“What I wish I knew about Accounting, when I was 20” & Case Method Overview

1. “What I wish I knew about Accounting, when I was 20” & Case Method Overview April 8, 2014 E140A Accounting Workshop

2. Why is accounting important? • Insight into a company’s financial health • Current and potential investors rely on financial statements to make decisions • Common base metrics for comparison • Compare to companies across industries • Compare financial ratios to determine liquidity, profitability, growth metrics • Helps executives plan ahead (cash burn rate) and build a narrative around numbers. E140A Accounting Workshop

3. Key Accounting Concepts • Financial vs. Managerial Accounting • Financial Accounting focuses on external reporting • Managerial Accounting internal operations & budgeting • For Profit, Not for Profit, Governmental Accounting • Generally Accepted Accounting Principles (GAAP) • Accrual vs. Cash Basis • The timing of when revenue and expenses are reported. • Cash Basis: small companies and personal finances • Accrual Basis: large companies E140A Accounting Workshop

4. Basic Financial Statements Income statement Cash flow statement Balance sheet E140A Accounting Workshop

5. Balance Sheet: Basic Principles How the ownership of assets was financed (by third parties or by the owners) What the company owns (used to generate income) Assets = Liabilities + Equity E140A Accounting Workshop

6. Assets are economic resources • An asset has the ability to provide future benefits to the company • Liabilities are creditors’ claims on the assets of a firm. The claims result from benefits the firm has previously received from the creditors • Shareholders’ equity is the owners’ claim • Contributed capital (paid-in capital): the amount invested • Retained earnings: increase in equity due to operations Balance Sheet Balance Sheet of XYZ Corp. - 31 December of 2008 (in thousand $) Accounts Payable Salaries Payable Accrued Expenses Income Taxes Payable Short Term debt Cash Accounts Receivable Inventories Current Liabilities (payable in less than a year) Long-Term Liabilities(bonds issued, bank loans) Shareholders’ Equity Current Assets (liquid in less than a year) Fixed Assets Other Assets Property, plant and equipment(less depreciation) Intangibles(less depreciation) Investment Securities Common Stock Additional Paid-in Capital Retained Earnings Total Assets = Total Liabilities + Shareholders’ Equity A snapshot of the investing and financing activities of a firm E140A Accounting Workshop

7. What is Stanford’s biggest Asset? • Investments • Works of Art • Student Loans • Plant & Buildings • The Students E140A Accounting Workshop

8. Wal-Mart HP Google Balance Sheets Comparison ($B) ($B) ($B) 6.6 5.9 40.7 - 1.8 55.0 112.3 20.7 5.5 193.4 55.9 6.3 - 62.3 47.1 12.3 121.7 71.3 193.4 8.0 21.4 7.5 - 14.1 51.0 12.3 55.5 10.8 129.5 34.3 8.1 8.1 50.4 22.6 17.5 90.9 38.6 129.5 10.0 6.4 - 34.6 1.7 52.8 9.6 8.9 0.8 72.6 7.1 1.2 0.5 8.9 3.0 2.6 14.4 58.1 72.6 Assets Cash . . . . . . . . . . . . . . . . . . . . . . . . . . Accounts Receivable . . . . . . . . . . . . . . Inventories . . . . . . . . . . . . . . . . . . . . . . Short Term Investments . . . . . . . . . . . Other Current Assets . . . . . . . . . . . . . . Total Current Assets: . . . . . . . . . . . . . . . . . . Property, Plant and Equipment . . . . . . Intangible Assets . . . . . . . . . . . . . . . . . Other Long Term Assets . . . . . . . . . . . Total Assets: . . . . . . . . . . . . . . . . . . . . . . . . Liabilities and Shareholders’ Equity Accounts Payable . . . . . . . . . . . . . . . . . Notes Payable . . . . . . . . . . . . . . . . . . . Other Current Liabilities . . . . . . . . . . . . . Total Current Liabilities . . . . . . . . . . . . . . . . Long Term Debt . . . . . . . . . . . . . . . . . . . Other Noncurrent Liabilities . . . . . . . . . . Total Liabilities . . . . . . . . . . . . . . . . . . . . . . . Shareholders’ Equity . . . . . . . . . . . . . . . . . . Total Liabilities and Shareholders’ Equity . . E140A Accounting Workshop

9. Evolution of a Balance Sheet • Liabilities and Equity • Contributed Capital …… $10,000 • Total…………………… $10,000 • Assets • Cash……………………… $10,000 • Total…………………… $10,000 $10,000 $10,000 Ann’s Mini Mart September 1, 2013 E140A Accounting Workshop

10. Evolution of a Balance Sheet • Liabilities and Equity • Note Payable ……...………$ 5,000 • Paid-in Capital…..……… $10,000 • Total…………………… $15,000 • Assets • Cash………………………$15,000 • Total…………………… $15,000 $5,000 $5,000 Ann’s Mini Mart September 2, 2013 E140A Accounting Workshop

11. Evolution of a Balance Sheet • Liabilities and Equity • Note Payable ……...………$5,000 • Paid-in Capital…..……… $10,000 • Total…………………… $15,000 • Assets • Cash……………………… $13,000 • Inventory………………….. $2,000 • Total…………………… $15,000 $2,000 $2,000 Ann’s Mini Mart September 3, 2013 E140A Accounting Workshop

12. Evolution of a Balance Sheet • Liabilities and Equity • Note Payable ……...………$5,000 • Paid-in Capital…..……… $10,000 • Retained Earnings…………. $400 • Total…………………… $15,400 • Assets • Cash……………………… $14,100 • Inventory………………….. $1,300 • Total…………………… $15,400 $700 $1,100 $400 Ann’s Mini Mart September 4, 2013 E140A Accounting Workshop

13. Evolution of a Balance Sheet • Liabilities and Equity • Accounts Payable…………$2,000 • Note Payable ……...………$5,000 • Paid-in Capital…..……… $10,000 • Retained Earnings…………. $400 • Total…………………… $17,400 • Assets • Cash……………………… $14,100 • Inventory………………….. $3,300 • Total…………………… $17,400 $2,000 $2,000 Ann’s Mini Mart September 5, 2013 E140A Accounting Workshop

14. Evolution of a Balance Sheet • Liabilities and Equity • Accounts Payable…………$2,000 • Note Payable ……...………$5,000 • Mortgage Payable………....$8,000 • Paid-in Capital…..………. $10,000 • Retained Earnings…………. $400 • Total…………………… $25,400 • Assets • Cash……………………… $12,100 • Inventory………………….. $3,300 • Land………………………. $10,000 • Total…………………… $25,400 $8,000 $2,000 $10,000 Ann’s Mini Mart September 6, 2013 E140A Accounting Workshop

15. Balance Sheet Analysis • Liquidity Ratios: Measures of the ability to meet short term financial obligations • Current Ratio = Current Assets / Current Liabilities • Quick Ratio= (Current Assets – Inventory) / Current Liabilities • Debt to Assets = Total Debt/ Total Assets • OperationalEfficiencyMeasures • InventoryTurnover = Costof Sales per year / CurrentInventory • ReceivableTurnover= AccountsReceivable / Sales • AccountsPayableCollectionPeriod= AccountsPayable / Costof Sales • Working Capital: Cash needed to sustain business activity through the cash flow cycle while paying the company’s bills and employee’s salaries. = Current Assets - Current Liabilities E140A Accounting Workshop

16. Balance Sheet Interactive http://www.sec.gov/edgar/searchedgar/companysearch.html Find 3 interesting trends that you would like to share with the class regarding the company’s balance sheet… E140A Accounting Workshop

17. Balance Sheet and Income Statement Assets = Liabilities + Equity Contributed Capital Assets = Liabilities + + Retained Earnings Contributed Capital Retained Earnings, Beginning of Period Net Income for Period Dividends for Period Assets = Liabilities + + + - Contributed Capital Retained Earnings, Beginning of Period Revenues - Expenses for Period Dividends for Period Assets = Liabilities + + + - E140A Accounting Workshop

18. What is Stanford’s biggest source of revenue? • Student Tuition Income • Investment Income • Sponsored Research • Health Care Services (Stanford Hospital) • Gift Revenue E140A Accounting Workshop

19. Income Statement of Bike Corp. – year 2013 $M % Rev. • + Revenues or Sales • - Cost of Revenue (product cost or COGS) • = Gross Profit • Sales and Marketing • General and Administrative • Research & Development • Depreciation and Amortization • = Operating Income (EBIT) • + Interest Income (expense) Net • = Net Income before Taxes • - Income Tax Provision • - Extraordinary Items • = Net Income Income Statement Reportstheeconomicresultsof a company over a time period. It shows thederivationofearningsorlosses. 100% 76% 24% 7% 5% 127.2 97.5 29.7 13.5 3.3 1.6 - 9.7 (0.7) 9.0 1.9 - 7.1 Net Income = Revenues– Expenses (Rev>Exp) Net Loss = Revenues – Expenses (Rev<Exp) E140A Accounting Workshop

20. HP Google Wal-Mart Income Statement Comparison ($B) ($B) ($B) 127.2 97.5 29.7 13.5 3.3 1.6 9.7 (0.7) - 9.0 1.9 7.1 37.9 13.2 24.7 7.8 5.2 - 11.7 0.6 - 12.3 2.6 9.7 447.0 335.1 111.8 85.3 - - 26.6 0.1 (2.3) 24.4 7.9 15.7 SG&A = Selling, General and Administrative Expenses + Revenues or Sales - Cost of Revenue (COGS) = Gross Profit • SG&A* • Research & Development • Depreciation and Amortization = Operating Income + Other Income / Expenses Net + Interest Income (expense) Net = Net Income before Taxes - Income Tax Provision = Net Income E140A Accounting Workshop

21. Income Statement Analysis • Other Important Measures: • Earnings Per Common Share (EPS) = Net Income / Common Shares • Price Earnings Ratio (P/E) = Market Price Per Share / Earnings Per Share • Some Profitability Measures: • Gross Margin =Gross Profit / Sales • Operating Margin = Operating Income / Sales • Profit Margin = Net Income / Sales E140A Accounting Workshop

22. Google ($B) Wal-Mart ($B) Income Statement Comparison 37.9 13.2 24.7 7.8 5.2 - 11.7 0.6 - 12.3 2.6 - 9.7 447.0 335.1 111.8 85.3 - - 26.6 0.1 (2.3) 24.4 7.9 - 15.7 Gross Margin: Google: 65% Wal-Mart: 25% Operating Margin: Google: 31% Wal-Mart: 6% SG&A = Selling, General and Administrative Expenses + Revenues - Cost of Revenue (COGS) = Gross Profit • SG&A* • Research & Development • Depreciation and Amortization = Operating Income + Other Income / Expenses Net + Interest Income (expense) Net = Net Income before Taxes - Income Tax Provision - Extraordinary Items = Net Income E140A Accounting Workshop

23. Income Statement Interactive finance.yahoo.com Find 3 interesting trends that you would like to share with the class regarding the company’s income statement… E140A Accounting Workshop

24. Cash Flow Statement • Net Income vs. Cash: • Net Income = Revenues – Expenses (Accrual Basis) • Cash = (Cash Basis) • Timing: Revenues and costs are not necessarily recognized when cash is transacted (e.g. accounts receivable, depreciation etc.) • Three components: Operating, Financing, Investing Activities • Operating – cash spent to generate company sales/revenue • Financing – mostly cash inflows • includes cash received through debt or equity financings • cash spent on repayment of such obligations • Investing activities: mostly cash outflows (includes cash spent on acquiring company assets (equipment, buildings, etc) E140A Accounting Workshop

25. E140A Accounting Workshop

26. Cash Burn Rate • Burn Rate – • Measure of (negative) cash spent per month • The rate at which a new company uses it’s venture capital to finance it’s operations, before generating positive cash flow. • Ex. Period 6 months; Revenues =$100K, Expenses $220K; Capital Remaining $200K • What is the cash burn rate? • How many month’s of runway? E140A Accounting Workshop

27. Accounting – from Startup to IPO Start-up IPO • Higher emphasis on Financial Statements, internal controls, SOX compliance, S-1 • Need A/R and A/P clerks, Tax accountants, Internal/External auditors • Looking at how to scale & remain profitable. • Cash still very important, but now you are thinking of how to re-invest it in the future of the business. • Rapid growth = many challenges with cash • Looking at company liquidity and maintaining a steady capital structure • Still need Financial Statements • Familiarity with Investors • If you need to get credit, most Banks or Merchants will not transact unless they think a company has cash • Higher emphasis on cash flow, burn rate, Income Statement (P&L) to stay solvent • Keeping good financial records • Equity agreements, tax filings, bank statements, contracts, stock options • Set internal controls to avoid embezzlement of funds and unaccountability in spending E140A Accounting Workshop