1. Financial Accounting Lesson 1: The Basics
Ben Trnka / Boz Bostrom

2. Example
A friend has his own business selling t-shirts to college students. On the surface, his business seems quite profitable, as he can buy the shirts for $5 apiece and then sell them for $15 apiece. What other costs may he have?
Storage, advertising, inventory, shipping, taxes
To help offset these additional costs, he has asked if you wish to invest in his business. What types of questions may you ask?
Prior and expected sales (cash inflows) and expenses (cash outflows)

3. Example
If your friend provides you with a printout showing his sales and expenses for last year, what additional questions may you have?
More prior years
Year to date information
Future expectations
Proof that what he is showing you is real
What else might you want to know?
How risky is this investment vs. what sort of returns can I expect?
What would be the return on other investments of my cash?

4. Overview
1. Understand what is meant by the term financial accounting 2. Understand the four types of financial statements 3. Understand how and why financial statements are prepared 4. Understand the concept of corporate governance

5. What is meant by “financial accounting”?
A set of established rules to prepare financial statements for external users
Accounting
Language of business
Measures results of business / communicates results to users
Established rules
GAAP – Generally Accepted Accounting Principles
Financial Statements
Reports summarizing the financial information of a business
External Users
Shareholders and Creditors

6. Shareholders and Creditors
Provide resources (usually cash) to the business in exchange for ownership
Can be individuals or groups
Two expectations:
Dividends
Appreciation of investment
Creditors
Provide resources (usually cash) to the business in exchange for promise of repayment
Most common are banks, bondholders
Two expectations:
Repayment of principal
Interest

7. Balance Sheet
Measures financial condition of a company at a point in time
Key equation:
Assets = Liabilities + Stockholder’s Equity

8. Income Statement Measures revenues and expenses over a period of time
Key equation
Revenues - expenses = net income

9. Statement of Stockholders’ Equity
Measures changes in equity over a period of time
Key components are common stock and retained earnings
Key equation
Beginning stockholders’ equity + increases (less decreases) = ending stockholders equity
Common increases – Profits, stock issuances
Common decreases – Losses, dividend payments, and share repurchases

10. Statement of Cash Flows
Summarizes cash flows going in and out of a business over a period of time
Key equation
Cash at the beginning of the year
+ Cash flows from operating, investing, and financing activities
= Cash at the end of the year

11. Preparation of Financial Statements
Most businesses are “private” and are not required to prepare financial statements
Once a business becomes “publicly traded” it is required to prepare financial statements
To be publicly traded means that a business has gone through a process to allow its shares to be freely traded (bought and sold) by investors
Other non-public businesses may issue financial statements if required by banks or for various other purposes

12. Regulations behind financial statements
Over four days in October, 1929, the stock market “crashed” and lost 25% of its value.
Triggered the Great Depression and destroyed investor confidence in public companies
Congress passed the Securities and Exchange Acts of 1933 and 1934, which created the Securities and Exchange Commission (SEC)

13. SEC FASB GAAP SEC, FASB, and GAAP
The SEC regulates publicly traded companies
The SEC delegated authority to the FASB (Financial Accounting Standards Board)
The FASB created GAAP (Generally Accepted Accounting Principles)
Financial Accounting is the method of accounting following GAAP

14. SEC Reports Two of the common reports required by the SEC 10-K 10-Q
An annual report. Prepared days after the end of each year
10-Q
A quarterly report. Prepared days after the end of each quarter
Both reports include financial statements and additional information about the business

15. Corporate governance
Big Question – How do stockholders make any decisions for the company?
The stockholders of a corporation elect the Board of Directors
The Directors make key decisions, such as appointing key executives, the top of which are the Chief Executive Officer (CEO) and the Chief Financial Officer (CFO)
The CEO and CFO appoint other executives and managers
The CEO and CFO are ultimately responsible for the financial statements

16. Home Depot Leaders

17. Corporate governance
The Board of Directors has a subcommittee called the Audit Committee
This committee appoints an independent CPA firm to audit the company’s financial statements for accuracy
A CPA firm is a group of individuals who have earned Certified Public Accountants (CPA) certificates
CPA’s often work together in accounting (CPA) firms
The biggest 4 CPA firms in the world are Deloitte, EY, KPMG, and PWC
Home Depot is audited by KPMG
The government has created the PCAOB (Public Company Accounting Oversight Board) to oversee the audit of public companies

18. Impact of financial statements
The value of a publicly traded company is set by supply and demand
How much do investors believe the company is worth?
Obviously very speculative so it is constantly changing
As of July 2018, Home Depot has about 1.15 billion shares of stock worth about $202 each, making the total value of Home Depot about $230 billion
As of July 2018, Apple has about 4.9 billion shares of stock worth about $190 each, making the total value of Apple about $930 billion

19. Impact of financial statements
Shareholders often don’t know how a company is performing on a day-to-day basis
Companies usually publish financial statements through a press release prior to issuing a 10-Q or 10-K
Shareholders will react
Higher than expected net earnings will often increase a company’s share price
Lower than expected net earnings will often decrease a company’s share price
On May 15, 2018, Home Depot “released earnings.” Earnings were better than expected, but sales were lower than expected. Its share price decreased slightly
On July 25, 2018, Facebook “released earnings.” Share price declined by nearly 20%. Mark Zuckerberg’s net worth instantly declined by over $15 billion!

20. Key Takeaways Thanks for tuning in!
Financial accounting – a method of accounting for a business’ results using GAAP
4 financial statements
Results of financial statements will impact stock prices
Governed by SEC and FASB, using GAAP
Thanks for tuning in!