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Culverhouse Investment Management Group
New Member Orientation – Fall 2014Day 2 – Financial Statements and Time Value
of Money
2
FINANCE VOCAB
3
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.
5
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
14
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
16
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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 [email protected]
25
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)