Assets are down by $6)
§  The decline of $6 from net income flows to retained earnings and both sides
balance!
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Accounting Basics
Capital Structure
Debt Advantages
Equity Advantages
§  Tax shield (cheaper)
§  Not dilutive
§  May signal that management is
confident in company’s success
§  No voting rights for debt holders
§  Reduces company risk level
§  No repayment, therefore no cash
flow planning
§  No “covenants”
§  No pledge of assets
Importance of Capital Structure
§  Will affect valuation considerations (WACC, Market Cap, etc.)
§  Important to know if the company has a healthy & sustainable capital
structure
§  Balance of debt/equity could affect future investment decisions (issuing
new shares, etc.)
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Accounting Basics
Ratio Analysis
Why Use Ratios
§  Allows users to analyze historical trends and compare the company to the
industry players
Ratio Categories
§  Profitability (How well is the venture doing?)
§  Investment Utilization (Measures balance between sales and assets)
§  Liquidity (Measures ability to pay short-term obligations and working
capital efficiency)
§  Stability (Measures debt/equity balance) & growth
Limitations of Ratios
§  Quantitative Only
§  Tells us what happened, not what will happen
§  Different definitions for the same ratio
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Accounting Basics
Ratio Examples
Investment
Utilization
Profitability
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Vertical
Analysis (I/
S items as a
% of sales)
Return on
Assets
Return on
Equity
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Inventory
Turnover
Fixed Asset
Turnover
Total Asset
Turnover
Stability /
Leverage
Liquidity
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Current
Ratio
Acid Test
Age of
Receivables
Age of
Inventory
Age of
Accounts
Payable
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Net Worth
to Assets
Debt to
Assets
Debt to
Capitalizati
on
Debt to
Equity
Long-Term
Debt
Interest
Coverage
Growth
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Sales
Growth
Profit
Growth
Asset
Growth
EBITDA
Growth
Accounting Basics
Where Do We Find Information?
Company Audited Statements
§  Annual report, earnings releases, MD&A, accounting policies, corp.
governance
Government Databases
§  Edgar – SEC (US)
§  SEDAR – CSA (Canada)
Thomson ONE
§  Financial information including statements, key ratios, projections and
reports
Bloomberg Terminal
§  Ivey Business Library (C.B. “Bud” Johnston)
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Accounting Basics
News
§  Yahoo Finance
–  Stock quotes and information
§  Bloomberg
–  Business and financial market news
§  Wall Street Journal
–  Break news and current headlines
§  Yahoo Finance
–  Stock quotes and information
§  CNBC
–  Morning Brief
§  NY Times Dealbook
–  M&A, IPOs, PE and VC deals
§  Economist
–  International economics and politics (opinion)
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Accounting Basics
Alex Apanovitch and Mikhail Stepanov
October 16, 2013