itroductio to accounting for mba

7/29/2019 itroductio to accounting for MBA

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Module 1:

Introducing FinancialAccounting for MBAs


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Buffets Acquisition Criteria

Large purchases (at least $50 million of before-tax earnings),

Demonstrated consistent earning power (future projectionsare of no interest to us, nor are turnaround situations),

Businesses earning good returns on equity while employinglittle or no debt,

Management in place (we cant supply it), Simple businesses (if theres lots of technology, we wont

understand it), An offering price (we dont want to waste our time or that

of the seller by talking, even preliminarily, about atransaction when price is unknown).

Financial performance is an important factor

in Buffets criteria


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Buffets Concept of Intrinsic Value

Intrinsic valueis an all-important concept that

offers the only logical approach to evaluating therelative attractiveness of investments andbusinesses. Intrinsic value can be defined simply:It is the discounted value of the cash that can betaken out of a business during its remaining life.


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Buffets Three Suggestions for

Investors:1. Beware of companies displaying weak accounting. If a

company still does not expense options, or if its pensionassumptions are fanciful, watch out. When managementstake the low road in aspects that are visible, it is likely theyare following a similar path behind the scenes. There is

seldom just one cockroach in the kitchen.2. Unintelligible footnotes usually indicate untrustworthy

management. If you cant understand a footnote or othermanagerial explanation, its usually because the CEOdoesnt want you to. Enrons descriptions of certain

transactions still baffle me.3. Be suspicious of companies that trumpet earnings

projections and growth expectations. Businesses seldomoperate in a tranquil, no-surprise environment, andearnings simply dont advance smoothly (except, of course,

in the offering books of investment bankers).


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Business Activities


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Planning Activities

A company exists to implement specific goalsand objectives.

A companys goals and objectives are captured

in a business plan.

Information on planning activities is oftenobtained through:

The Letter to Shareholders

The Management Discussion and Analysis (MD&A)


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Financing Activities

A company requires financing to carry out itsbusiness plans.

Financing activities refer to methods thatcompanies use to raise the funds to pay forresources such as land, buildings, and equipment

There are two main sources of financing:

Equity financing

Creditor (or debt) financing


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Examples of Company Financing


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Types of Creditor Financing

Investing creditorsthose who primarilyfinance investing activities (such as banklenders).

Operating creditorsthose who primarilyfinance operating activities (such as suppliers).


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Breakdown of Creditor Financing


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Investing Activities

Investing activities are the acquisition anddisposition of resources (assets) that a companyuses to produce and sell its products and

services.The investing resources, or assets, are of two

types

Operating assetsresources devoted to operatingactivities

Nonoperating (financial) assetsresources devotedto nonoperating activities


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Breakdown of Operating and

Financial Assets


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The Accounting Equation


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Operating Activities

Operating activities are the use of companyresources to produce, promote, and sell itsproducts and services.

Operating Revenues (or sales) - the inflow ofassets from selling products and services.

Operating Expenses (or costs) - the outflow of

assets to support operating revenues Operating Income = Operating Revenues

Operating Expenses


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Defining Company Value

Most owners and nonowners formalize theirclaims on a company in the form of a contractor asecurity.

Equity securities are common for owners andbonds (notes) are common for nonowners.

These securities are traded in capital markets.

Value of Company =

Value of Nonowner Claims + Value of Owner Claims


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The Financial Statements

Balance Sheetassets, liabilities and equity at one point in time

Income Statementrevenues, expenses, and profit over aperiod of time

Statement of Equitychanges in contributed and earnedcapital

Statement of Cash Flowsnet cash inflows (outflows) formoperating, investing and financing activities


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Financial Statements


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Balance Sheet

A balance sheet reports on investing andfinancing activities.

It lists amounts for assets, liabilities, and equityas of a point in time.

The accounting equation (also called the balancesheet equation) is the basis of the balance sheet:

Assets = Liabilities + Equity


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Berkshire Hathaways Balance Sheet


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Income Statement

An income statement reports on operatingactivities.

It lists amounts for sales (and revenues) less all

expenses (and costs) over a period of time. Sales less expenses yield the bottom-line net

income amount.


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Berkshire Hathaways

Income Statement


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Statement of Equity

The statement of equity reports on changes inthe accounts that makeup equity

Contributed capital

Earned capital (retained earnings and accumulatedother comprehensive income)

This statement is useful in identifying and

analyzing reasons for changes in owners claimson a companys assets.


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Berkshire Hathaways

Statement of Stockholders Equity


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Statement of Cash Flows

The statement of cash flows reports on cash flows foroperating, investing, and financing activities over a periodof time.


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FinancialStatement

Linkages


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Information Beyond Financial

Statements

Management Discussion and Analysis

(MD&A)

Independent Auditor Report

Financial Statement Footnotes

Regulatory Filings and Proxy Statements


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Buffet on MD&A


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Economics of Accounting

Information: Demand & Supply

Demand for financial accounting informationextends to numerous users that include:

Managers and employees

Creditors and suppliers

Shareholders and directors

Customers

Regulators

Voters and their representatives


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Supply of Accounting Information

Determined by a companys estimates of the

benefits and costs of disclosure.

Regulation and bargaining power also play rolesin determining the supply of financialaccounting information.

The SEC requires financial statements, various

note disclosures, and other reports on a regularbasis.


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Supply of Accounting Information

Benefits of disclosure

lower capital cost from improved transparency

reputation effects enhance labor recruiting

Costs of disclosure

Information gathering costs

More information to competitors

Potential litigation costs

Potential political costs


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Market Efficiency


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Profitability Analysis

Return on Assets (ROA):

ROA = Net Income / Average Assets

For example, if we invest $100 in a savingsaccount yielding $3 at year-end, the return onassets is 3%.


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Disaggregating Return on Assets


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Profit Margin, Asset Turnover, and Return on

Assets for Selected Industries


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Competitive Analysis

Bargaining Power of BuyersBuyers with strong bargainingpower can exact price concessions and demand a higher level ofservice and delayed payment terms

Bargaining Power of SuppliersSuppliers with strong

bargaining power can demand a higher price for their goods andearly payments.

Threat of SubstitutionWhen the number of productsubstitutes increases, sellers lose their ability to raise pricesand/or pass on cost increases to buyers

Threat of EntryNew entrants to a market increasecompetition. To mitigate that threat, companies expend moneyto erect barriers to entry. These include R&D, advertising,management hires with special expertise, and mergers to createeconomies of scale.


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Five Forces of Competitive Intensity


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Business Context for Financial

Statements


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Accounting Principles and

Governance Structures

Information in financial statements enablescompany valuation and, by extension, thevaluation of its debt and equity securities.

The importance of financial statements meansthat their accuracy is of paramount importance .

To the extent that financial performance and

condition are accurately communicated tobusiness decision makers, debt and equitysecurities will be more accurately priced.


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Oversight of Financial Accounting

Oversight of Financial Accounting

SEC oversees all publicly traded companies

EDGAR database (www.sec.gov)

Financial Accounting Standards Board (FASB) Generally Accepted Accounting Principles (GAAP)

Board of Directors

Audit Committee

Courts


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Audit Report

Financial statementspresent fairlyand in all material respectscompany financial condition.

Financial statements are prepared in conformity with GAAP

Financial statements are managements responsibility. Auditor

responsibility is to express an opinion on those statements Auditing involves a sampling of transactions, not investigation

of each transaction

Audit opinion provides reasonable assurancethat the statements

are free ofmaterialmisstatements Auditors review accounting policies used by management and

estimates used in preparing the statements


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Sarbanes-Oxley Act

The SEC requires the CEO and CFO of a company topersonally sign a statement attesting to the accuracy andcompleteness of the companys financial statements.

The statements signed by both the CEO and CFO contain thefollowing commitments: The CEO and CFO have personally reviewed the annual report There are no untrue statements of a material fact or failure to state a

material fact necessary to make the statements not misleading The financial statements fairly present in all material respects the financial

condition of the company All material facts are disclosed to the companys auditors and Board of

Directors No changes to the companys system of internal controls are made unless

properly communicated


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Financial Accounting:

not an exact science

GAAP allows companies choices in preparingfinancial statements (inventories, property, andequipment).

Companies must choose among the alternativesthat are acceptable under GAAP.

Financial statements also depend on countless

estimates.


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Financial Accounting in Context

A companys financial statements only tell part

of the story.

You must continually keep in mind the world inwhich the company operates.

Financial statement analysis must be conductedwithin the framework of a thorough

understanding of the broader forces whichimpact company performance.


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itroductio to accounting for mba

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