H O W T O R E A D A N D U N D E R S TAN D Y O U R C O M P A N Y ’ S F I N A N C I A L S T A T EMEN TS

De-Mystify Financial Statements

Beth Bockenhauer, CPA Email: beth@bethbcpa.com Blog: www.bethbcpa.com

Twitter: @bethbcpa Facebook: Go to my website

WELCOME! My objective for this webinar is for you to take away and implement one thing that will make you be a better manager and decision maker using your company’s financial statements.

CASH vs. ACCRUAL

Cash – recognize sale and expense when PAID

Accrual – recognize sale when earned; recognize expense when incurred.

Implications – AR & AP; Customer deposit; Prepaid Expenses

PROFIT AND LOSS

INCOME – GENERATION OF REVENUES

COSTS OF GOODS SOLD These costs are directly related to generation of revenue

Direct labor Direct costs (aka brick and mortar) Retail item costs Costs to construct Costs to provide service These costs are known as variable costs.

PROFIT AND LOSS - GP

INCOME – COST OF GOODS SOLD = GROSS PROFIT Jan - Dec 15 % of Income

Income

Discounts -11.98 -0.01%

Landscaping Services 194,118.30 95.11%

Markup Income 815.00 0.4%

Retail Sales 620.54 0.3%

Service 8,568.00 4.2%

Total Income 204,109.86 100.0%

Cost of Goods Sold

Direct Labor 98,499.96 48.26%

Cost of Goods Sold 7,561.18 3.7%

Total Cost of Goods Sold 106,061.14 51.96%

Gross Profit 98,048.72 48.04% GP%GROSS PROFIT IS ALSO KNOW AS MARGIN

PROFIT AND LOSS - GP

HOW DO YOU ANALYZE GROSS PROFIT? Gross profit (GP) = sales price – costs Gross profit % (GP%) = gross profit/sales price

Markup = Costs * Markup % $15 = $100 * 15% • So the sales price = $115.00

Markup and Margin ARE NOT THE SAME Above example has a Markup of 15%

HOWEVER the GP% = 13% (Gross Profit)/Sales Price = $115 – 100= $15 (GROSS PROFIT)/ $115 = 13%

PROFIT AND LOSS

Act. Cost Act. Revenue ($) Diff. (%) Diff.

Inventory GP GP% MARKUPIrrigation Hose

1/2" Line 77.64 97.05 19.41 20.0% 25.00%1/4" Line 1.05 1.50 0.45 30.0% 42.86%3/4" Line 36.00 54.00 18.00 33.33% 50.00%

Total Irrigation Hose 114.69 152.55 37.86 24.82%

Lighting 836.00 4,098.94 3,262.94 79.6% 390.30%Pump 811.13 1,150.00 338.87 29.47% 41.78%Soil 524.20 676.50 152.30 22.51% 29.05%Sprinkler Hds 686.31 915.45 229.14 25.03% 33.39%Sprkl pipes 4,580.10 5,997.75 1,417.65 23.64% 30.95%

Total Inventory 7,552.43 12,991.19 5,438.76 41.86%

PROFIT AND LOSS

HOW DO YOU ANALYZE GROSS PROFIT? The gross profit is an indicator of a company’s ability to

cover direct costs and have profits remaining to cover overhead (fixed) costs.

Gross profit tells the reader of the financial statement how much gross profit every dollar of revenue a company is earning.

PROFIT AND LOSS - GP

Jan - Dec 15 % of Income

Income

Discounts -11.98 -0.01%

Landscaping Services 194,118.30 95.11%

Markup Income 815.00 0.4%

Retail Sales 620.54 0.3%

Service 8,568.00 4.2%

Total Income 204,109.86 100.0%

Cost of Goods Sold

Direct Labor 98,499.96 48.26%

Cost of Goods Sold 7,561.18 3.7%

Total Cost of Goods Sold 106,061.14 51.96%

Gross Profit 98,048.72 48.04%

Using this example from before, it costs 52 cents to generate $1 dollar of revenue. OR, the company keeps 48 cents for each $1 of revenue generated

A high gross profit indicates that a company has the potential for an overall profit, as long as the company keeps overhead costs in control.

PROFIT AND LOSS - GP

HOW DO I INCREASE GP? Cut costs (the most obvious) Perfect processes – use the right tools Create job budgets (estimates) and analyze to actual for variances Analyze sales prices Is the company absorbing costs that can be passed on to the

customer (shipping, software, administration)? ??? WHAT IF YOU INCREASED GROSS PROFIT BY $100 for 12

CLIENTS/RETAIL ITEMS PER MONTH? This would equate to $1200 (12*$100) is GP/month or $14,400

GP/year that could be used to cover overhead expenses and possibly be realized in profits!!!!

PROFIT AND LOSS

EXPENSES INDIRECT COSTS – OVERHEAD

These costs consist of admin support & office expenses Insurance Occupancy costs (rent, utilities, Internet) Professional support (accounting, legal, consulting) These costs are known as fixed costs

PROFIT AND LOSS - Overhead

As mentioned before, are also referred to as fixed costs; as revenues fluctuate these costs stay relatively the same.

An overhead budget should be created annually to determine how much gross profit needs to be generated.

The monthly actual costs are compared to the budget to analyze the costs controls.

Keep in mind, when budgeting conferences, training, company development costs should be considered.

Also, when preparing the budget, what overhead costs will increase to support the company’s growth. HR, space, technology……..

PROFIT AND LOSS - Overhead

Overhead costs can be expressed as a % of income and this helps to quickly determine the company’s largest overhead expenses.

Uncontrolled overhead expenses can be the demise of a company.

What expenses provide a return? What expenses provide no return? Expenses to be aware of: interest, officer wage,

rent, utilities, office expenses, insurance. ALL OF THEM!

PROFIT AND LOSS – Net Income

REVENUES – COGS – OVERHEAD = NET INCOME Net Income or Operating Profit shows the

efficiency of a company controlling its costs and expenses associated with business operations.

This can be expressed as a percentage sales. Jan - Dec 15 % of Income

Total Income 204,109.86 100.0%

Total COGS 109,176.29 53.49%

Gross Profit 94,933.57 46.51%

Total Expense 60,639.01 29.71%

Net Income 34,294.56 16.8%

For each $1 in revenue earned, the company retained earnings after COGS and Overhead 17 cents.

BALANCE SHEET

Assets Includes what you OWN

Current Assets – Liquid Cash, AR, Inventory Long Term Assets – Useful life > 1 Year: equipment,

vehicles, building, investments, long term receivables

Liabilities What your company OWES

Current Liabilities – Paid in 1 Operating cycle : AP, taxes, credit cards, lines of credit

Long Term Liabilities – Paid over a period > 1 Year: term loans, mortgages, capital leases

BALANCE SHEET

Equity What you HAVE

Common Stock/Partner Equity if a corporation or partnership Owner; Shareholder or Partners’ draws & contributions Retained Earnings – this can be a negative or positive number Positive = the company has a history of profitable years and

has not distributed all profits to owners; “retained profits” Negative = the company has a history of loss years; or the

company has distributed greater than profits earned. Net Income – Net Income is a part of equity. At the end of

each operating cycle net income closes into retained earnings if you are using QB as your accounting software.

Equity = Assets – Liabilities and represents the amount of

money the company owes the owners after all liabilities are paid.

BALANCE SHEET

Profit and Loss helps manage sales and expense. You can not manage your company from just analyzing profit.

The Balance Sheet actually tells more about the company than the P&L. Liquidity AR Collection Health Inventory Health Debt service coverage

BALANCE SHEET - Liquidity

One of the most important ratios is THE QUICK RATIO – this ratio reveals the ability of a

company to pay it’s current obligations. Good Rule of thumb = 1

This means that current assets can pay current liabilities What if the QR < 1- the company has a cash-flow issue and is

unable to meet it’s current obligations. What if the number is much higher than 1? You must

determine how much cash for a rainy day you would like to retain. After that, too much cash on hand becomes a wasted resource and should be invested back in the company or distributed.

BALANCE SHEET - AR

Accounts Receivable Health AR should be monitored regularly.

Referring back to the Quick Ratio that measures liquidity; what if the company has a strong QR but it is because of AR? Well this can be deceiving since AR maybe old an uncollectible.

A/R Turnover Ratio measure how fast a company collects its accounts on credit and reveals the potential for future cash crunches. Turnover = SALES/AVERAGE RECEIVABLES Days = 365/receivable turnover

BALANCE SHEET - AR

EXAMPLE: Average AR = (beginning AR + ending AR)/2 ($3,583 + $141,310)/2 = $72,447

AR Turnover = Sales/Avg AR $202,589/$72,447 = 2.79 x's

How can a company stay in business?

Days Outstanding = 365 days/AR Turnover 365/2.79 = 130.82 DOS

Cash flow problems BEWARE!

BALANCE SHEET - AR

EXAMPLE: Average AR = (beginning AR + ending AR)/2 ($3,583 + $9,650)/2 = $13,233

AR Turnover = Sales/Avg AR $202,589/$13,233 = 15.3 x's

Days Outstanding = 365 days/AR Turnover 365/15.3= 23.85 DOS What can you do to get paid quicker and increase cash-flow? Analyze client!!! Ask questions!!!! Get paid ahead of time, don’t offer terms to slow payers, credit cards, progress bill and MONITOR – don’t let it get past 60 days.

BALANCE SHEET - Inventory

Just like AR – Inventory can be measured to see how quickly inventory turns.

Poor turnover can be a cause of cash-flow problems. Too much cash tied up in Inventory that does not turnover is a buzz-kill!

BALANCE SHEET - Inventory

Example: Average Inv = (beginning Inv + ending Inv)/2 ($2,164 + $6,937)/2 = $4,551 Inventory Turnover = COGS/Avg Inventory $109,176/$4,551 = 23.98 times

Inventory Days = 365/Inv Turnover 365/23.98 = 15.22 days it takes for inventory to turnover

BALANCE SHEET – Fixed Assets

Return on Assets – ROA = net profit/average assets

$33,628/$13,750 = 2.44 What does this mean? For every dollar invested in equipment, the company has a

return of $2.44. The ROA should not decline but if it does it means that the

company is not using its asset wisely; or the company has heavily invested in assets that cannot be put too work.

So, if the company is planning on investing in equipment it should analyze ROA and then determine how much profit the equipment needs to generate to prevent a ROA decline.

May the company has too many vehicles, the building is too large, too many fancy computers, etc.

BALANCE SHEET - Debt

Debt to Equity –It indicates what proportion of equity and debt the company is using to finance its assets. Total LONG term liabilities/Total Equity

$20,213/$225,572 = .089 The result you get after dividing debt by equity is the percentage of the

company that is indebted (or "leveraged").

If a lot of debt is used to finance increased operations (high debt to equity), the company could potentially generate more earnings than it would have without this outside financing.

If this were to increase earnings by a greater amount than the debt cost (interest).

However, the cost of this debt financing may outweigh the return that the company generates on the debt through investment and business activities and become too much for the company to handle. This can lead to bankruptcy, which would leave shareholders with nothing.

CASH FLOW

Cash Management – cannot be managed by just the balance sheet or the profit and loss. Actually cash management has it’s own report known as the Statement of Cash Flow. This is a difficult report to understand.

As an alternative to the Statement of Cash Flow, you can manage cash with a simple Excel spread sheet.

CASH FLOW

The most asked question – Why do I have a profit on my profit a loss report but NO cash?

There are many answers to this question and require analysis of the balance sheet.

What ways can you manage cash? Prepare an annual budget that will project out monthly

expenses and deferred expenses. Deferred expenses are usually overlooked. PLAN for income and expense trends.

Increase your AR turnover. Be aware that new debt will decrease cash pools. Credit cards not used wisely will decrease cash pools. Budget for quarterly tax payments and retirement goals Look for new profit centers

Beth Bockenhauer, CPA Email: beth@bethbcpa.com Blog: www.bethbcpa.com

Twitter: @bethbcpa Facebook: Go to my website

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