Financial Accounting II

BUSI 721: Data-Driven Finance I

Kerry Back, Rice University

A Simplified Balance Sheet

Invested Capital

• The balance sheet balances: LTA + STOA + OSTA = LTL + STOL + OSTL + SE
• Therefore, LTA + STOA - STOL = SE + LTL + OSTL - OSTA
• Both sides are invested capital
  • Left-hand side is, roughly, Net PP&E plus NWC
  • Right-hand side is, roughly, Shareholders Equity + Net Debt
• Shareholders equity is capital contributed by shareholders plus the sum over all past years of net income minus dividends paid (retained earnings)

An Income Statement Example

Item	With interest	Without interest
EBIT	300	300
Less interest	(100)	0
Pre-tax income	200	300
Less taxes @ 30%	(60)	90
Net income	140	210

• What is the 70 difference? It is interest net of the tax deduction (70% of 100), i.e., the after-tax interest.
• So, to go from "with interest" to "without interest," we add the after-tax interest expense.

Return on Capital Employed

• On Monday,

$$ \frac{\text{EBIAT}}{\text{Net PPE} + \text{NWC}}$$

• An equivalent definition:

$$ \frac{\text{Net Income} + \text{After-tax Interest}}{\text{Shareholders Equity} + \text{Net Debt}}$$

Accounting for Acquisitions

• Suppose you buy a company for 100 mllion cash
• The company had assets of 150 million and liabilities of 70 million
• So, it had shareholders equity of 80 million
• The assets and liabilities (not shareholders equity) go directly on your balance sheet as they were on the target company's balance sheet.
• You are net adding assets of 50 million (assets of 150 but drawing down cash of 100).
• You are net adding liabilities of 70 million.
• How does the balance sheet balance? You add another asset of 20 million called "goodwill."

Accounting for Subs and JVs

Suppose two companies jointly own a third company. Suppose ABC has two-thirds ownership.

• Because ABC has a controlling interest, all of the assets and liabilities of the joint venture are shown on ABC's balance sheet, just as if they were directly ABC's assets and liabilities.
• To reflect XYZ's part ownership, ABC shows a liability: "equity of noncontrolling interests." Also "income to noncontrolling interests" on income statement.
• XYZ's balance sheet reflects its part ownership by showing an asset: "investments and advances to equity affiliates." Also, in the income statement: "income from equity affiliates."

Timing of Balance Sheets and Income Statements

• Balance sheet is at a point in time (end of fiscal year)
• Income statement describes things that happened during the fiscal year
• Compare income statement to beginning-of-year balance sheet?
• Or compare to end-of-year balance sheet?
• Usually average balance sheet items. Examples:
  • ROCE = net income + after-tax interest / average invested capital
  • asset turnover = sales / average assets
  • etc.

Basic Rules of Accrual Accounting

1. In income statement as $+$ but not cash inflow $\Rightarrow$ asset (like receivables)
2. Not in income statement as $-$ but cash outflow $\Rightarrow$ asset (like PP&E)
3. In income statement as $-$ but not cash outflow $\Rightarrow$ liability (like payables)
4. Not in income statement as $+$ but cash inflow $\Rightarrow$ liability (like provision for warranties)

• Rules 1 & 2: Income statement overstates cash $\Rightarrow$ asset
• Rules 3 & 4: Income statement understates cash $\Rightarrow$ liability
• These are why subtracting $\Delta$ (assets-liabilities) from income produces cash.

Profitability Ratios

• Gross profit margin = (revenue - COGS) / revenue
• Net profit margin = net income / revenue
• Return on equity = net income / shareholders equity
• Return on assets = net income / total assets
• ROCE (also called ROIC = return on invested capital)

Efficiency Ratios

• Asset turnover = revenue / assets
• Inventory turnover = COGS / inventory

Liquidity/Solvency Ratios

• Leverage ratio = assets / debt
• Debt to equity = debt / shareholders equity
• Current ratio = current assets / current liabilities
• Quick ratio = (current assets - inventory) / current liabilities

DuPont Analysis

$$\text{ROE} = \text{Net Profit Margin} \times \text{Asset Turnover} \times \text{Equity Multiplier}$$$$\frac{\text{Net Income}}{\text{Equity}} = \frac{\text{Net Income}}{\text{Sales}} \times \frac{\text{Sales}}{\text{Assets}} \times \frac{\text{Assets}}{\text{Equity}}$$

Getting financial Statements with yfinance

# !pip install --upgrade yfinance
import yfinance as yf

ticker = yf.Ticker('COP')
income_statement = ticker.financials
balance_sheet = ticker.balance_sheet
cash_flows = ticker.cashflow

for item in income_statement.index:
    print(item)

Tax Effect Of Unusual Items
Tax Rate For Calcs
Normalized EBITDA
Total Unusual Items
Total Unusual Items Excluding Goodwill
Net Income From Continuing Operation Net Minority Interest
Reconciled Depreciation
Reconciled Cost Of Revenue
EBITDA
EBIT
Net Interest Income
Interest Expense
Interest Income
Normalized Income
Net Income From Continuing And Discontinued Operation
Total Expenses
Diluted Average Shares
Basic Average Shares
Diluted EPS
Basic EPS
Diluted NI Availto Com Stockholders
Net Income Common Stockholders
Otherunder Preferred Stock Dividend
Net Income
Minority Interests
Net Income Including Noncontrolling Interests
Net Income Continuous Operations
Tax Provision
Pretax Income
Other Income Expense
Other Non Operating Income Expenses
Special Income Charges
Gain On Sale Of Ppe
Write Off
Impairment Of Capital Assets
Earnings From Equity Interest
Gain On Sale Of Security
Net Non Operating Interest Income Expense
Interest Expense Non Operating
Interest Income Non Operating
Operating Income
Operating Expense
Other Operating Expenses
Other Taxes
Selling General And Administration
Gross Profit
Cost Of Revenue
Total Revenue
Operating Revenue

for item in income_statement.columns:
    print(item)

2022-12-31 00:00:00
2021-12-31 00:00:00
2020-12-31 00:00:00
2019-12-31 00:00:00

for item in balance_sheet.index:
    print(item)

Treasury Shares Number
Ordinary Shares Number
Share Issued
Net Debt
Total Debt
Tangible Book Value
Invested Capital
Working Capital
Net Tangible Assets
Common Stock Equity
Total Capitalization
Total Equity Gross Minority Interest
Minority Interest
Stockholders Equity
Gains Losses Not Affecting Retained Earnings
Other Equity Adjustments
Treasury Stock
Retained Earnings
Additional Paid In Capital
Capital Stock
Common Stock
Total Liabilities Net Minority Interest
Total Non Current Liabilities Net Minority Interest
Other Non Current Liabilities
Employee Benefits
Non Current Deferred Liabilities
Non Current Deferred Taxes Liabilities
Long Term Debt And Capital Lease Obligation
Long Term Debt
Long Term Provisions
Current Liabilities
Current Debt And Capital Lease Obligation
Current Debt
Pensionand Other Post Retirement Benefit Plans Current
Payables And Accrued Expenses
Current Accrued Expenses
Payables
Total Tax Payable
Accounts Payable
Total Assets
Total Non Current Assets
Other Non Current Assets
Non Current Note Receivables
Non Current Accounts Receivable
Investments And Advances
Other Investments
Investmentin Financial Assets
Held To Maturity Securities
Long Term Equity Investment
Net PPE
Accumulated Depreciation
Gross PPE
Other Properties
Current Assets
Other Current Assets
Prepaid Assets
Inventory
Finished Goods
Raw Materials
Receivables
Accounts Receivable
Allowance For Doubtful Accounts Receivable
Gross Accounts Receivable
Cash Cash Equivalents And Short Term Investments
Other Short Term Investments
Cash And Cash Equivalents
Cash Equivalents
Cash Financial

for item in balance_sheet.columns:
    print(item)

2022-12-31 00:00:00
2021-12-31 00:00:00
2020-12-31 00:00:00
2019-12-31 00:00:00