ACCOUNTING I Income Statement. Fall 2015 Comp Week 3

Transcription

1 ACCOUNTING I Income Statement Fall 2015 Comp Week 3

2 CODE: COMPW3

3 Administrative Stuff The location of all lectures will be Yenching Auditorium, located at 2 Divinity Avenue. Send an to trentnelson@college.harvard.edu if you have not been added to the HFAC Comp mailing list. Talk to me afterwards if you haven t been assigned to a comp section.

4 Timeline Date Topic 9/10/15 Introductory Meeting 9/17/15 Qualitative Analysis: SWOT and Porter s Five Forces 9/24/15 Income Statement 10/1/15 Balance Sheet 10/8/15 Cash Flow Statement and Linking the Financial Statements 10/15/15 Financial Metrics, Ratios, and Comparables Analysis 10/22/15 The Discount Rate: CAPM and WACC 10/29/15 Discounted Cash Flow Analysis (DCF) 11/5/15 DCF Practical 11/12/15 Review & Stock Selection 11/19/15 Fundamentals of Investing and Sample Stock Pitches 12/3/15 Stock Pitch Competition

5 Outline for Today I. A Quick Recap 1) SWOT and Porter s Five II. Accounting: The Language of Finance 1) The financial statements III. Income Statement 1) What it is 2) Accrual Accounting 3) Line Items 4) Why it s important 5) Game time

6 A quick recap: SWOT

7 A quick recap: Porter s Five

8 Accounting The Language of Finance We ve formalized our intuitive understanding of a business using qualitative methodologies: SWOT and Porter s Five

9 Accounting The Language of Finance We ve formalized our intuitive understanding of a business using qualitative methodologies: SWOT and Porter s Five Now we want to be able to understand the technical aspects of the quantitative side of a business

10 Accounting The Language of Finance We ve formalized our intuitive understanding of a business using qualitative methodologies: SWOT and Porter s Five Now we want to be able to understand the technical aspects of the quantitative side of a business We need accounting in order to speak the language of finance

11 Accounting describes the fundamental performance of a business: 1. How a company makes money and the costs associated with making money 2. The actual cash a company generates 3. The company s assets and liabilities Each of the functions listed above is reported quarterly in financial statements: 1. Income Statement 2. Cash Flow Statement 3. Balance Sheet Accounting The Language of Finance

12 INCOME STATEMENT

13 What is it? The income statement summarizes the inflows and outflows of money (not necessarily cash) over an accounting period *Technical note: inflows/outflows of money are only those line items that affect the company s taxes Inflows = Revenues Outflows = Expenses

14 Accrual Accounting Accounting doesn t just track the cash position of a business Why is this important?

15 Accrual Accounting Accounting doesn t just track the cash position of a business Why is this important? Accrual accounting measures the performance of a company by recognizing economic events regardless of when cash transactions occur

16 Accrual Accounting Accounting doesn t just track the cash position of a business Why is this important? Accrual accounting measures the performance of a company by recognizing economic events regardless of when cash transactions occur Uses the matching principle, meaning that economic events are recognized by matching revenues to expenses at the time the transaction occurs

17 Matching Principle Example Suppose we manufacture widgets for $3 a piece, and sell them for $5 a piece Under the matching principle, we only record the manufacturing expense ($3) at the time we sell the widget, not at the time of production Similarly, if a customer buys our widget using a credit card, we record the revenue ($5) at the time we sell the widget, not at the time the actual cash is received

18 Line Items Think of the income statement as a coffee filter We start with the top line (revenue) and filter down through each of our expenses to the bottom line (net income or earnings)

19 Line Items 1) (+) Revenues 2) (-) Cost of Goods Sold (COGS) 3) (-) Operating Expenses a. Research & Development b. Selling, General, & Administrative c. Depreciation & Amortization 4) (-) Other a. Non-recurring b. Interest 5) (-) Taxes 6) = Net Income

20 Revenue Revenue is the total value of all products/services a company sells in a given period Remember, revenue is recorded when the product/service is sold, not just when cash is received Are high revenues better than low revenues?

21 Cost of Goods Sold Also known as COGS, these are the costs of inputs associated with producing the goods sold That is, they are the direct costs such as for the raw materials and labor, but not indirect expenses like distribution What kinds of companies have high COGS? Why? What kinds of companies have low/no COGS? Why?

22 Operating Expenses 1) Research & Development (R&D) R&D refers to the expenses associated with research to find new discoveries/products/procedures, or to improve existing products/procedures What kinds of companies have lots of R&D?

23 Operating Expenses 2) Selling, General, and Administrative (SG&A) Selling expenses refer to those attributable to the sale of a good/service, such as advertising, travel, telephone, or postal charges General and Administrative expenses include salaries of non-sales personnel (think executives), rent, utilities, and other miscellaneous expenses Why might some companies have very high SG&A?

24 Operating Expenses 3) Depreciation & Amortization (D&A) Depreciation refers to the allocation of the cost of a tangible (i.e. physical) asset over its useful life E.g. A $100 plant used for 20 years Amortization refers to the allocation of the cost of an intangible (i.e. non-physical) asset over its useful life E.g. A $500 patent for 10 years What is especially unique about D&A unlike many of our other expenses?

25 Other Expenses 1) Non-recurring These are one-time costs/sources of income that the company does not expect to realize repeatedly in the future What are some examples?

26 Other Expenses 2) Interest Expenses These are interest payments made on any outstanding debt Interest payments are tax-deductible, which is why they appear on the income statement These are not the same as a debt/principal repayment What can interest expenses tell us about a company?

27 Taxes 3) Taxes are taxes Companies are taxed on their revenues less all of the previously reviewed line items at a certain corporate tax rate (depending upon country of incorporation) In America, corporate tax rate is 35% on income over $18.3 million

28 Why is the Income Statement important? The income statement gives investors a good idea of: 1) The company s profitability 2) Margin of profitability 3) How it earns money, where it spends money 4) Taxes Just remember- the income statement uses accrual accounting, and therefore some subjectivity is involved Be careful when looking through income statements!

29 Time for a game You re going to try to figure out the company I m displaying based only on the income statement I show Take note of everything we ve talked about!

30 What company might this be?

31 What company might this be?

32 What company might this be?

33 What company might this be?

34 An interesting comparison

35 Final Announcements Be sure to submit the attendance form with code COMPW3 Talk to me if you are not on the mailing list/not in a section Sections start this Friday, 9/25 Homework and lecture slides will be sent out tonight Homework due by start of next comp lecture, Thursday at 6pm Any questions?

36 Thank you! See you next Thursday!