Video Transcript: Financial Statement Analysis

Hello, welcome. We're going to discuss financial statement analysis. So basic  financial statements are is the balance sheet, which summarizes what a firm  owns and owes at a given point in time. The balance sheet is a snapshot of a  company's financial performance at any given time the income statement, it  reports on how much a firm earned in the period of analysis. So if we do an  annual report, say for 2016 we want to know how company XYZ performed as  far as being profitable, we can look at their income statement over the year 2016 we can also look at financial income statement, at quarterly, monthly, things like  that. So any period, you can see the profitability of the firm, the statement of  cash flows, reports on cash inflows and outflows to the firm during the point of  analysis. So we want to see how cash flow is cycling throughout our  organization, the inflows and the outflows. So let's take a look at the balance  sheet again. On the left side, assets, current assets, investments, plant, property and equipment, intangible assets, other assets, total assets. On the right hand  side of the balance sheet, we have liabilities and owner's equity. Liabilities  consist of current liabilities, long term liabilities and total liabilities. Now we have  owner's equity beneath liabilities, total liabilities and owner's equity should equal assets, principles underlying the balance sheet, an unabiding belief in book  value as the best estimate of nominal value. So let's discuss that for a second.  So book value of a company is going to be related to the amount of owners  equity that they have after you subtract out assets liabilities from assets, so you  have assets minus liabilities equal owners equity, that is the real value of the  firm. So you want to look at the book value, which is what our balance sheet  shows as the actual value of the firm. So the nominal value is the real actual  value. So you'll have a market price which is your stock right, times the amount  of shares outstanding. So again, the $10 stock price, with the 10 million shares  outstanding, that is going to give us the market value of our company. The  market capitalization is going to be what the market says that our company is  worth. But that value may be different than the book value, the book value,  again, is going to be assets minus liabilities, equals owner's equity. So our book  value is going to be derived from the balance sheet, whereas the market value  of our company will be derived by the actual equities market, a distrust of the  market of estimated value. So the difference, again, between the market value  and the book value of a of an asset, right or of our company, the market price of  an asset is often viewed as both much too volatile and too easily manipulated to  be used as an estimate of value for an asset, the suspicion runs even deeper  when values are estimated on future cash flows. So what we're trying to say  here is we can't trust the market, because the markets can be artificially  manipulated through short selling, or things like that. Short selling is artificially  driving down the price of a stock through selling short, which we'll discuss later.  So So markets can equity markets can be manipulated. Stock markets can be  manipulated. So that's why it's best to trust the book value, because it's the 

actual nominal value of the firm. In regards to owner's equity, a preference for  underestimating value rather than over estimating the value. Obviously, you  want to be on the conservative side. Nobody wants to have or nobody wants to  deal with inflated numbers. We want to make sure that we are staying  conservative. We would rather underestimate the value of our firm than  overestimate it, just on a conservative basis, because it's better to be  conservative with your approach, because, you know, when we go to sell the  firm or the organization, or we want to be bought out, and we have our  estimations are conservative, we can actually negotiate potentially a higher price and have investors run the actual nominal numbers and actually probably pay  you out of the higher price per share. If you're looking at a buyout situation  measuring asset value. Since accounting statements begin with the historical  cost at which assets were acquired and financing raised. They are not designed  to measure the current value of the assets, so assets depreciate over time, but  using the book value and the accounting methods here, our price, our value of  an asset, potentially property, plant and equipment, will stay the same as when  we bought it. Now how we can in the accounting phase, how you can offset that  value is through the depreciation and amortization function, which will also cover later, the only assets that are reported at or close to market value are current  assets, which may be your inventory, the actual value of that inventory that you  hold current assets as a consequence the liabilities and the shareholders equity  from an accounting statement are not measures of the current values of either  so accounting takes the original value and doesn't take into account  appreciation of the value or potential depreciation value, until you add that into  the accounting mix. Fair value accounting, a trend in the US and internationally,  aims to bring asset values in accounting balance sheets close to their current  market values. So a concept that is actually being floated globally is a fair  accounting, fair value accounting standard, which will move assets closer to  their current market values, which will actually give you a better representation  of a company's actual owner's equity, which will be the book value of the firm.  So let's look at the income statement. Income statement is a statement of your  profitability, notice we have revenue. This is our sales. This is the money that  we've earned that with our company has brought in. Now we take out expenses, right? So we've got 53,000 expenses, our revenue, 82 five expenses, 53,000  income before income tax. So now we have our tax expense. So we subtract out the 53 from the 82 given this 29 five, our income tax expense. And this line item  29 five, the income before income tax, is known as EBIT, or earnings before  interest and taxes. Now we'll take out the income tax expense, 11,500 to give us a net income or our profit margin, or profitability, or our profit of $18,000 so the  income statement is revenue minus expenses. Then we deduct for taxes, and  then we have our profitability. So this is a simple example of an income  statement, but you can get the concept principles underlying the income 

statement in accrual accounting, the revenue from selling a good or service is  performed a corresponding effort is made on the expense side to match  revenues to expenses. Expenses are categorized in operating financing and  capital expenses. So our operating expenses will be how much money we  spend to fund operations the financing piece is, what do we have to pay down  on our debt and capital expenses are, what are we investing in our plant,  property and equipment? Operating expenses are expenses that provide  benefits only for the current period. Cost of labor and materials spent to create  products that are sold in the current period is a good example. Financial  expenses are expenses arising from non equity financing used to raise capital  for the business. Most common example is interest expense on our debt. Capital expenses are expenses that are spent expected to generate benefits over  multiple periods. For instance, the cost of property, plant and equipment now  this is a cash flow statement. So now we can see cash flow for the year ending  December, 31 2017, so cash flow from operation, operating activities. So you  can see that we brought in receipts from customers, 1.3 million payments to  suppliers and employees, 1.564 million total cash from operating activities. So  these are all going outflows. So we have a negative 2.864 million cash inflows  from investing activities, 500,000 there cash flows from financing activities, other cash items from financing activities, 5000 so maybe in the cash flow for finance  activities here, with the 5000 we potentially issued more stock here. That's why  we see the positive inflow. Or we went into the market and leveraged up with  some more debt. So now we have the cash so our net cash flows, so we'll  subtract so we'll see we have got the 5000 from financing activities. We've got  the 500 from investing activities. So we'll subtract out the 2864, from the  operating activities. So our net cash flows for this period were $2,635.07 so now we'll record at the bottom of the ledger, you can see the net change in cash for  the period was 263507 so valuation of the cash flows the cash flow statement is  distinct from the income statement and balance sheet, because it does not  include the amount of future, incoming or outgoing cash that has been recorded  on credit. So we have, you know, an accounts payable, or we have an accounts  receivable, the cash flow statement does not reflect that like an income  statement would, because it is not cash that has actually been outflowed or  inflowed. It is money to be paid out in the future. So our current cash flow  analysis cannot show that, because it hasn't occurred yet. Therefore cash is not  the same as net income, which on the income statement and balance sheet  includes cash sales and sales made on credit. So let's look at operations on the  cash flow, measuring the cash flows, inflows and outflows caused by core  business operations. The operations component of cash flow reflects how much  cash is generated from a company's products or services. Generally, changes  made in cash, accounts receivable, depreciation, inventory and accounts  payable are reflected in cash from operations investing, changes in equipment, 

assets or investments relate to Cash From Investing. Usually cash changes  from investing are a cash out item, because cash is used to buy new equipment, buildings or shirt short term assets such as marketable securities like equities or stocks. However, when a company divests of an asset, the transaction is  considered cash in for calculating Cash From Investing. So we use cash to go  buy the PPE plant, property, equipment, right? So that's the cash outflow, the  cash inflow. The reason why this is an investing mechanism in the cash flow is  because when we sell that asset, hopefully the value of that asset is  appreciated, and we consider the appreciation and price of capital gain. So this  is an investment mechanism of the cash flow financing. Changes in debt, loans  or dividends are accounted for in cash from financing. Changes in cash from  financing are cash in when capital is raised, and they are cash out when  dividends are paid. Thus, if a company issues a dividend to the public, the  company receives cash financing. However, when interest is paid to  bondholders, the company is reducing its cash position.