Financial Statements By John C. Kelly

Discussion Question How do you measure your personal financial condition?

Net Worth Cash + investments + property Minus Bills + loans + mortgages Equals Your Net Worth

Discussion Question How much of your net worth is usable?

Usable Net Worth That which is liquid That which can be easily converted to cash Cash in the bank Investments you can sell Amount you can borrow

Financial Statements ► Sources and Uses of Funds – What money do you need to start your business and where will you get it. ► Balance Sheet – Snapshot of financial condition ► Income Statement – Financial performance over an interval of time. Also called profit and loss or P&L. ► Cash Flow Statement – Similar to P&L but includes cash expenditures which are not expenses buying capital equipment and loan principle payments.

The Balance Sheet ► A snapshot of the financial condition of the company at a moment in time. ► You can think of it as a statement of what would be left if all the assets were sold and all the bills paid. An individual would call this a net worth statement. Net worth = Asset - Liabilities

Balance Sheet Format ASSETS ► Cash in Bank ► Accounts Receivable ► Prepaid Expenses ► Inventory ► Equipment ► Real Estate LIABILITIES ► Accounts payable ► Accrued payroll ► Bank loans ► Mortgages ► Credit Card Balances Net Worth Assets = Liabilities + Net Worth

Discussion Question What does your balance sheet look like the day you start your business?

Initial Balance Sheet ASSETS ► Cash$1000 LIABILITIES ► Amount Owed $0 NET WORTH ► Equity $1000

Balance Sheet Terminology ► Net Worth = ► Shareholder’s Equity = ► Owner’s Equity = ► Equity = ► Book Value All names for the same thing. Think of it like the equity in your house, which is the market value minus the mortgage amount. It is money you could have if you sold your house. Of course, you would get a little less because of the cost of selling.

Income Statement ► Measures financial performance over time. Balance sheets are snapshots. Income statements are interval oriented. ► Measures profit over an interval of time. Profit = Revenue – Expenses

Income Statement Format Sales Cost of Goods Sold Gross Profit Selling Expenses General & Administrative Net Profit Provision for Income Tax Profit

Income Statement Terminology ► Income, revenue, profit, and earnings are all frequently used interchangeable with conflicting meanings. ► The words net and gross are some times used to clarify meaning. ► I say Revenue = Sales = Gross Income Profit = Earnings = Net Income

Discussion Question What happens when you make a sale but don’t receive the money right away?

Accrual Vs Cash Accounting ► Cash accounting, like you do in your personal life, says an expense occurs when the cash is spent, and income occurs when the cash is received. ► Accrual accounting assigns expenses and income to the period in which they occur, whether or not cash is received or spent. See Pub 583 and Pub538 Accounting PeriodsPub 583Pub538

Golden Rule for Small Biz Use cash accounting as long as possible

Discussion Question How should you account for the purchase of a car or a large piece of equipment like a pizza oven?

Depreciation Depreciation is classic example of accrual accounting where the cost of an asset is spread over the expected life of the asset. For example, a car is not expensed in the year it is purchased, rather it is expensed over a period of years. If the depreciation period is five years. Only 1/5 of the cash spent will show up as an expense in the year the money is spent. Therefore, the change in cash on hand shown in the balance sheet will not jive with the profit shown on the income statement. The cash flow statement corrects for this.

Multiple Sets of Books Depending Upon the Audience ► Managers – focus on cash flow ► Investors – meet SEC requirements ► Tax Collectors – meet IRS requirements Perfectly legal, perfectly confusing

SEC Financial Reporting ► 10-K Annual financial report ► 10-Q Quarterly financial report ► 8-K Unscheduled report of change in financial condition SEC Edgar Financial Database

Discussion Question How would you use the numbers in the financial statements to evaluate the health of a business?

Performance Ratios ► Revenue per employee ► Average sale amount ► Number of sales/deals per month ► Survival ratio ► Profit Margin ► Return on Equity (ROE) ► Inventory Turnover ► P/E Ratio

Tax Reporting ► Small Business Guide – Pub 583 Pub 583Pub 583 ► Sole Proprietorship – Schedule C Schedule CSchedule C ► Corporation Return – ► S-Corp Return – 1120S 1120S ► Partnership and LLC

Basic Guidelines to Get Started ► Maintain a separate checking account ► Pay your taxes ► Use a payroll service ► Start with basic Quicken ► Advance to QuickBooks