Study: What are equity investors and what information do they use to make investment decisions?
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Slide 1 (:12s)
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Welcome to Introduction to Accounting Preparing for a User’s Perspective. What are equity
Links to an external site. investors and what information do they use to make investment decisions?
Slide 2 (:09s)
Links to an external site.This is Bill. Bill currently sits on a pile of resources but wants to make his pile of resources grow.
Slide 3 (:05s)
Links to an external site. But how can he make it grow?
Slide 4 (:06s)
Links to an external site. Bill is considering becoming an investor.
Slide 5 (:23s)
Links to an external site. When people like Bill, invest their resources in ideas, projects, and companies, they often receive some form of ownership equity in the investment. When such investments are in corporations
Links to an external site., the investors receive ownership shares
Links to an external site. to represent their ownership and are called “equity” investors.
Slide 6 (:14s)
Links to an external site. When equity investors invest in a company they increase their owners’ equity claims against the company and thereby provide equity financing
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Slide 7 (:33s)
Links to an external site. For example, during Google’s business lifetime, it has obtained a variety of resources such as cash, vehicles, furniture and buildings. Resources owned and/or controlled by an entity are called assets
Links to an external site.. Like all businesses, Google must obtain its assets by financing them from the only two sources available, 1) owners, or 2) creditors
Links to an external site. (which are the focus of our next learning topic).
Slide 8 (:25s)
Links to an external site. Therefore, at all times, Google’s total assets WILL and MUST ALWAYS be exactly equal to the financing it received to obtain those assets. This logic leads to one of the most fundamental formulas in all of business called the balance sheet equation. It is written as Assets = Liabilities + Equity.
Slide 9 (:47s)
Links to an external site.In other words, if you wanted to quickly see what assets Google had at the end of the year 2012 and how they were financed, you could obtain its balance sheet either directly from Google’s website, or from the Securities Exchange Commission
Links to an external site. (SEC) which we will learn about later. On that balance sheet you would notice that Google had $94 billion in assets. You would also notice that Google’s owners had $72 billion in equity representing their claims against Google as a result of their equity financing, and Google had $22 billion in liabilities to its creditors for their creditors’ claims against Google as a result of their debt financing
Links to an external site.. As you can see, the balance sheet will ALWAYS balance.
Slides 10 (:12s)
Links to an external site.We will later learn the advantages and disadvantages that companies face as a result of being financed via debt or equity.
Slide 11 (:19s)
Links to an external site.Balance sheet users can learn more about the company by reviewing its sources of financing. For example, if we knew that a company had $100 in assets, we would also immediately know that the company had $100 in financing that provided those assets.
Slide 12 (:16s)
Links to an external site.Even better, if we knew that a company had $100 in assets AND we knew that it had $30 of liabilities
Links to an external site., we could solve for the unknown owners’ equity and arrive at $70.
Slide 13 (:51s)
Links to an external site. A company’s equity can also be referred to as its net assets. This concept of net assets begins with the standard balance sheet equation. Assets = Liabilities + Equity. Assume a company has $200 in assets and $120 in liabilities. You could solve for equity by deducting the $120 of liabilities from both sides of the equation to arrive at the following net assets equation Assets – Liabilities = Equity. A company’s net assets, $80 in this example, are the same thing as owners’ equity and represent the amount of the company’s assets that the owner would “net” AFTER the company paid of all of its liabilities.
Slide 14 (:15s)
Links to an external site. A company’s total debt financing as would appear within the liabilities account, is also referred to as temporary financing because it usually must be repaid within a specific period of time.
Slide 15 (:27s)
Links to an external site.Equity investors, like Bill, invest in companies to achieve financial returns
Links to an external site. which help them grow their pile of resources. Bill’s equity investments can provide him financial returns in two different ways:
1) He can receive dividend
Links to an external site.income when the companies he invests in pay out their profits in the form of stock
Links to an external site., cash or other asset dividends.
Slide 16 (:34s)
Links to an external site.2) He can also achieve gains on the sale of his ownership shares
Links to an external site. when he sells them to other investors at higher prices.
a. For example, if Bill took one share of Google stock that he purchased originally for $100 and then sold it to a new investor for $800, his $800 sales price could be broken out into two pieces 1) a $100 return OF his investment and 2) a $700 return ON his investment called a gain on sale.
Slide 17 (:20s)
Links to an external site.b. Watch out though, if Bill sold his $100 share for only $70, he would only receive a $70 return OF his investment and would incur a $30 Loss OF his investment.
Slide 18 (:15s)
Links to an external site. Equity financing is also known as permanent financing because there is usually no specific time frame when the companies are legally obligated to pay back the owners’ original investments.
Slide 19 (:59s)
Links to an external site. Investors like Bill want to make good investment decisions, but making good investment decisions is not always easy.
To assist them in making the best investment choices possible, investors will strive to obtain and properly analyze a variety of different information.
Some information used by investors is disorganized and comes from a variety of random sources at random points in time, such as: news reports, social media, and personal experiences.
Other information is quite well-organized and is often produced by governmental or non-profit agencies, such as housing, unemployment and production data. For profit companies also provide well-organized investor information such as Bloomberg, Moody’s and Standard & Poor’s.
Still other information comes in pre-specified formats, such as the general purpose financial statements.
Slide 20 (:17s)
Links to an external site. The general purpose financial statements
Links to an external site.are produced directly by the companies themselves.
When properly analyzed, general purpose financial statements can be extremely helpful to investors and creditors when making investment and lending decisions.
Slides 21 to 26 (:28s)
Links to an external site.A company’s general purpose financial statements consist of its income statement, statement of equity, balance sheet, statement of cash flows, and related footnote disclosures.
We will spend the rest of this course studying the general purpose financial statements with the hope that you will learn how to prepare, read and use them when making investing and lending decisions.