1. Computer and Financial Analysis
Financial Statements
Prepared By
Eng. Hani A. Abuamer

2. Objectives After studying this chapter, you should be able to:
1. Explain the purpose and understand the format of the firm’s three basic financial
statements: the income statement, the balance sheet, and the statement of cash
flows.
2. Construct each of these statements in Excel with data for any company.

3. Objectives
3. Link worksheets together so that formulas in one worksheet can reference data
in another and update automatically when changes are made.
4. Use Excel’s Outline tool to selectively display or hide parts of a financial statement.

4. 1. Balance Sheet 2. Income Statement 3. Cash Flows
Financial Statements
1. Balance Sheet 2. Income Statement 3. Cash Flows

5. UNDERSTANDING FINANCIAL STATEMENTS
Balanced Sheet

6. Balanced Sheet
The balance sheet describes the assets, liabilities, and equity of the firm at a specific point in time. Assets are the (tangible or intangible) things that firm owns. Liabilities are the firm’s debts. Equity is the difference between what the firm owns and what it owes to others. Because the balance sheet is specific to a point in time, it is much like a photograph. What it shows was true when the snapshot was taken, but is not necessarily true when it is viewed.

7. Excel Principles
Principle 1: Make Excel do as much of the work as possible. Whenever possible, a formula should be used rather than entering numbers. In the long run this will minimize errors Principle 2: Format the worksheet so that it is easy to understand. Borders, shading, and font choices are more than just decorations. Properly chosen, they can make important numbers stand out and get the attention they deserve .

8. Elements of a Balance Sheet
A balance sheet, also called the statement of financial position, lists:
Assets
Liabilities
Owners Equity
as of a specific date. It gives an idea of what the company is worth.
Let us now look at these terms in more detail.
$ IN
$ OUT ?

9. Elements of a Balance Sheet
$ IN
Assets
Assets are all those things a company owns which are of value to the business.
Assets can be tangible like e.g. a manufacturing plant, computers or cash in the bank.
Tangible assets like cash or goods for sale that can easily (i.e. within an accounting year) be converted into cash are called current assets while other assets like properties and equipment are called fixed assets.
Assets can also be intangible like e.g. copyrights.

10. Elements of a Balance Sheet
Liabilities
Liabilities are all those things for which the company eventually needs to pay. There are two types of liabilities:
Current Liabilities need to be paid within one accounting year. Examples are: Outstanding rent, goods bought on credit.
Long Term Liabilities are those liabilities which will not be paid during the current accounting year. Examples are: Long term debts, bank loans.
$ OUT

11. Elements of a Balance Sheet
Owner’s Equity
Owner’s Equity is by definition the difference between the Assets of a company and its Liabilities. Owner’s Equity is the sum of two parts:
Contributed Capital is the money that the owners invested in the company.
Retained Earnings are those earnings which were not distributed to the owners. These can accumulate to a large sum over the years. ?

12. Elements of a Balance Sheet
Let me stress again: A Balance Sheet must balance the assets, liabilities and owner’s equity.
Assets – Liabilities = Owner’s Equity
Most commonly, the assets are on top and the liabilities and owner’s equity on the bottom.
Let’s now have a look at a balance sheet.
$ IN
$ OUT

13. Some Notes Note how the top and bottom parts balance
Presentation indeed makes a big difference. In a sense ‘design’ is an important ingredient of financial modeling. After all, what is the use of great information if no-one understands it?
Now, let us look at the items in the balance sheet one by one.

14. Elements of a Balance Sheet
$ IN
Assets – Current Assets
Cash and Cash Equivalents Cash is all the cash the company has, be it in bank accounts or in the cash box. Cash Equivalents are short term investments that can be converted to cash with no or very little delay. Examples of Cash Equivalents are: Money Market Investments, Government Bonds.
Accounts Receivable Most businesses do not immediately receive payment for (some or all) of the goods or services they sell. Assuming that payment will indeed be made in the near future, a receivable account is an asset.

15. Elements of a Balance Sheet
Assets:Total Current Assets
In this case, of course, its just the sum of ‘Cash and Equivalents’ and ‘Accounts Receivable’, but there could be many more ‘current’ items.
Total current assets is an important item since it indicates how much money the company has to run its business.

16. Elements of a Balance Sheet
Assets: Fixed Assets
Plant and Equipment In order to run a business one usually will need to buy some equip- ment (even when one is in the service business) like e.g. machines and computers. The total cost price of the bought equipment is listed in this item (note, the fact that equipment becomes worth less is accounted for in the next item).
Accumulated Depreciation Naturally, when one uses equipment it will get old and thus become worth less. It is therefore necessary to subtract a certain amount from the original equipment value every year. Since one would like to keep the original value listed above, one needs to ‘accumulate’ i.e. sum up all the previous year’s depreciations.

17. Elements of a Balance Sheet
Assets: Net Fixed Assets
In this case the net fixed assets are ‘Plant and Equipment’ minus ‘Accumulated Depreciation’, but there could be many more items.
Note that having a lot of fixed assets does not necessarily mean that the company is ‘rich’. It is also important to realize that fixed assets do not provide cash for running the business (though they could be use as collateral for a loan).

18. Elements of a Balance Sheet
Assets: Total Assets
Total Assets = Current Assets + Net Fixed Assets
Note: While total assets in a sense represent the current value of the business, they do not necessarily represent the resale value or the liquidation value of the business.
The total assets are the value of the business as seem from the perspective of a continuation of the currently operating business.

19. Elements of a Balance Sheet
$ OUT
Liabilities: Current Liabilities
Accounts Payable Just as there are accounts receivable, there are also accounts payable. Businesses usually do not need to pay immediately upon delivery but have e.g. 30 or 60 days ‘credit-terms’. In other words, ‘accounts payable’ are unpaid bills due soon.
Other Current Liabilities All the liabilities which are due within one accounting year and which are not separately listed (in this case only accounts payable) are lumped together here. Examples are: unpaid salaries, interest, short term loans.

20. Elements of a Balance Sheet
Liabilities: Total Current Liabilities
The total current liabilities are an important indicator of how much money a company will need in the near future.
If the total current liabilities are much bigger than the total current assets great caution is warranted.

21. Elements of a Balance Sheet
Liabilities: Long Term Liabilities
Long Term Debt While in daily life having debts (especially credit card debts!) is usually not a good thing, the proper use of long term loans is an essential part of many business activities. It is for example very rare that a company has enough cash to build a new state of the art manufacturing plant. The idea is of course that you earn more than you pay in interest. (This is somewhat similar to buying a condo with a mortgage).
Other Long Term Liabilities All other liabilities which do not need to be returned within one accounting year and which are not separately listed. E.g. Royalties, asbestos claims.

22. Elements of a Balance Sheet
Liabilities: Total Liabilities
Total Liabilities = Total Current + Long Term Liabilities
Note: If the Total Liabilities exceed the Total Assets, the company is almost certainly in some sort of danger. But there are exceptions to this! (Especially companies in new hot industries like e.g. dot.coms or genetics).

23. Elements of a Balance Sheet
Liabilities: Shareholder’s Equity
Common Stock When a corporation is set up or when it needs money and desires to do so, it can issue common stock. The amount received is entered under this item. Note that the value printed on the stock certificate may be quite different from what one actually pays.
Retained Earnings At the end of an accounting year, a company can have a profit or a loss. The profit or loss (in case of loss, naturally with a minus sign) is added to the retained earnings. The retained earnings sum up all the profits and losses since the inception of the company (minus paid out dividends).

24. Elements of a Balance Sheet
Liabilities: Total Shareholder’s Equity
This is the amount the company ‘owes’ its shareholders.
Note that from an operational point of view, these debts have no impact on the daily running of the business since they do not need to be repaid.

25. Elements of a Balance Sheet
Liabilities: Total Liabilities and Owner’s Equity
As such this item is mainly a cross check for the accuracy of the balance sheet. It must be exactly the same number as the total assets or something is wrong!

26. Key Points of the Day Assets – Liabilities = Owner’s Equity
The Balance Sheet provides a snapshot of the assets and liabilities of a company.
The Balance Sheet is one of the most important financial statements.
Remember:
Assets – Liabilities = Owner’s Equity
$ OUT
$ IN
And again:
Assets – Liabilities = Owner’s Equity

27. UNDERSTANDING FINANCIAL STATEMENTS
INCOME STATEMENT

28. Income Statement Revenues less Expenses = Net Income
Also called the Statement of Earnings
Comparative financial statements enable users to analyze performance over multiple periods and identify significant trends.
Consolidated financial statements combine
the financial results of a “parent
company” with its subsidiaries.

29. Income reported on income statement
is based on Accrual Accounting, all revenues earned in the year & all expenses incurred in that year (NOT on the cash generated or cash paid during accounting period)
Income Statement may be presented in the multi-step or single step form.

30. Income Statement Single-step Multiple-step
All operating revenues and gains are reported first, followed by all operating expenses and other losses.
No separate section is prepared for COGS and gross profit.
Multiple-step
Divided into separate sections, various subtotals are reported.
Involves separate sections for gross profit, operating income, other income/losses, income before income taxes, and net income.
Gross Profit
Operating Income
Other Income/losses

31. Focus on Multi-step format (it has more detail and is more useful)
Income Statement
Focus on Multi-step format
(it has more detail and is more useful)
NET SALES: A firm’s sales are usually reported as Sales less Sales Returns less Sales Allowances
the major source of revenue for most
Companies trends are important

32. Income Statement (continued)
Net Sales
Less: Cost of Goods Sold (COGS)
Cost to seller of products sold to customers.
If purchased, then price plus freight-in.
If manufactured, then DM, DL, Manf. Ovhd.
The relationship between COGS and sales is an important one.
= Gross Profit
Key analytical tool in analyzing firm’s operating performance.
Gross profit percentage equals
Gross profit/Sales

33. Income Statement (continued)
Gross Profit
Less: Operating Expenses
Selling Expenses:
Advertising expenses
Salesmen’ salaries
General and Administrative Expenses:
Office and officer salaries Payroll taxes
Depreciation expense Repairs & maint.
Insurance expense Rent expense
Lease expense Bad debt expense
Research and Development Supplies
= Operating Income (or Operating Profit or Income from Operations)
Measures overall performance of company’s operations
Operating Income Percentage=Operating Income/Sales

34. Income Statement (continued)
Operating Income
+/- Other Income/Expense
Interest income
Gain from sale of equipment
Gain from sale of investments
Interest expense
Loss from sale of equipment
Loss from sale of investments
Loss from write-down of inventory
Earnings before income taxes
Less: Income taxes
Net Earnings or Net Income
(or Income from Continuing Operations)
FOR SALE

35. Income Statement (continued)
Income from Continuing Operations
+/- Income from Discontinued Operations (net of tax)
+/- Extraordinary Gains and Losses (net of tax)
+/- Cumulative Effect of a Change in Accounting Principle (net of tax)
Net Earnings or Net Income
Net Earnings Percentage =Net Earnings/Sales

36. Income from Discontinued Operations
Income (loss) from operations of discontinued operations (from 1/1 to measurement date)
Less: Income tax
Gain (loss) from sale of discontinued operations
(a)Income (loss) from operations (after measurement date)
(b)Gain (loss) on disposition of segment of assets
Net Income from Discontinued Operations

37. No “cumulative effect” of the change
Changes in estimates
Estimates are made using the BEST available information at the statement date.
Changes in estimates should be reflected in the current period (date of the revision) and in future periods, if any, that are affected.
No “cumulative effect” of the change

38. Comprehensive Income
Beginning in 1998, companies required to report COMPREHENSIVE INCOME
Comprehensive income includes ALL changes in stockholders’equity during a period except those resulting from investments by owners and distributions to owners
Does not include:
Dividends to stockholders
Issuance of stock
Treasury stock transactions

39. Net Income (from Income Statement)
Comprehensive Income
Net Income (from Income Statement)
+/- Foreign currency translation adjustments
+/- Unrealized gains/losses on available-for-sale securities
+/- Additional pension liabilities
+/- Changes in fair market value of cash flow hedges
= Comprehensive Income/Loss

40. Comprehensive Income may be reported in one of three ways:
on the face of the income statement
in a separate statement of comprehensive income
in a statement of stockholders’ equity

41. Common size Balanced Sheet and Income Statement
Analytical tool to compare firms with different level of sales.
Used to facilitate structural analysis of a firm, to evaluate trends and make industrial comparisons.
Expresses each income statement
category as a percentage of net sales.

42. UNDERSTANDING FINANCIAL STATEMENTS
Financial Cash Flow

43. Businesses are like Fruit Trees
Fruit = Operating Activities
Trunk & Branches = Investing Activities
Roots = Financing Activities

44. Managing Risks With Financial Analysis
What's Your Plan?

45. Montana State University
Are You a Risk Taker?????
Production
Financial
Marketing
Human Resource
Montana State University

46. Montana State University
Do You Take Unnecessary Risks????
Montana State University

47. Just Like Balancing a Check Book
These are
Linked
Beginning Cash Balance
Inflows
Outflows
= Ending Cash Balance

48. Signs of Cash Flows for the Statements of Cash Flow
Direction of Changed
Order of Subtraction
Type of item
increased
decreased
Assets - +
Older- Newer
Liability or Equity
Newer - Older