Balance Sheet Analysis

1. Balance Sheet Analysis

2. Agenda Recap of the Income Statement What is the Balance Sheet Assets Liabilities Equity Putting it all together Case Study

3. What is an Income Statement • The income statement summarizes the inflows and outflows of money (not necessarily cash) over an accounting period • Inflows = Revenues • Outflows = Expenses Inflow Outflow Outflows

4. Accrual Accounting Example Month 1: You cater an event where the cost to you was $100. The customer pays you $200 for your services. Month 2: You cater an event where the cost to you is $100. The customer agrees to pay you $200 next month

5. Income Statement Line Items • Start with the revenues and filter down through each expense to the bottom line (net income/earnings) • Revenue • - Cost of Goods Sold (COGS) • - Operating Expenses • Research and Development • Selling, General, & Administrative (SG&A) • Depreciation & Amortization • - Other • Non-Recurring • Interest • - Taxes • = Net Income

6. Balance Sheet What is it? • Snapshot of a company’s financial condition at a specific point in time • Called a balance sheet because it balances • Everything a company has (assets) is either owed to someone else (Liabilities) or belongs to the firm’s owners (Equity)

7. Assets The stuff that a company has • Assets Definition: resources that bring future economic benefit – either the prospect of future cash inflows or the prevention of future cash outflows

8. Assets The stuff that a company has • Assets vary in liquidity • Liquidity – how quickly an asset can be converted to cash Most Liquid • Cash and Cash Equivalents • Accounts Receivable • Inventory & Surplus • Short-term investments • Long-term investments • Property, Plant, and Equipment • Intangibles (including goodwill) • Land Current Assets Long-Term Assets Least Liquid

9. Liabilities • How does a company get these assets? • They can borrow money to buy assets • Liabilities

10. Liabilities Types of Liabilities • Accounts Payable • Deferred Revenue • Interest Payable • Short-term Debt • Current Long-term Debt • Long-term Debt • Pension Obligations Current Liabilities Long-Term Liabilities

11. Equity • What is Equity • The difference between a companies Assets and Liabilities • The “book value” of a company • Two Different Types of Equity • Owner’s Equity – If the company is a sole proprietorship • Stockholder’s Equity – If a company is a corporation • Includes: • Retained Earnings • Additional Paid-In Capital • Common Stock • Preferred Stock

12. Putting it all together Assets = Liabilities + Equity • BCI & Company buys a factory for $1 Billion, using some of its own cash and $400 Million of money it borrowed from the bank • What happens to the balance sheet? • $600M cash decrease • $1000M PP&E increase • TOTAL: Assets up $400M Liabilities Assets • $400M borrowed • TOTAL: Liabilities up $400M

13. Putting it all together Assets = Liabilities + Equity • BCI & Company delivers its service for $8000. The customer paid only $1000, promising to pay the remaining in monthly installments • What happens to the balance sheet? • $1000 cash increase • $7000 accounts receivable increase • TOTAL: Assets up $8000 Equity Assets • $8000 increase in retained earnings • TOTAL: Equity up $8000

14. The Balance Sheet Case Introduction • Does the balance sheet capture the real value of a company? • Not really • Cost Principle: Companies report assets at their historical cost • Monetary Unit Assumption: Assumes the dollar is stable over time • This creates problems • Is a piece of land worth $20,000 in 1950 worth only that amount today? • What is the purchasing power of $20,000 today anyway?

15. The Balance Sheet Case Study

16. The Balance Sheet Case Study • An asset’s book value can be higher or lower than its true value • Some assets are essentially fictional

17. The Balance Sheet Microsoft Case Study • What happened in Q4 2012?

18. The Balance Sheet Microsoft Case Study • aQuantive was the 14th largest advertising firm agency worldwide in 2005 • In 2007, MSFT spent $6.3B to acquire aQuantive • It paid an 85% premium over the then-current stock price “Joining the capabilities of [MSFT and aQuantive] is an important step toward our goal of becoming an industry leading, Internet-wide advertising platform.” - Kevin Johnson, Platforms and Services Division President, Microsoft

19. The Balance Sheet Microsoft Case Study • When you pay a premium for a company, the premium is recorded as “Goodwill” on a balance sheet • Example • If BCI & Co. pays $10 for “Common Cents Investment Group” with a book value of $5, what happens to BCI & Co.’s balance sheet? • Assets • Cash will decrease $10 • Common Cents’ assets of $5 will be added • Goodwill will increase $5 to balance out the transaction

20. The Balance Sheet Microsoft Case Study

21. The Balance Sheet Microsoft Case Study • Who here uses Google? • Who here uses Yahoo? • Does anyone use… Bing? • aQuantive was been never made a penny for Microsoft • In 2012, Microsoft was forced to admit that their $6B of goodwill was worth almost nothing • In other words, Microsoft “wrote down” the worthless goodwill

22. The Balance Sheet Microsoft Case Study