Culverhouse Investment Management Group New Member Orientation – Fall 2014 Day 2 – Financial...

Culverhouse Investment Management Group

New Member Orientation – Fall 2014Day 2 – Financial Statements and Time Value

of Money

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FINANCE VOCAB

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Financial Health

• Current Ratio = Current Assets/Current Liabilities

• Debt/Equity = Total Debt/Stockholder’s equity• Coverage = EBIT/Interest• Profit Margin = Net Income/Sales• FCF Conversion = FCF/Net Income• Return on Equity = Net Income/Stockholder’s

Equity

Financial Statements/Model

• Vocab:– COGS- Cost of Goods Sold– Gross Profit= Revenue – COGS– SG&A- Selling, General & Administrative Costs– R& D- Research and Development– OPEX- Operating Expenses (Sum of expenses)– EBIT- Earnings Before Interest and Taxes– NOPAT- Net Operating Profit After Tax– CAPEX- capital expenditures

• Note: Some companies label things differently.

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FINANCIAL STATEMENTS

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Accounting Overview

Two Types of Accounting:• Cash and Accrual– You use cash, businesses use accrual– Importance of timing differences

• Value investors have a deep understanding of accounting principles– Accountants lie– Good investors can tell when

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Financial Statements

• Income Statement– Summarizes revenue and expenses over a period of time– Reports the profit performance of a business

• Balance Sheet– Assets = Liabilities + Stockholder’s Equity– Reports the balances of the above accounts at a point in time– Shows the financial condition of the business

• Cash Flow Statement– Reports cash inflows and outflows over a period of time– Shows changes in investments and financial structure

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How They Connect

Revenue

Net Income

Net Income Δ cash

Cash

CashAssets

=Liabilities

Equity

Income StatementStatement of Cash

Flows Balance Sheet

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INCOME STATEMENT

• MAIN PURPOSE– Profit and loss (P&L)– How revenue is

transformed to net income

– Represents a period of time• January 1st-March 31st

2013

Income Statement

Balance Sheet

• Snapshot of a company’s financial position at a given time. For example: Dec. 31, 2013

• Assets = Liabilities + Shareholders Equity– This is always true

• These terms will vary given sector of a company

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BALANCE SHEET

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STATEMENT OF CASH FLOWS

• Accounts for actual cash movement of company

• Operating – continuing operations of company

• Investing- long term assets & liabilities

• Financing- inflow from investors, outflow as dividends

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Questions?

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TIME VALUE OF MONEY

Time Value of Money

• Key foundation of finance• $1 today > $1 tomorrow• How do we determine what we would pay

today for $1 guaranteed to us in the future?

• Answer: Discount Rate

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Discount Rate

• Accounts for the opportunity cost of not having that dollar working for you today

• Ex. the interest if it was in a savings account• Usually the hardest input to find/define when

solving for PV/FV• Conceptually, discount rate = the rate of

return (interest) required by investors

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TV of Money Example

• For entering freshmen, CIMG offers $400 at graduation for an up-front payment from students who choose to invest

• How much would you pay on your first day of school for the promise of $400 from CIMG when you cross the stage at graduation?– Write that number down, we will use it later

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TV of Money Example

• For the class of 2018, CIMG offers $400 at graduation for an up-front payment of $300 by all students who choose to invest

• We can calculate the discount rate implied by CIMG’s offer

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Calculations

• Two ways to find the implied discount ratea) Solve for x

a) Financial calculator (TI BA-II Plus)a) N=4, PV=-$300, PMT=0, FV=$400

• Answer: 7.46%

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What Does it Mean?

• Investors who opt in believe that the annual return of 7.46% offered by CIMG is fair

• If this is the only way to raise capital, then CIMG’s cost of capital is 7.46%

• Does it make sense for CIMG to be offering these returns to freshmen?– Should freshmen invest in this deal?

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Considerations

• Think back to when you picked your acceptable initial investment with CIMG

• What factors went into your decision?– Amount of money in your bank account– Ability to sell $400 note to other students– Probability that CIMG will be able to pay in 4 years– Potential returns from other available investments

• What risks is CIMG taking in this deal?

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Practice

• Take a few minutes to calculate the discount rate implied if CIMG agreed to take the initial investment you wrote down

• A lower(higher) initial investment leads to a higher(lower) discount rate / rate of return

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Conclusion

• Next lecture date: 11/4– Same time, same place

• Between now and then…– Research NIM and WACC on Investopedia– Continue reading Berkshire Hathaway letters• Move to http://www.valuewalk.com/ after that

• Please address any feedback to Matt Lambert at cimg.cba@gmail.com

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Questions?

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Appendix: Calculator Terms

• Financial calculator– Future value (FV)– Present value (PV)– Payment (PMT) – cash inflows/outflows– Interest (Discount) Rate (I/Y)– Number of periods (N)