For example, if a company’s net assets are valued at $1 million and the acquirer pays $3 million, then goodwill of $2 million goes onto the acquirer’s balance sheet. That $2 million reflects all the value that is not reflected in the acquiree’s tangible assets—for example, its name, reputation, and so

Financing a Company How a company is financed refers to how it gets the cash it needs to start up or expand. Ordinarily, a company is financed through debt, equity, or both. Debt means borrowing money from banks, family members, or other creditors. Equity means getting people to buy stock in the company.

Allocations Allocations are apportionments of costs to different departments or activities within a company. For instance, overhead costs such as the CEO’s salary are often allocated to the company’s operating units.

But the term “shareholder value” crops up in a number of different contexts and has a variety of meanings. Sometimes it just means market cap; sometimes it refers to the expected future cash flows of a company (which, after all, is what investors are buying when they purchase a share of stock); sometimes it refers to the increase in dividends, shar

“It’s called the balance sheet because it balances. Assets always equal liabilities plus owners’ equity.”

The Big Five are: • Revenue growth from one year to the next • Earnings per share (EPS) • Earnings before interest, taxes, depreciation, and amortization (EBITDA) • Free cash flow (FCF) • Return on total capital (ROTC) or return on equity (ROE). ROE is the right metric for financial businesses such as banks and insurance companies.

Now move from an individual to a business. Same concepts, different language: • What the company owns is called its assets. • What it owes is called its liabilities. • What it’s worth is called owners’ equity or shareholders’ equity. And the basic equation now looks like this: or this:

Some investors—Warren Buffett, for example—like to look at the “market to book” ratio. Buffett often tries to find companies that are trading at a market cap close to or even below their book value.

A noncash expense is one that is charged to a period on the income statement but is not actually paid out in cash. An example is depreciation: accountants deduct a certain amount each month for depreciation of equipment, but the company isn’t obliged to pay out that amount, because the equipment was acquired in a previous period.