Financial Accounting

1
Financial Accounting

• A Valuation Approach

2
Accounting and Valuation

• Balance sheet picture of the company at a point
  in time
• Income or earnings statement- measures earnings
  over a period of time.

3
Earnings

• Revenue- Expenses
• Informal definitions
• Revenues- amounts collected or expected to be
  collected from customers in exchange for
  providing goods or services
• Expenses- amounts paid or expected to be paid in
  return for resources that go into production and
  marketing of goods and services

4
Business model
5
Business components

• Assets- Items of value used in the business
  recognized as assets in accounting
• Liabilities- obligations of the business
  recognized in accounting
• Owners equity- the difference between assets and
  liabilities

6
Business organization

• Proprietorship
• Partnership
• Limited liability company
• Corporation

7
Corporation

• Focus of this course is on publicly traded
  corporations
• Structure of public corporations
• Sell stock to shareholders
• Returns to shareholders are in the form of
• Dividends
• Sale of stock

8
Claires

• Claire's Stores Stock Charts
• Claires Stores Financial Statements

9
Valuation

• How do we decide if Claires market price
  reflects its underlying (intrinsic) value?
• Financial statements can provide information that
  is helpful in assessing a firms value.

10
Valuation and a firm

• Price earnings ratios are a simple way of
  assessing value
• The price earnings or P/E ratio is a measure of
  the value that the market places on a dollar of a
  firms earnings
• Forward P/E ratio based on forecasted earnings
• Trailing P/E ratio based on past earnings

11
Valuation models

• Another way to look at a firm is its Price/Book
  ratio. The price book ratio is the ratio of of
  the firms stock price to its book value/share.
• Free cash flows what is the present value of the
  cash flows that the firm is generating that can
  be used for growth?
• Present value of abnormal earnings. How much is
  the firm earning above its cost of capital?

12
Claires P/E and P/E

• Claires (CLE) price 23.92
• EPS diluted 1.47 (excluding extraordinary
  items)
• P/E ratio 23.92/1.47 16.27 (trailing)
• Earnings forecast (WSJ) 1.62
• If the P/E ratio stays the same- the price should
  be 1.62 16.27 26.35

13
Firm Activities

• Financing
• Raising funds for the firm
• Issue Stock
• Issue long term debt
• Investing
• Purchase property, plant and equipment to allow
  the firm to conduct operations
• Operating
• Making and selling goods and services to earn a
  profit

14
Accounting rule setting

• Securities and Exchange Commission (SEC)
• www.sec.gov
• Financial Accounting Standards Board (FASB)
• www.fasb.org
• Public Company Accounting Oversight Board (PCAOB)
• www.pcaobus.org

15
GAAP

• GAAP (Generally accepted accounting principles)
• Large body of standards from current and past
  standard setting bodies
• Accounting Research Bulletins (ARBs)
• APB opinions
• FASB Standards and interpretations
• SEC Accounting Series Releases

16
Accounting

• Accounting is a political process
• Accounting standards are a product of compromise
• Example Oil and gas industry successful
  efforts versus full cost accounting

17
Accounting Concepts

• Relevance
• Capable of making a difference in decisions
• Feedback value- How well did we do?
• Predictive Value-How well will we do in the
  future?
• Timeliness-disclosed soon enough to be useful
• Reliability
• Information represents the events it was intended
  to portray
• Verifiability
• Independent users use the same methods to get the
  same results

18
Accounting Concepts

• Neutrality
• Information should not be biased to meet the
  needs of a particular consistency
• Comparability
• Information should be comparable across firms and
  across time for the same firms
• Consistency
• The same accounting methods should be used from
  one period to the next

19
Accounting Concepts

• Materiality
• Relates to relevance, the decision matters
• SEC has dictated that materiality cannot be used
  as excuse for bad accounting
• Conservatism
• Tendency to recognize expenses and costs earlier
  than revenues and gains
• Results in assets generally being carried at
  lower levels on the balance sheet than market
  value.
• Also means that when we look at the market value
  of a company relative to its book value, usually
  market value is greater (Market/Book values 1)

20
Auditors

• Provide independent assessment of whether
  financial statements fairly present the
  financial situation of a company
• Auditing is changing. New requirements imposed on
  auditors and companies under PCOAB.

21
Economic Consequences

• The idea of accounting as having economic
  consequences means simply that accounting affects
  real business decisions and wealth creation.
• Examples-
• Enron
• MCI Worldcom
• Fannie Mae
• Rite-Aid

22
Fannie Mae
23
Jacuzzi
24
Counting horses