Understanding the Numbers: Essential for the Entrepreneur

Understanding Financial Statements Goal: Understand the financial consequences of decisions What are the three basic financial (or accounting) statements? –Income Statement –Balance Sheet –Cash Flow Statement The Goal: Making Good Financial Decisions 3 types of financial statements

Income Statement Sales Revenue Cost of Goods Sold Operating Expenses Gross Profit Operating Income Interest Expense Operating Income Earnings Bef Taxes Income Taxes Net Income Operating Activities Financing Activities minus equals What is the format of an income statement?.

Income Statement An Example The Income Statement for Trimble & Associates: Sales $850 Cost of Goods Sold 550 Gross Profit on Sales $300 Operating Expenses: Marketing Expenses 90 General & Admin Expenses 80 Depreciation 30 Total Operating. Expenses $200 Operating Income 100 Interest Expense 20 Earnings Before Tax 80 Income Tax (25%) 20 Net Income 60 Income from operating the business Income after \paying interest Cost of borrowing

Income Statement Can You Put It Together? Cost of Goods Sold $250 Depreciation $ 8 Sales $290 Income Taxes(25%) $ 2 Admin. &Sales Exp. $ 18 Interest Expense $ 6 Organize this Income statement Put the pieces where they go!! 4. Good judgment Gross Profit on Sales $ Operating Expenses: Total Op. Exp. $ Operating Income $ Earnings Before Taxes $ Net Income $

Gross Profit on Sales $ Operating Expenses: Total Op. Exp. $ Operating Income $ Earnings Before Taxes $ Net Income $ Here You Go! Cost of Goods Sold $250 Depreciation $ 8 Sales $290 Income Taxes(25%) $ 2 Admin. &Sales Exp. $ 18 Interest Expense $ 6 Depreciation $ 8 Sales $290 Income Taxes(25%) $ 2 Admin. &Sales Exp. $ 18 Interest Expense $ 6 Cost of Goods Sold $

Balance Sheet What is the basic format of a balance sheet? In its simplest form, the Balance Sheet is: Total assets always equal debt plus equity. Total Assets Owner’s Equity Outstanding Debt Debt & Equity = +

Balance Sheet Describe the 3 main parts of a balance sheet. Assets –What the company owns Liabilities (Debt) –What the company owes Owner’s Equity (Net Worth) –Amount invested by the owners Basic pieces of the balance sheet Continue

What does the balance sheet tell us? A Snapshot of a company’s financial position at a specific point in time How is it different from an income statement? The Income Statement covers a period in time (Jan 1 – Dec 31, 2007) The Balance Sheet represents a specific moment (December 31, 2007)

Balance Sheet Income Statement and Balance Sheet The Income Statement and Balance Sheet complement each other January 1 December 31 Balance Sheet on December 31, 2006 Balance Sheet on December 31, 2007 YEAR 2007 Income Statement for 2007

Balance Sheet What are the 3 types of assets? Current assets, consisting of? What is the nature of current assets? They are cash or moving toward cash.

Balance Sheet Fixed assets include: –Machinery and Equipment –Buildings and Land The cost of a depreciating fixed asset is recorded in the balance sheet as an asset (not an expense) and depreciated over its useful life.

Other assets include such things as: –Patents –Copyrights –Goodwill OK, enough about assets. Now let’s look at how they are financed

Balance Sheet Debt or Liabilities What is debt? Financing provided by a creditor Debt is divided in two parts: –Current debt or short-term liabilities –Long-term debt Where does debt come from?

Balance Sheet Owners’ Equity What is owners’ equity? Money invested by the owners, as the esidual owners. Equity consists of what? –Amount invested when purchasing ownership in the business –Retained Earnings: All the profits retained in the company (profits not paid out in dividends to the owners) Owners have 2 ways to invest in a business: Buy stock Reinvest all or part of the firm’s profits

Balance Sheet Owners’ Equity Let’s say it again! Retained Earnings is the accumulated profits (gains-losses) of the business, less the dividends paid to stockholders since the firm was created Owners’ Equity Cumulative Profits Owners’ Investment Cumulative Dividends Retained Earnings Owners’ Equity Owners’ Investment Retained earnings: A concept that many students fail to understand. Do you?

Balance Sheet () An Example ASSETS DEBT AND EQUITY Current Assets Current Liabilities: Cash $50 Accounts payable $20 Accounts receiv 80 Short-term notes80 Inventories 220Total current debt$100 Total current assets$350 Long-term debt 200 Fixed assets: Total debt: $300 Gross fixed assets$960 Common stock$300 Accum depreciation -390 Retained earnings 320 Net fixed assets $570 Total common equity $620 TOTAL ASSETS $920 TOTAL DEBT AND EQUITY$920 The Balance Sheet for Trimble & Associates:

Balance Sheet Can you put itd together? Given the information below, can you arrange the balance sheet? Remember: ASSETS = LIABILITIES + EQUITY Cash $ 70 Accounts Receivable $ 220 Inventories $ 310 Total Current Assets $ 600 Gross Fixed Assets $2,500 Accumulated Depreciation $(300) Net Fixed Assets $2,200 Assets: Current Assets Fixed Assets TOTAL ASSETS $ 2,800 FIRST:ASSETS Cash $ 70 Accounts Receivable $ 220 Inventories $ 310 Total Current Assets $ 600 Gross Fixed Assets $2,500 Accumulated Depreciation $(300) Net Fixed Assets $2,200

Balance Sheet Putting it together Common Stock $ 900 Long-term debt $ 800 Total Owners’ Equity $1,750 Total Debt $1,050 Total Current Liabilities $ 250 Short-term Notes $ 20 Accounts Payable $ 230 Liabilities: Current Liabilities: Owners’ Equity: TOTAL DEBT&EQUITY $ 2,800 NEXT:DEBT & EQUITY Retained Earnings $ 850 Common Stock $ 900 Long-term debt $ 800 Total Owners’ Equity $1,750 Total Debt $1,050 Total Current Liabilities $ 250 Short-term Notes $ 20 Accounts Payable $ 230 Retained Earnings $ 850

Balance Sheet All Together The complete balance sheet is as follows Assets: Current Assets Fixed Assets TOTAL ASSETS $ 2,800 Liabilities: Current Liabilities: Owners’ Equity: TOTAL DEBT&EQUITY $ 2,800 Cash $ 70 Accounts Receivable $ 220 Inventories $ 310 Total Current Assets $ 600 Gross Fixed Assets $2,500 Accumulated Depreciation $ 300 Net Fixed Assets $2,200 Common Stock $ 900 Long-term debt $ 800 Total Owners’ Equity $1,750 Total Debt $1,050 Total Current Liabilities $ 250 Short-term Notes $ 20 Accounts Payable $ 230 Retained Earnings $ 850

Cash Flow Statement “Cash is King!! Cash flow problems is a major reason for small firms failing—even at times when the business is profitable. Run out of cash and your business will fail! CASH IS KING is not some cliché, but a principle you cannot afford to violate!

Cash Flow Statement Accrual versus Cash Accounting What is the difference between accrual-basis accounting and cash- basis accounting? So what?

Cash Flow Statement “What question does the cash flow statement answer? “Where did the cash come from and where did the cash go?”

Cash Flow Statement Where does the information come from to prepare a cash flow statement? Income statement All the changes in the balance sheets from the beginning of the year to the end of the year –Except changes in accumulated depreciation and retained earnings

Cash Flow Statement Cash inflows and outflows result from three activities: –Operating Activities: Cash flow from normal operations –Investment Activities: Cash flow related to the investment in or sale of assets –Financing activities: Cash flow related to financing the firm Three activities cause cash to increase or decrease

Cash Flow Statement Operating Activities Cash flow from operations consists of the net flow of cash from day-to- day business activities Start withOperating income Add backDepreciation expense (a non-cash expense) Subtractincome taxes (to work on an after-tax basis) Subtractincrease in net working capital Which consists of: –Increase in A/R(a use of cash) –Increase in inventories(a use of cash) –Decrease in A/P(a source of cash) What is cash flow from opera- tions?

Cash Flow Statement Investment Activities Investment activities consist of –The purchase or sale of fixed assets (change in gross fixed assets) –The purchase or sale of other long-term assets (changes in goodwill, patents, etc.) What is cash flow from investment activities?

Cash Flow Statement Financing Activities Financing activities include: –Paying dividends and interest expense –Increasing or decreasing short-term and long-term debt Increase: borrowing more money Decrease: paying off debt –Owners invest more or less in business Buy more stock Company buys owner’s stock back What is cash flow from financing activities?

Cash Flow Statement Cash Flow Statement for Trimble Associates Operating Activities Operating income$ 100 Plus depreciation 30 Less income taxes (20)$ 110 Change in net working capital: Less increases in A/R$ (5) Less increases in inventories (40) Plus increases in A/P 5(40) Cash flows from operations$ 100 Investment Activities Less increase in gross fixed assets$ (100) Financing Activities Less interest expenses$ (20) Less dividends paid (15) Plus incr in short-term notes 20 Plus incr in long-term notes 50 Total Financing Activities$ 35 Increase (Decrease) in cash$ 5 Change in net working capital

Cash Flow Statement Can You Arrange this Cash Flow Statement? Operating activities: Plus Less Plus Cash flows from operations: Investment activities Less Financing activities Less Plus Total financing activities Increase (Decrease) in cash Operating Income $120 Depreciation $ 40 Taxes $(30) Increases in accts receivable $(20) Increases in inventories $(10) Increases in accounts payable $ 5 Increase in gross fixed assets $(90) Interest expenses $(30) Increases in short-term notes $ 15 Increases in long-term notes $ 30 Dividends paid $(10) $100 $ 5 $ 100 $ (90) $ 5 $ 15