cf an der Universität zu Köln

Balance Sheet

- snapshot of a firm’s assets, liabilities, and equity at a given point in time

Income Statement

- summary of the financial performance during the reporting period

- based on “matching principle”

Cash Flow Statement

- summary of cash inflow & outflow during the reporting period

- famous quote: “Cash is a fact, profit is an opinion.”

Owners

- evaluate the management of “their” company based on financial statements

- reduction of information asymmetries (principals vs. agents)

- assess the profitability of their investment

Employees and managers

- job security

- often remunerated based on a firm’s financial performance (e.g., bonus payments)

Customers

- interested in valid warranties over economic lifetime of purchased goods

Prospective investors

- derive information for input parameters in valuation models

- assess the profitability of potential investment

Financial institutions

- use financial statements to assess the creditworthiness of a company

- link loan conditions to development of financial ratios (“covenants”)

Regulatory institutions

- use financial statements to review a firm’s regulatory compliance (e.g., with respect to capital requirements)

- Current Assets + Fixed Assets = Current Liabilities + Long-term Liabilities + Shareholders’ Equity

Current Assets are expected to be consumed (e.g., raw materials) or to be converted into cash (e.g., accounts receivable) within one year

- Fixed Assets have an (expected) lifetime of more than one year and are acquired for use in operation (not for resale) (e.g., production machinery)

Current Liabilities are obligations due within one year (e.g., bank overdrafts, accounts payable, notes payable)

- Long-term Liabilities are obligations not due within one year (e.g., pension provisions, bank loans)

Operating Expenses can be either reported by nature (e.g., raw materials, salaries, depreciation & amortization) or by function (e.g., cost of goods sold (COGS), selling, general & administrative expenses (SG&A), research & development (R&D))

- both formats lead to the same Operating Income (EBIT) and therefore also to the same Net Income

- Common shares: shares with voting right and residual claim on profits/assets; dividends can be paid to common shareholders

- Preferred shares: shares (usually) without voting right, but preferred claim on profits/assets (but still subordinate to creditors and bondholders); dividends are typically guaranteed

- Note: within the course Corporate Finance, we generally assume that companies only issue common shares (thus, we use the terms common stock and paid-in capital interchangeably)

- Shares that a company repurchased from its shareholders (“buyback”)

- Motivation: reward investors (alternative to cash dividend), reduce (excess) cash, defensive strategy in hostile takeover, improve financial ratios (e.g., EPS)

- Accounting: decrease in cash, decrease in equity (“negative” equity account “Treasury shares”)

- Company can decide to retire shares or to resell shares to investors

- Basic EPS = Net Income / number of common shares outstanding

- Diluted EPS = Net Income / number of common shares outstanding including potential additional shares from convertible securities or stock options

- Note: if a company also issued preferred shares, preferred dividends paid are excluded from the Net Income

- Continued operations: business segments which are operated in the foreseeable future

- Discontinued operations: business segments which are shut down or sold (should be excluded for long-term financial planning and valuation purposes)

- Non-recurring items: gains/losses related to a one-time (unpredictable) event; not related to ordinary operations (e.g., litigation charges, natural catastrophe); unlikely to happen again

- Extraordinary items: gains/losses related to an infrequent event; not related to ordinary operations (e.g., write-down of discontinued operations); similar gain/loss may happen again

provision of business information to interested recipients for financial analysis and valuation purposes