Culverhouse Investment Management Group New Member Orientation – Fall 2014 Day 2 – Financial Statements and Time Value of Money

FINANCE VOCAB 2

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 3

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.

FINANCIAL STATEMENTS 5

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 6

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 7

How They Connect 8 Revenue Net Income Δ cash Cash Assets = Liabilities Equity Income Statement Statement of Cash Flows Balance Sheet

INCOME STATEMENT MAIN PURPOSE – Profit and loss (P&L) – How revenue is transformed to net income – Represents a period of time January 1 st -March 31 st

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

BALANCE SHEET 12

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 13

Questions? 14

TIME VALUE OF MONEY 15

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

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 17

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 18

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 19

Calculations 20

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? 21

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? 22

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 23

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 after thathttp:// Please address any feedback to Matt Lambert at 24

Questions? 25

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) 26