Chapter 17
Understanding
Financial Information
& Accounting
Accounting Information
Importance of AI
Recording
Classifying
Summarizing
Interpreting
What is Accounting
Providing management & others with
information needed to make good decisions
An Accounting System groups transactions that
are similar
Inputs  Processing  Outputs
Inputs
Accounting Documents
Sales documents/Receipts
Purchasing documents
Shipping documents
Payroll records
Bank records
Travel records
Entertainment records
Processing
1. Entries are made into journals: recording
2. The effects of these journal entries are transferred
or posted into ledgers: classifying
3. All accounts are summarized
Outputs
Financial Statements
Balance sheets
Income statement
Statement of cash flows
Other reports (Annual Reports)
Users of Reports
IRS – Taxing authorities
Regulatory agencies
Investors/Shareholders/Creditors/Suppliers
Managers of the Firm
5 Key Areas of Accounting
Managerial (ICMA certifies credentials) Budgeting & Controlling
(CMA = Certified Management Accountant)
Financial (FASB & PCAOB certifies credentials) Annual Report
(CPA = Certified Public Accountant) GAAP
Auditing (Institute of Internal Auditors certifies credentials)
(CIA = Certified Internal Accountant)
Tax Accounting (tax accountant)
Government & Not-for-profit Accounting
Standards set by GASB
(Government Accounting Standards Board)
40 CEU credits per year required to maintain credentials
The Accounting Cycle:
Needs both a bookkeeper & an accountant
1) Analyze source documents
2) Record transaction in journals
3) Post (transfer) journal entries to ledger
#2 & #3 = “double-entry bookkeeping”
4) Take a trial balance
5) Prepare financial statements
Balance Sheet/Income Statement/Cash Flow Statement
6) Analyze financial statements
Computer Accounting
QuickBooks
Peachtree
Customized Software for corporations
Key Financial Statements
Balance Sheet = report of the firm’s financial
condition on a specific date
Income Statement = summary of revenues, costs
& expenses (w/ taxes) for a specific period
Statement of Cash Flows = summary of money
coming into & going out of the firm
(tracks cash receipts & cash payments)
Fundamental Accounting Equation
Assets = Liabilities + Owner Equity
Balance Sheet: 3 major accounts
1 Assets (things owned by the firm)
2 Liabilities (things owed by the firm)
The difference between Assets & Liabilities =
3 Owner’s Equity
Primary Data
Interviews
Surveys/Online Surveys
Observations
Focus Groups
Questionnaires
Customer Comments
Letters from Customers
Secondary Data
Government Publications (many online)
Commercial Publications: A C Nielsen, MRCA
Magazines: Fortune, Forbes, Inc., etc.
Newspapers: WSJ, Barron’s
Internal Sources: Firm’s Records
General Source: Internet Searches
Classifying Assets
Current Assets
Fixed Assets
Intangible Assets
Liabilities & Owner’s Equity
Liabilities
Accounts Payable
Notes Payable
Bonds Payable
Owner’s Equity = Assets - Liabilities
Nonincorporated Businesses
Show Owner’s Equity through a Capital Account
Corporations
Capital Stock: Dividends
Retained Earnings
The Income Statment
Net Worth = What you own – What you owe
= Assets – Liabilities
Income Statement
Revenue - Cost of goods sold = Gross Profit
GP - Operating Expenses = Net Income (pretax)
NI – Taxes = Net Profit or Loss
Revenue
Revenue = Quantity of Units Sold – Price/Unit
R=QxP
Supply
Price
Q
Profit
Revenue is the
Blue Rectangle
Cost
P
Quantity
Demand
Operating Expenses
Rent
Salaries
Supplies
Utilities
Insurance
Transportation
Advertising
Depreciation
The Bottom Line
The Statement of Cash Flows
Operations (business transactions)
Cash Received
Cash Paid
Interest Paid
Income Tax Paid
Interest & Dividends Received
Investments (internal financing)
Financing (external financing)
Cash Balance at end of year = Profit of Loss
Analyzing Financial Statements
Ratio Analysis
Liquidity Ratios = Current Ratio = Asset/Liabilities
Leverage (Debt) Ratios = Debt/Equity
Profitability Ratios
Earning Per Share = EPS = post-tax income/# shares
Return on Sales = ROS = Net Income/Net Sales
Return on Equity = ROE = post-tax income/OE
Activity Ratios
Inventory Turnover Ratio
Chapter 18
Financial
Management
Role of Finance
Management of Funds within the Firm
Budgeting
Cash Flow Analysis
Planning for Expenditures
Plant
Equipment
Machinery
Bonuses
Financial Managers
Examine data prepared by accountants
Make recommendations to top management
regarding strategies for improving the health
of the firm
Treasurer of the firm
Vice President of Finance
Comptroller
CFO = Chief Financial Officer
What do Financial Managers do?
Auditing = check records to establish what was done
Budgeting = set amounts given for various tasks
Collecting Funds (Credit Management)
Controlling Funds = track where funds go
Managing Taxes = tax reduction strategies
Obtaining Funds = where fund come from
Planning = develop strategies for future activities
 Advising top management on financial matters
Financial Planning
Financial
Plan
Short-term
Forecasting
Long-term
Forecasting
Operating
Budget
Capital
Budget
Feedback
Financial
Controls
Cash
Budget
Feedback
Forecasting Financial Needs of a Firm
Short-term: less than one year
Revenues, Cost & Expenses
Cash Flow: inflows & outflows for months or
quarters
Long-term: I year, 5 years, or 10 years
Budgeting
Capital Budget: spending plan for large
purchases
Cash Budget: cash inflows & outflows for a
month or quarter; debt repayments, operating
expenses & short-term investments
Operating (master) Budget: ties all budgets
together
The Need for Operating Funds
Managing day-to-day needs of the business
pay obligations on time; TVM
Many pay as late as possible, unless cash/early
discount is available
Controlling credit operation
up to 25% of accounts may be tied up in credit
Acquiring inventory
Making capital expenditure
Alternative Sources of Funds
Debt
Credit market
Commercial Paper
Business Credit
Bonds
Accounts Receivable
Equity
Stock
Trade Credit/Family & Friends/Commercial Banks
Forms of Short-term Loans
Secured: backed by something of value
Unsecured: unbacked; IOU or Promissory Note
Line of Credit
Revolving Credit Agreement
Debt Financing: borrowing to repay debt
Debt vs Equity Financing
Debt (Loaner)
Equity (Owner)
No change in
management
Maturity Date
Interest Paid yearly
Common Stockholders
have voting rights
No maturity date
No requirement to pay
dividends
Dividends are paid
after tax & are not
deductible
Tax benefits
Chapter 19
Securities
Markets
Where it Happens
Stock exchanges
NYSE
NASDAQ
Start with IPO (Initial Public Offing)
Investment Bankers
Institutional Investors
Traded on secondary markets (NYSE), (NASDAQ), etc.
People like you and me; Institutional Investors
Steps in Becoming a Stock Company
Private firm = controlled by a small number of owners
Wants to raise capital/become stock (publicly traded) company
1. Applies to SEC to begin process
2. Company promoted to Investment Banks/Finances reviewed
3. Investment Banker review potential & predict price/share
4. Firm decides the number of share to offer
5. SEC Approval of IPO obtained
6. Number of share times share price equals capital raised
7. Announcement of IPO made, date set for first day of trading
8. Investment banker facilitate IPO sales to initial purchasers
9. Secondary market begins trading firm’s stock
10. Shareholders have input to how company is run
11. Appreciation, Capital Gains & Dividends earn money for
investors
Investment Bankers &
Institutional Investors
Goldman Sachs
Citigroup
Bank of America
Institutional
Investors
Investment Banks
Pension Funds
Mutual Funds
Insurance Companies
Banks
Exchange Traded Funds
NYSE Registered Firms
Region
Firms registered
USA
Europe
Asia/Australia
Latin America
Canada
Africa/Middle East
Total
2797
967
126
80
72
21
4063
NASDAQ
Region
Firms registered
USA & Canada
Europe
Asia/Australia
Latin America
Africa/Middle East
Total
2502
50
183
28
61
2824
The Language of Bonds
Loans
Bond = a loan of long-term duration
Maturity date = date the bond matures
& is repaid
Interest = payment for borrowing money
a percentage of the principal
Principal = original amount borrowed
Coupon Rate = interest rate on bond
Yield of a Bond
A 20-yr corporate bond with 10% Coupon Rate
has a Par Value of $1,000
At the end of the 1st year the bondholder
earns 10% of the $1,000 Face (Par) Value, or
$100 (& each year this will happen) for 20 years.
Then at the end of 20 years the principal
amount ($1,000) will also be repaid.
The bondholder made $2,000 in interest from
his $1,000 that he loan to the corporation.
What if…
… a bondholder sells a bond on the secondary
market?
The bond can be sold above par value, at par, or
below par value.
Above par means the bond is sold at a premium
(the bondholder make a capital gain on the sale
of the bond).
Below par means the bond is sold at a discount &
the yield for the bond will be higher than the
coupon rate.
Example of increased yield
$1,000 bond with a coupon rate of 5% is sold for
$900 after being held for two years.
$50 of interest paid/year.
The yield for the new owner is calculated below:
New Yield = $50/$900 = 5.56%
Not $50/$1,000 = 5% Yield for original owner.
the yield is better for the new owner
Buying a discounted bond increased the yield.
Reinvestment & Compounding
If the $100 of interest earned each year was
put into more 10% bonds for the 19 years
remaining on the original bond, the
bondholder would have $12,455 from his
original $1,000 invested. This is due to the
power of compounding.
The Rule of 72
$10,000 invested for 48 years at 3%, 6%, 12%
yr
3%
6%
0
$10,000
$10,000
6
12
$20,000
18
24
$20,000
$40,000
30
36
$80,000
42
48
$40,000
$160,000
Which would you prefer after waiting 48 years?
12%
$10,000
$20,000
$40,000
$80,000
$160,000
$320,000
$640,000
$1,280,000
$2,560,000
Other Rules of Thumb
For every $100/month invested @ 12% ROR
you will have $100,000 in 20 years.
For every $100/month invested @ 6% ROR
you will have $100,000 in 30 years.
For every $100/month invested @ 3% ROR
you will have $100,000 in 42 years.
Different Ratings of Bonds
AAA
AA
A
BBB
BB
B
CCC, CC
C
D
S&P
Highest quality, Lowest risk
High quality
Upper medium grade
Medium grade
Lower medium grade
Speculative
Poor quality, high default risk
Highly speculative
Lowest grade, Junk bonds
Aaa
Aa
A
Baa
Ba
B
Caa
Ca
C
Moody’s
Special Features of Bonds
Sinking fund
Callable
Convertibles
Zero Coupon Bonds
The Language of Stock
Equity
Ownership of a part of a company/corporation
Dividends: return to owners (profit)
if the firm does well; not guaranteed
Appreciation: value of stock goes up
a share is worth more than at purchase
Capital Gains: you gain from the sale of
your shares
Types of Stock
Common Stock
voting rights
paid dividends, if approved by board of directors
Preferred Stock
May be callable
May be convertible
Dividends can be cumulative, if missed
More likely to be paid dividends
How are Stocks Traded?
OTC = Over-the-counter, not on any exchange,
through thousands of brokers
NYSE
Amex (now owned by NYSE)
NASDQ
Regulatory Agencies
Securities & Exchange Commission = SEC
NASD, now FINRA (Financial Regulatory Authority)
Firm registration to sell stocks or bonds
Oversight of firms in financial industry &
exchanges in the USA
Insider Trading: “Befitting Unfairly”
Investment Strategies
Short-term
Day trader
Volitility
Stock picking
Seek quick increases
Channels
Bottom-fishing
Double Down
Timing the Market
Long-term
Buy & Hold Investor
Trend/Dividends
Portfolio Management
Dollar-Cost Averaging
Diversification
Bottom-fishing
Double Down
Time in the Market
Investment Vehicles
Stocks
Debt
Common
Bonds: > 10yrs
Preferred
Notes: 1-9 yrs
Convertible
T-Bills:< 1 yr
Mutual Funds
Municipal Bonds
Exchange Traded Funds
Corporate Bonds
Style Box for Stocks
Value
Large Cap
Mid Cap
Small Cap
Blend
Growth
Style Box for Bonds
Long
High Quality
Medium Quality
Low Quality
Medium
Short
5 Criteria For Choosing an Investment
1) Investment Risk
2) Yield/ROR = Rate of Return
3) Duration
4) Liquidity
5) Tax Consequences
Interest Rates affect stocks & bonds
If interest rate go up
Stock prices generally go higher
If interest rates go up
Bond prices generally go lower
Mutual Funds & ETFs
A mutual fund/EFT is a pile of money that has been given
to a mutual fund/EFT company to be invested by a
portfolio manager or management team.
Stocks/Bonds/Cash/other investments are selected based
on critieria set out in a prospectus. To redeem share in
a mutual fund, you request the number of share or
amount of money you want to withdraw. Within 5
business days the money can be back in your bank.
EFT are not redeemed, they are sold on a secondary
market similar to the way stocks are sold.
Benefits of Mutual Fund Investing
Professional Management
Diversification
Access/Liquidity
Dollar-Cost Averaging
Flexibility
Historic long-term ROR
Small amounts invested periodically
Portfolio Allocation
People have different needs & portfolios based on
Risk Tolerance
Age
How soon funds are needed
Grow assets/manage assets/provide income
Investment Experience
Areas you may want to avoid
Junk bonds
Derivatives
Commodities
Futures
Because of their complexity, these will be left to
the experts.
DJIA & S&P 500
The Dow = Dow Jones Industrial Average
The top 30 U.S. firms; changes over time
The Standard & Poor’s 500
The top 500 U.S. firms; changes over time
Other indices: The Russell 3000
Volitility
The roller coaster ride that can be seen by watching
the ups & downs of the stock market
The average mutual fund return for the last 30 or 70
years has been more than 10%.
The next 10 years may produce similar results.
Past performance is no guarantee of future results.
Investing in the 21st Century
4 reasons why many will not be successful
Lack of Knowledge
Depending on others
Lack of a plan
Procrastination
Chapter 20
Understanding Money,
Financial Institutions, &
The Federal Reserve
The Last 3 FED Chairmen
Paul Volcker 1979-1987
Alan Greenspan 1987-2006
Ben Bernanke 2006-present
Nominated by the US President for 4-yr terms, not
to exceed 14 years, unless fulfilling the remainder
of a predecessor’s term.
What is Money
Anything that is accepted as payment of good &
services
Barter = trading tangible real property for another
kind of tangible real property
Why use money?
Portability, Divisibility, Stability, Durability,
Uniqueness
The Money Supply
M-1 = Transactional Money; Cash + Coin +
checking account balances + traveler’s checks
M-2 = M-1 + savings account balances + money
market account balances + money market
mutual funds + certificate of deposits (up to
$100k)
M-3 = M-2 + deposits > $100k (or $100,000)
Controlling the Money Supply (Ms)
Why?
Ms affects currency purchasing power
value of U.S. currency compared to others
Ms affect interest rates which affect economic
growth, employment, tax revenues &
inflation
Strong Dollar versus Weak Dollar
Strong $
buy more foreign G & S
our exports are more
expensive to foreign
buyers
reduces U.S. exports
increases imports
Weak $
buy less
our exports are
less expensive
increases exports
decreases imports
Federal Reserve & Money Supply
The FED can manipulate the Money Supply in 3 ways
1) Increase or decrease the discount rate
(this influence lending & other interest rates)
2) Buy or sell U.S. Treasury debt
(bonds, notes & T-bills)
3) Alter the Require Reserve Ratio that banks
must keep in their vaults or at the FED
(reduces the money available to lend)
What’s behind door #1
Increase discount rate
reduces money borrowed from the FED
and/or increases other interest rates which
decreases borrowing & economic activity
Decrease discount rate
stimulates money borrowed from the FED
and/or decreases other interest rates which
increases borrowing & economic activity
What’s behind door #2
Buying or selling U.S. Bonds
Buying bonds from those who own them
increase cash in system, more lending,
more economic activity
Selling bonds to those who want them
reduces the cash in the system, less
lending, less economic activity
What’s behind door #3
Changing the Require Reserve Ratio
From 10 % to 20% - Banks must keep more
money in reserve & decreases lending
From 10 % to 5% - Banks must keep less
money in reserve & increases lending
The Banking System
U.S. Treasury Dept. supplies currency
The FED acts as fiscal agent to distribute $$$
to Commercial Banks, Credit Unions, etc.
Banks provide services to the public
Demand deposits (savings accounts)
Storage of assets (savings account & CD, etc.)
Credit Cards, Loans & Mortgages
ATMs, Debit Cards
Savings & Loans (S&L)
Started in 1831
Thrifts encouraged consumer thrift & home
ownership.
Thrifts provided slightly higher interest rate on
savings accounts.
1979-1983 - S&Ls hurt by increases in capital gains
tax rates – 20% of S&L failed.
1989-1991 – S&L hurt when housing market tanked
Resolution Trust Corporation formed to sell off
S&L properties at a cost of $250 billion to the U.S.
tax payer.
Credit Unions
Nonprofit, member-owned
typically high checking & savings rates
lower loan rates
Organized by government, corporations, unions,
professional associations
Nonbanks
Insurance Companies
Pension Funds
Brokerage Firms
Commercial Finances Companies
Corporate Financial Services
Deposit Insurance
Banks – FDIC
up to $250,000 per account
S&Ls – SAIF
up to $100,000 per account
Credit Unions – NCUA
up to $100,000 per account
The Future of Banking
Glass-Steagall Act of 1933
Prohibited banks from owning brokerages
Gramm-Leach-Bliley Act of 1999
Allowed banks to combine with securities
firms to market & sell each others services
Technology & new services
ATMs, EFT, ECC, MICR, ACH, Debit Cards,
Smart Cards
Has cash become a thing of the past?
International Banking
Letter of Credit
Banker’s Acceptance
Wire transfers rather than physical transfers of
money
World Bank & IMF
World Bank – Make loans for develop projects
where capital may be difficult to come by.
IMF = International Monetary Fund
Provides funds to countries with monetary
instability
Members pay in Special Drawing Rights (Dues)
Protests and Conflict
To who does the World Bank lend?
What about the countries that in debt & can
not pay it back?
Should the WB forgive these countries debt?
What about the USA?
$13 trillion in debt, who gets hurt if all
debt is forgiven.