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 Investment  Club  
Analyst  Training  Program  

When  you  come  in    

•  Sign-­‐in   sheet   is   at   the   front   –   if   there’s   a   grey   box   somewhere   next   to   your   name,   make   sure   to  
 fill  in  the  info  that  I’m  missing  

•  Take  a  copy  of  Nike’s  1Q10  Balance  Sheet,  next  to  the  sign  in  sheet  

•  Find  a  seat,  and  login  

•  Username:  “training”  
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•  Password:  “perkins”  

0   Duke  Investment  Club  

  SESSION  2:  Fundamentals  of  Financial  AccounSng  

14  October  2009  

Duke  Investment  Club  

Analyst  Training  Program  
 Agenda  

•  DefiniSons  and  examples  of  assets,  liabiliSes,  and  shareholders’  equity  

•  IntroducSon  of  the  accounSng  equaSon  

•  Corporate  financial  statements:  balance  sheets  

•  ApplicaSon  to  fundamental  financial  analysis  

•  PracSce  examples  
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 Disclaimer  and  general  comments  
We’re  students,  just  like  you  

•  We  highly  encourage  you  to  challenge  what  we’re  saying  –  if  you  see  a  mistake,  tell  us,  even  if  
 it’s  in  front  of  the  whole  class.  This  is  pracSce  for  us,  too  

•  We   will   be   the   first   to   acknowledge   that   we’re   full   of   any   four   leYer   word   you’d   like   to  
  subsStute   in,   but   the   reason   we’ve   started   this   class   is   because   we   find   this   stuff   really  
 interesSng.  Hopefully,  you  do  too  

•  The   people   to   your   le\   and   right   may   one   day   run   the   government,   an   investment   bank,   a  
 consulSng  firm,  or  become  the  next  Warren  Buffet  (get  to  know  him  or  her)  

•  Addi(onal   disclaimer:   There’s   a   difference   in   learning   how   to   read   balance   sheets   from   a  
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 finance  viewpoint  versus  learning  the  same  skill  in  an  accounSng  class.  The  accounSng  version  
  is   harder   to   learn,   but   it   teaches   the   right   way   to   think   about   assets,   liabiliSes,   and   equity.   Take  
 Econ182  if  you  want  to  know  that  side  of  it.  This  lecture  is  about  a  bunch  of  shortcuts    

3   Duke  Investment  Club  

 The  balance  sheet  
Corporate  financial  statements,  part  I  

•  www.sec.gov  

•  “Search  for  Company  Filings”  

•  “Company  or  fund  name”  

•  Enter  company  name  or  stock  Scker  

•  Find  the  most  recent  10-­‐K  

•  Search  (ctrl  +  f)  for  “consolidated  balance  sheet”  and  scroll  through  unSl  you  find  the  balance  
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 sheet  

4   Duke  Investment  Club  

 The  balance  sheet  
Corporate  financial  statements,  part  I  

•  Summarizes  a  company’s  assets,  liabiliSes,  and  shareholder’s  equity  at  a  specific  point  in  Sme,  
 and  it’s  divided  up  into  three  secSons,  one  for  each  category  listed  above  

•  A   publically   traded   company   will   report   the   state   of   its   balance   sheet   at   the   close   of   every  
 quarter  to  the  SEC  

•  The  three  balance  sheet  segments  give  investors  an  idea  as  to  what  a  company  owns  and  owes,  
 as  well  as  the  amount  invested  by  shareholders    
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A s s e t s   =   L i a b i l i S e s   +   S h a r e h o l d e r s ’   E q u i t y  

5   Duke  Investment  Club  

 The  balance  sheet  
Assets  

•  Defini*on:  a  resource  that  a  company  owns  with  the  expectaSon  that  it  will  provide  a  future  
 benefit  

•  An   asset   is   a   resource   that   a   company   owns   with   the   expectaSon   that   it   will   provide   a  
future  benefit  

•  Tangible  (physical)  assets:  machinery,  buildings,  and  land  

•  Intangible  assets:  patents,  trademarks,  copyrights  

•  Assets  can  also  be  divided  into  two  categories  based  on  their  liquidity  
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•  Current   assets:   can   be   converted   into   cash   within   one   year   (cash,   accounts  
receivable,  inventory,  marketable  securiSes)  

•  Long-­‐term   assets:   assets   that   are   expected   to   be   usable   for   more   than   one   year  
and  are  less  liquid  (machinery,  property)  

•  Physical  assets  (PP&E)  versus  assets  as  a  measure  of  future  benefit  

6   Duke  Investment  Club  

 The  balance  sheet  
Assets  

Common  current  assets   Common  fixed  assets  

Cash  and  cash  equivalents  (CCE)   Plant,  property,  &  equpiment  (PP&E)  

Accounts  receivable  (A/R)   Accumulated  depreciaSon  (contra-­‐asset)  

Short-­‐term  investments   Goodwill  and  other  intangibles  

Inventories  
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Prepaid  expenses  

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Assets  
The  balance  sheet  

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Fixed  assets  
Current  assets  

Duke  Investment  Club  

 The  balance  sheet  
LiabiliSes  

•  Defini*on:  LiabiliSes  are  a  company’s  legal  debts  or  obligaSons  that  arise  through  the  course  of  
 business  

•  Vital  to  a  company’s  operaSons  because  they  are  used  to  finance  operaSons  and  pay  for  large  
 expansions  

•  LiabiliSes  include  loans,  accounts  payable,  mortgages,  and  accrued  expenses  

•  Like  assets,  there  are  both  current  and  long-­‐term  liabiliSes  

•  Current   Liability:   a   company’s   debt   or   obligaSons   that   are   due   within   one   year   (short  
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term  debt,  accounts  payable)  

•  Long-­‐Term   Liability:   debts   that   are   payable   over   a   longer   period   than   one   year   (bond  
issue  with  a  10  year  maturity)    

9   Duke  Investment  Club  

 The  balance  sheet  
LiabiliSes  

Common  current  liabiliSes   Common  long-­‐term  liabiliSes  

Accounts  payable  (A/P)   Long-­‐term  debt  

Accrued  liabiliSes   Deferred  income  taxes  

Current  maturiSes  of  long-­‐term  debt  (short-­‐
term  debt)  
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Commercial  paper  

10   Duke  Investment  Club  

 The  balance  sheet  
LiabiliSes  

Current  liabiliSes  
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Long-­‐term  liabiliSes  

11   Duke  Investment  Club  

 Net  working  capital  (NWC)  

•  Defini*on:  NWC  =  current  assets  –  current  liabiliSes  

•  NWC   is   a   very   important   factor   to   debt-­‐investors,   and   it   is   an   important   variable   used   in  

 projecSng  future  performance  in  financial  modeling  

•  PosiSve   net   working   capital   indicates   that   a   company   is   able   to   pay   off   its   short-­‐term   debts,  
 while  negaSve  net  working  capital  indicates  a  company  may  be  in  trouble  soon  

•  When  used  in  conjuncSon  with  some  of  the  financial  raSos  presented  at  the  end  of  this  
presentaSon,  NWC  can  give  even  inexperienced  investors  a  decent  grasp  on  the  effects  of  
debt  on  a  company’s  finances  
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•  A  declining  working  capital  raSo  over  Sme  could  be  a  red  flag  for  further  analysis    

•  Why  would  this  be  the  case?  

•  Also   gives   investors   an   idea   of   a   company’s   operaSonal   efficiency   (and   thus   managerial  
effecSveness)  

•  High   working   capital   may   imply   that   a   company   does   a   poor   job   at   collecSng   accounts  
receivable  

12   Duke  Investment  Club  

 The  balance  sheet  
Equity  

•  Defini*on:   shareholder’s   equity   represents   the   amount   by   which   a   company   is   financed  

 through  common  and  preferred  shares  

•  Comes  from  two  main  sources:  

•  The   first   and   original   source   is   the   money   that   was   originally   invested   in   the   company  
(IPO),  along  with  any  addiSonal  investments  made  therea\er  (new  share  offering)  

•  Second   comes   from   retained   earnings   which   the   company   is   able   to   accumulate   over  
Sme  through  its  operaSons  (this  porSon  is  typically  the  largest  component)  
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A s s e t s   =   L i a b i l i S e s   +   S h a r e h o l d e r ’ s   E q u i t y  
W h a t   a   c o m p a n y   h a s   =   w h a t   i t   o w e s   +   w h a t   i t   o w n s  

13   Duke  Investment  Club  

 The  balance  sheet  
Equity  

Common  components  of  equity   DefiniSon  

Common  stock  

Dividends  
Like  common  stock,  but  has  a  higher  claim  on  earnings  in  
Preferred  stock  
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exchange  for  fewer  voSng  rights  

Paid-­‐in  capital   The  par  value  of  shares  of  equity  (typically  $0.01/share)  

The  premium  that  investors  pay  for  shares  of  equity:  

AddiSonal  paid-­‐in  capital   APIC  =  (Issue  price  –  par  value)  x  shares  issued  

Retained  earnings   The  percentage  of  net  income  not  paid  out  as  dividends  

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Equity  
The  balance  sheet  

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Duke  Investment  Club  
 Retained  earnings  
Equity  

•  Retained  earnings  are  the  porSon  of  net  earnings  not  paid  out  as  dividends,  but  retained  by  the  
 company  

•  Can  be  reinvested  into  the  business  (buying  new  machinery,  R&D)  or  be  used  to  pay  down  debt  

Retained  Earnings  (RE)  =  Beginning  RE  +  Net  Income  –  Dividends  

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•  Thus,  a  dividend  is  the  porSon  of  a  company’s  earnings  that  is  distributed  to  shareholders  

•  High-­‐growth   companies   rarely   offer   dividends   because   all   of   their   profits   are   reinvested   to   help  
 sustain  above  average  growth  

16   Duke  Investment  Club  

 Financial  raSos  
RaSos  derived  from  balance  sheet  data,  p.  1  

RaSo   EquaSon   ExplanaSon  [alternaSve  names]  

current assets [Liquidity  ra(o]  The  CR  shows  a  company’s  ability  to  pay  
Current  raSo   Current = back   ST   debts;   gives   a   sense   of   the   ability   of   the  
current liabilities
company’s  ability  to  turn  its  product  into  profit  
[Acid-­‐test   ra(o]   Ability   to   repay   ST   debts   without   selling  
CCE + A /R + ST Investments inventory;   when   compared   with   the   working   capital,  
Quick  raSo   Quick =
€ current liabilities investors   can   get   a   sense   of   how   reliable   a   company’s  
assets  are  to  the  company’s  inventory  
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Total assets One   method   of   determing   how   much   leverage   a  

Leverage  raSo   Leverage = company  has  taken  on,  or  how  much  debt  must  be  used  
€ Stockholders' equity
to  finance  the  company’s  assets    

Total debt Another   type   of   leverage   raSo,   the   debt   raSo   can   be  
Debt  raSo   DR =
€ Total assets indicaSve  of  unserviceable  debt  loads  

17   Duke  Investment  Club  

 Financial  raSos  
RaSos  derived  from  balance  sheet  data,  p.  2  

RaSo   EquaSon   ExplanaSon  

Another  type  of  leverage  raSo,  the  D/E  raSo  allows  for  
the  calculaSon  of  the  raSos  of  debt  and  equity  used  to  
Debt-­‐to-­‐equity   Total liabilities finance   a   company,   a   very   important   factor   in  
D/E =
raSo   Total shareholders' equity investment   banking   and   invesSng.   Note   that   long-­‐term  
debt  is  someSmes  subsStuted  for  total  liabiliSes  in  the  
numerator  

LT  debt-­‐to-­‐total  
€ LT debt
D/E = Similar  to  above  
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capital  raSo   LT debt + total common stock + total pref stock

When   compared   to   the   market   value   of   equity   (i.e.,  

Price-­‐to-­‐book  
€
Pr ice /share what   the   stock   trades   for   on   the   market),   the   book  
P /B =
raSo   Book value /share value   can   indicate   if   a   stock   may   be   overvalued   or  
undervalued  

N.B.:  some  important  raSos,  such  as  return  on  equity  (ROE),  return  on  assets  (ROA),  inventory  turnover,  and  receivables  turnover  have  been  omiYed  
unSl  a  more  detailed  study  of  the  income  statement  is  presented  

18   Duke  Investment  Club  

 PracSce  
Analyzing  the  balance  sheet  from  Nike’s  1Q10  (FQE  5/31)  

•  Complete  handout  at  front  

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QuesSons,  comments,  &  criSques  

Duke  Investment  Club