Q Whats the difference between an accountant and a lawyer A Accountants know theyre boring Bill H dropped out of law school to start a farm He owns ten cows land a barn and has 100 Bill sells milk for 5 and cheese for 10 It costs him 3 to make milk and 6 to make cheese ID: 782088
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Slide1
Business 101: Breaking Business Down to Brass Tacks
Q: What's the difference between an accountant and a lawyer?
A: Accountants know they're boring.
Slide2Bill H. dropped out of law school to start a farm. He owns ten cows, land, a barn, and has $100.
Slide3Bill sells milk for $5 and cheese for $10. It costs him $3 to make milk, and $6 to make cheese.
Costs $3, sells for $5 Costs $6, sells for $10
Slide4Each year, Bill has income (a.k.a. sales, revenue) and expenses (costs & bills).
Income:
He sells 120 each of milk and cheese
(120 x $5 = $600 milk) + (120 x $10 = $1200 cheese) = $1,800 per year (“revenue”)
Sometimes he gets paid in cash, sometimes he adds it to his customer’s tab (“accounts receivable”)
Expenses:
He pays $1,080 for supplies (cow food? cheesecloth?)(120 x $3 = $360 milk) + ($120 x $6 = $720 cheese) = $1,080Sometimes he pays cash, sometimes suppliers add it to his tab (“accounts payable”)
Represents Bill’s Costs of his Goods (milk & cheese) Sold (“COGS”)He pays $360 for electricity & utilities in cashRepresents operating expenses (“Opex
”)
Slide5Income Statement (a.k.a. Profit & Loss Statement, a.k.a. “P&L”)
Income Statement
Fiscal Year Ending 20X1
Revenues
Sales
$1,800
Expenses
Cost
of Goods Sold ($1,080)
Operating Expenses ($360)
Operating Income
$360
Other Income & Expenses
Interest
Expense
($9
)
Net
Income
$351
Slide6Financing
Bill wants to buy another cow.
Each cow costs $300.
Bill has two options to get some more cash: Borrow from a bank: get cash in exchange for Bill promising to pay them back in the future, with interest
Taking on debt (a “liability”)Or, find some investors: get cash in exchange for partial ownership of the farmBill will still run the farm This should sound familiar! There are arguments for and against both of these options.
Slide7Debt
LOANS
The bank offers Bill a $100 loan, due in five years, with a 5% annual interest rate.
So, Bill gets $100 in cash now, and in five years, he will pay the bank $100 back. In the meantime, he will pay the bank $5 each year in interest.
BONDS
Bill sells his friend Camille 10 bonds at $5 each ($50 total), due in 10 years, with 8% annual interest.
So, Bill gets $50 in cash now, and in ten years, he will pay Camille $50 back. In the meantime, he will pay her $4 each year in interest.
In olden times, bonds were paper and had coupons that the owners would bring in to get interest payments in cash. So, sometimes the interest rate for a bond is called the “coupon rate.”
Slide8Income Statement (a.k.a. Profit & Loss Statement, a.k.a. “P&L”)
Income Statement
Fiscal Year Ending 20X1
Revenues
Sales
$1,800
Expenses
Cost
of Goods Sold ($1,080)
Operating Expenses ($360)
Operating Income
$360
Other Income & Expenses
Interest
Expense
($9)
Net
Income
$351
Slide9Equity: Stock
Bill’s friend Joanna invests $150, and in exchange Bill gives Joanna a 5% ownership stake in the farm.
This means the farm is worth $3,000 total
Which sounds right, because the cows are worth $3,000, and he makes $360/year
Because Joanna is a shareholder in Bill’s farm, Bill’s decisions about the farm are on her behalf, too, even though he’s running everything
Bill owes Joanna a duty to act in the farm’s best interest, which is also Joanna’s best interest.
Slide10Balance Sheet:Assets = Liabilities & Equity
Assets
Liabilities & Equity
Cash $251
Liabilities
Accounts
Receivable $50
Accounts Payable $150
Inventory $300Debt $100
Property, Plant, & Equipment (PP&E) $6,000Stock $50
Land $2,000
EquityFarm $1,000
Common Stock Issued $150Cows $3,000
Owners Interest $11,800
Retained Earnings $351
Total Assets: $12,601
Total Liabilities & Equity: $12,601
Slide11Statement
of Cash Flows
Fiscal Year Ending 20X1
Cash
Flows from Operations
Net Income
$351
Changes in Accounts Receivable
($50)
Changes in Inventory
($300)
Changes in Accounts Payable
$150
Net Cash Flows from Operations
$151
Cash
Flows from Investing
Purchase of PP&E (Cows)
($300)
Net Cash Flows from Investing
($300)
Cash
Flows from Financing
Issuance
of Stock
$150
Issuance of Bonds
$50
Bank
Loan
$100
Net Cash Flows from Operations
$300
Beginning Cash
$100
Change in Cash
$151
Ending Cash
$251
Statement
of Cash Flows
(“SOCF”)
*Sort of Crying Feeling
Slide12Reporting
Bill could offer to sell small pieces of ownership of the farm to investors on a public exchange
Ex: NASDAQ, New York Stock Exchange (“NYSE”)
The first time Bill does this is called an Initial Public Offering, an “IPO”
To do that, Bill needs audited financial statements
Bill needs to work with attorneys to make sure he dots his i’s and crosses his t’s (“due diligence”)
The Sarbanes-Oxley
Act (SOX) requires
public companies to file annual audited financial statements (a 10-K) and quarterly financial statements (10-Qs) with the Securities and Exchange Commission (“SEC”)
Usher!
Slide13Special Projects
Mergers
A deal to unite two
companies into one company.
AcquisitionA company buys an asset or some or all of another company Joint Ventures (“JV”)Commercial enterprise undertaken by two or more parties that otherwise retain their distinct identities
*Full disclosure: “Hathaway” was a mill and didn’t make stomach bitters but they had no cool pictures
Slide14A Glossary of Random Terms
Liquidity = how easily you can convert an asset cash
Very liquid = cash, 3 month CDs
Not at all liquid = paintings worth $50 million
In the middle = stocks & bonds
Capital, capitalized, etc. Something becomes an assetGAAP/IFRS
Generally Accepted Accounting Principles International Financial Reporting StandardsInvoice
A bill for goods or servicesInternal ControlsWays to ensure your company complies with laws, regulations, internal & external policies
GoodwillOverpaying for a company because you think it’s just got something extra specialWrite-offs/Bad Debt
An expense in the year you realize you won’t get paid back money you're owedAccrual
Accounting for the lag in time between when you’re legally entitled to an asset or liability versus when you actually get paid or pay the vendor Fixed expenses vs. variable expenses Rent = fixed expense = same each month
Electric = higher bill when you use more = varies each monthResearch & Development (“R&D”)
Slide15A Glossary of Random Terms (continued)
Budget-to-Actual
How much your estimates were off
The “delta” is the change -> a big delta is a bad delta
Dodd-Frank Act = post-Recession regulation of investments
Securitize/ securitized assets Groups of future payments, sold as a bundle and made “liquid”
See “The Big Short”Off-balance sheetEnronBig 4 Accounting
HedgesOffsetting investment risksDiversify
Shorting Ratios/MetricsNet income
Gross profitEBIT = Earnings Before Interest & TaxesEBITDA = Earnings Before Interest, Taxes, Depreciation, & Amortization
ROA = Return on AssetsDebt/Equity a.k.a. “Leverage”
Securities = tradeable financial asset Short-term (within 1 year) vs. long-term (over 1 year)Ex: Short term debt