1. GEM2508 1 A Finance Survival Kit GEM2508 Frederick H. Willeboordse frederik@chaos.nus.edu.sg

2. GEM2508 2 The Income Statement Lecture 1

3. GEM2508 3 Today’s Lecture Excel Basics Understand the elements of the Income statement Use MS Excel to make a simple Income statement

4. GEM2508 4 Excel Basics After launching Excel, you should have a window that looks like this. What are its elements?

5. GEM2508 5 Excel Basics – the various areas Menu Bar Tool Bars Name Box Sheet Tab Status Bar Formula Bar

6. GEM2508 6 Excel Basics – the cells Cells Currently Active Cell Each cell has an address so that we can refer to it. E.g. this is cell E11.

7. GEM2508 7 Excel Basics - help Help Box If you type ‘formula’ in the Help Box and click return, you’ll get a short list of topics that are related to the term ‘formula’. Click on any of them to find out more about that topic.

8. GEM2508 8 Excel Basics - help Help Box After clicking ‘about formulas’ you’ll get the window to the left.

9. GEM2508 9 Excel Basics – enter and edit data Click on a cell and start typing …. Cells can contain numbers, words or formulas If you want to edit a cell, just click on it and type something new …

10. GEM2508 10 Excel Basics – enter and edit data Formulas start with an ‘=‘ sign. Usually, formula cells display the result of the formula and not the formula itself. However you can see the formula in the formula bar.

11. GEM2508 11 Excel Basics – references The address of another cell can be used in formulas E.g. if we enter the number 4 in cell B2, we can write our formula in cell B3 as: =B2*2.

12. GEM2508 12 View Points But it IS important to be aware that the same data (modeled with the same tools) can mean very different things to different people. Management Investor Bank Supplier Customer …

13. GEM2508 13 Different Perceptions P&L, Balance Sheet Customer Management Investor “All right, I just wish I could do this online” “No need to adapt everything is going well!” “Let’s take over something.” “These guys will be out of business in a year” The Company

14. GEM2508 14 Income Expenses That would give us some idea, but not really enough. Hence we’ll need a little more detail and it is customary to split Income and Expenses up into the main items. Let’s just think of what a company does … Very roughly, from a financial point of view, there are only two things: Money IN and Money OUT. Or, in more proper terms, we have: $ IN $ OUT Elements of the Income Statement

15. GEM2508 15 Sales (a retail or manufacturing operation) Service (a doctor or consulting firm) Interest (an investment firm) Commissions (a money changer or broker) Income In many cases, especially in the case of smaller companies, this is just one or two items depending on the nature of the business $ IN Elements of the Income Statement

16. GEM2508 16 Cost of Sales Wages Interest (on loans) Rent (for office and store space) Taxes … Expenses Usually, there are a least a few categories. Exactly which ones again depends on the nature of the business. $ OUT Elements of the Income Statement

17. GEM2508 17 Let’s have a sneak preview… +Sales -Cost of Sales =Gross Profit -Other Expenses =EBITDA -Interest, Taxes and Amortization =Net Income (hence Profit if + and Loss if -) So many terms … don’t worry, it’s not too bad. We’ll go over them one by one. A quick preview

18. GEM2508 18 Gross Profit This is the first indication of how a company is doing (if this is negative, watch out!). The gross profit is basically the difference between the income from the main line of the business minus the actual cost associated with generating that income. For a shop i.e. : Gross Profit = Sales – Cost of Goods sold. Elements of the Income Statement

19. GEM2508 19 Gross Profit Be careful though! Gross Profit (as is the case with quite a few accounting terms) can be defined in many ways. In the case of a small shop, there will probably be little dispute about what Gross Profit is (sales price – cost price). But how about service or labor intensive industries. In general, wages closely related to e.g. production are included in ‘cost of sales’ but wages of the upper management are not. The question will be: where to draw the line? It is often up to the individual company to decide what exactly is part of the ‘cost of sales’ and what not. Elements of the Income Statement

20. GEM2508 20 EBITDA Earnings before Interest, Taxes, Depreciation and Amortization This is quite a mouthful, but fortunately not as difficult to understand as one would initially think. EBITDA provides important insight into how well the company is doing from an operational point of view. This is also called ‘operating profit’ Let’s have a closer look at the five terms. Elements of the Income Statement

21. GEM2508 21 EBITDA - Earnings This is probably the easiest term. To many, it is just another word for profit. Contrary to profit, however, the term earnings is also used when certain items are excluded (as in EBITDA). Elements of the Income Statement

22. GEM2508 22 EBITDA - Interest Many companies borrow money in order to finance their operation or their expansion plans. Naturally, the companies will need to pay interest on the money they borrow. Sometimes this number can be negative when companies have excess cash. Elements of the Income Statement

23. GEM2508 23 EBITDA - Taxes We all need to pay taxes and so do companies … well most of the time. There are many exceptions and rules of course. Elements of the Income Statement

24. GEM2508 24 EBITDA - Depreciation When a company buys equipment, it is reasonable to spread the costs every year such that the entire cost is accounted for by the time the equipment reaches the end of its useful life. A computer e.g. is often written off over a time period of three years. This means that each year, e.g., one third of the computer’s cost is subtracted from the Gross Profit. Doing this provides a more accurate picture of the true performance of the company. Elements of the Income Statement

25. GEM2508 25 EBITDA – Depreciation continued If a company would write off its equipment in one go, it would incur an unnatural loss in the first year and an unnatural profit in subsequent years. Such a distortion of the financial performance would make it very difficult to judge whether the company is doing well or not. Elements of the Income Statement

26. GEM2508 26 EBITDA - Amortization Basically, this is the same as depreciation but rather than spreading the cost of equipment over a time span, Amortization is the systematic reduction of a lump sum paid or the write off of an intangible asset over time. Example of Lump Sum: Spread out the costs of hiring a ‘super CEO’ over the time of his contract. Example of Write Off: Spread the expenses related to a copyright over the economic lifetime of the copyright. Elements of the Income Statement

27. GEM2508 27 Other Expenses In the end, all expenses need to be accounted for somewhere. Hence everything that is not part of ‘Cost of Sales’ and ‘EBITDA’ is lumped together here. This may include: Wages, Rent, Advertising …. Elements of the Income Statement

28. GEM2508 28 Net Income Net income is the real profit or loss of the company. In other words, the money that the company has earned (unless it’s loosing money of course) for its owners. Elements of the Income Statement

29. GEM2508 29 A convenient table that lists Income and Expenses and sums them up. +Sales -Cost of Sales =Gross Profit -Other Expenses =EBITDA -Interest, Taxes and Amortization =Net Income (hence Profit if + and Loss if -) So what is an Income Statement?

30. GEM2508 30 The data is here, but this is neither very informative nor very easy to understand. An Example in Excel

31. GEM2508 31 This looks a lot better but it’s still not so informative. Use the Center and Merge Button Change the Font Make the subtotal bold Underline before the subtotal An Example in Excel

32. GEM2508 32 A simple income statement is indeed easy to make in Excel! Add the percentage for each row An Example in Excel

33. GEM2508 33 An Example in Excel Why the $ in the formula for the percentages? Wait a moment … Why do the percentages fail to add up? After all shouldn’t “Cost of Sales + Other Expenses + ITDA + Net Income” be 100%?

34. GEM2508 34 Key Points of the Day The Income statement sums up all the income and expenses of a company in a convenient way. It is quite straightforward to put the Income statement into Excel

35. GEM2508 35 References Better than most books!