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Economic Analysis of Law
Villanova University School of Law
Lund, Andrew C.W.

Intro to Business and Economic Analysis of Law Outline

Professor Lund

Spring 2017

Part 1: Accounting & Finance

Introduction to Accounting

Importance of Accounting

How to run the business
Judging performance
Valuing company

Financial Statements

Balance sheet
Income statement
Cash Flow statement

Francis v. United Jersey Bank

Facts:

-Reinsurance business

-Lilian Pritchard owns business and on board of directors

-Sons take over business when father dies

-Sons take money out of business as shareholder’s loans

Issue: Is Lilian responsible for money siphoned out of company as a board of director?

Notes:

Director must maintain familiarity with financial status of company
Financial statements have serious limitations

-Historical- Only looks at past

-Only tangible assets (intangible assets such as human capital, brand value not considered)

-Questionable assumptions (depreciation)

-Produced by people

Balance Sheet

Assets = Liabilities + Equity

Equity = Book Value

Snapshot at one moment in time
All assets are spoken for by either creditors or equityholders

Equity

Book Value (accounting)

-Amount on the books

-Assets – liabilities

-Can’t calculate equity independently

Is it possible to have a negative book value and a positive market value of equity? If so, what factors could account for this discrepancy?

Yes, could have more liabilities than assets on the books, but market may value the assets at a greater price.
Book value is historical cost measure so value on books is based on what the company paid for it
The value of assets could have gone up since they were recorded on the books
Good will and human capital not recorded on balance sheet- may have value to the market

Market value or market cap= # of Shares x Share Price
Owning shares

-Possible dividends

-Possible appreciation

-Vote for board members

-Residual claim of assets – liabilities

P/B- Ratio of market value to book value

What does it mean that an equityholder is a residual claimant?

Equityholder does not get paid until all other liabilities are paid off. They don’t have to get anything.
They get leftovers, back of the line in terms of getting assets

Kahan v. US Sugar

Buying back shares
Company must disclose certain things to shareholders so they can make decision
Sugar discloses value of land- Bought it in 1931 so it shows up as whatever they paid for it on statements
True value is the market value now
Shareholders sued because they were only told book value

Klang v. Smith’s Food & Drug

Book numbers can be inaccurate
Not confined by accounting numbers in assessing value

Gov always gets paid first out of fixed claimants
Fixed claims get paid before equityholders
Equityholders have more risk because they get paid last. Good thing that they get to vote for board members because they have incentive for company to do well

F. Working Capital and Capital Assets

Current assets and liabilities are ones that are payable within one year
Other assets and liabilities are long-term
Net Working Capital = Current Assets – Current Liabilities
Good net working capital means a business has good liquidity and can pay off current liabilities
Capital Assets are long-term assets including property, plant, and equipment
Capital assets are financed through long-term debt and/or equity

Tax

Subtract out taxes

Equity

Net profit (or loss)

Net income can either be distributed to shareholders as a dividend or will be recorded on the balance sheet as retained earnings under equity. Cash increases by same amount as retained earnings

What is Profit?

Earnings before interest and tax (EBIT)
Earnings before interest, tax, depreciation, and amortization (EBITDA)

Accrual Accounting

Matching Principle: Revenue and expenses are matched and recognized at the time of the transaction, and not when cash is received or disbursed
Risk that receivables may not be paid. Don’t have actual cash to use for other things
Cash accounting is recorded when actual cash is going in or out. Does not represent real picture of how business is doing because it doesn’t consider what is owed to us and what we owe to others

Depreciation and Amortization

Accrual accounting recognizes depreciation as a non cash expense. Don’t have to spend money on it but it’s included on financial statements
Depreciation: The diminishment of value of tangible assets such as a physical plant, property, or equipment.
Amortization: Diminishment of value of intangible assets such as patents and goodwill.
Firms cash flow exceeds it profit by the amount of the D&A. EBITDA is approximation of cash flow because it adds back in D&A
Methods to depreciate or amortize assets