"The Income Statement and Cash Flows" in Minneapolis 2011
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Transcript of "The Income Statement and Cash Flows" in Minneapolis 2011
Business Journalism Boot Camp
The Income StatementAnd Cash Flows
Oct. 4, 2011
Donald W. Reynolds National Center For Business Journalism At Arizona State University
Income Statement and Cash Flows
Income Statement and Cash Flows
James K. Gentry, Ph.D. Clyde M. Reed Teaching Professor School of Journalism and Mass Communication University of Kansas [email protected]
Income Statement and Cash Flows
Types of Companies Public Private
Financial statements conforming to public company statements
Non-profits
Income Statement and Cash Flows
Important Terms Unaudited Audited Accountants Certified Public Accountants (CPAs) GAAP, FASB, AICPA, PCAOB
Income Statement and Cash Flows
Assessing a Company Context Trends Rules Outsiders Insiders
Income Statement and Cash Flows
Annual Report (or 10-K) Auditor’s report: Clean, qualified? MD&A or Management’s Discussion
and Analysis Financial statements and footnotes Management’s letter if annual report
Income Statement and Cash Flows
MD&A Must read it Often a source of good information and
insights Densely written Explains financial information SEC says it wants greater transparency
Income Statement and Cash Flows
Goal of Accounting Record, classify and report financial
transactions. To provide managers across the organization with information that facilitates: Control of activities and expenditure Refinement of operational plans Accountability Reporting on project outcomes Writing of bids for new funds
Income Statement and Cash Flows
Goal of Finance Maximize shareholder wealth as
reflected in market price of the stock Achieving this goal requires financial
manager to focus on economic profit, not accounting profit
Income Statement and Cash Flows
Financial Decisions Long-term investment decisions
Capital budgeting: Assets company wants to hold
Long-term financing decisions Capital structure: Funds for long-term
investments Working capital management decisions
Net working capital
Income Statement and Cash Flows
Generally Accepted Accounting Principles Guidelines based on theory and
practice Evolved over time Procedures, concepts and standards
Income Statement and Cash Flows
GAAP: Assumptions Periodicity Going concern Economic entity Monetary unit
Income Statement and Cash Flows
GAAP: Principles Full disclosure Matching Historical cost Revenue realization Consistency
Income Statement and Cash Flows
GAAP: Underlying Considerations Materiality Industry practices Conservatism
Income Statement and Cash Flows
Cash or Operating Cycle Cash Purchase inventory Produce product Sell product Cash
Income Statement and Cash Flows
Cash or Operating Cycle (cont.) “Cash”
Cash Receivables Debt
Inventory Raw materials Work in progress Finished goods
Income Statement and Cash Flows
Cash or Operating Cycle (cont.) Sell product
Accounts receivable Cash
Cash Collect receivables as cash
Pay off payables Start over
Income Statement and Cash Flows
Accrual Method Records revenues as soon as the “sale”
occurs Records expenses as soon as the bill is
received IE, transactions enter the financial
records when they occur, not when cash changes hands
Accrual method, therefore, shows “scores,” not real spendable dollars
Income Statement and Cash Flows
About These Numbers: They’re Squishy Goods will not necessarily be paid for Goods are not necessarily going to be
kept Inventory might be out of date, obsolete
or unsellable Status of some inventory may be
uncertain Intangible assets are estimates
Income Statement and Cash Flows
About These Numbers: They’re Squishy (cont.) Machinery or other fixed assets might be
obsolete or falling apart long before the so-called useful life is up
Goodwill Accounting conventions Timing issues Bottom line: In many ways, statements
are a collection of estimates.
Income Statement and Cash Flows
Because They’re Squishy You need to know the rules and
assumptions used to create the numbers
Income Statement and Cash Flows
Income Statement or ... Statement of earnings Statement of operations Statement of income and
comprehensive income
Income Statement and Cash Flows
Income Statement Covers a period of time, typically a year
or quarter Reports income from ongoing activities Reports income from activities beyond
management’s control (comprehensive income)
Involves estimates
Income Statement and Cash Flows
Basic Income Statement Sales or revenues Expenses Taxes Net income or profit
Income Statement and Cash Flows
Income Statement Sales or revenues Cost of goods sold Gross profit Operating expenses
Sales, general and administrative Depreciation, amortization
Operating profit Other income/expenses Interest Income taxes Net income or profit
Income Statement and Cash Flows
Cost of Goods Sold Expenses incurred in the cost of
manufacturing or creating or acquiring the product the company sells.
Income Statement and Cash Flows
Cost of Goods Sold Manufacturer: What the company pays
for inventory, i.e. raw materials and supplies used to make its product(s). Includes price of raw materials plus cost of turning it into a product, and transportation costs, i.e. direct factory labor, overhead costs, energy costs. Inventory is largest percent of CGS for manufacturer.
Income Statement and Cash Flows
Cost of Goods Sold Retailer: What the company pays
suppliers for the products it sells on its shelves. Only the cost of merchandise purchased for resale, not the cost of providing the service to customers.
Service business: Since it doesn’t make or sell a product per se, typically find a modest CGS.
Income Statement and Cash Flows
SGA Includes office expenses, accounting,
shipping department, advertising, R&D, depreciation and other expenses that can’t be directly attributed to particular items for sale.
Often includes depreciation and amortization.
Income Statement and Cash Flows
Other Income/Expenses Discontinued items Unusual/extraordinary items Changes in accounting principle Impairment charge Sale of investment Minority interest
Income Statement and Cash Flows
Thinking Inside the Box Revenues Minus cost of goods sold Equals gross profit Minus operating expenses Equals operating profit Minus or plus other expenses/income Minus or plus interest expenses/income Minus income taxes Net income
Income Statement and Cash Flows
Inside the Box Earnings Sales or revenues Cost of goods sold Gross profit Operating expenses
Sales, general and administrative Depreciation, amortization
Operating profit
Income Statement and Cash Flows
‘One-Time’ Gains That Reoccur Don’t be fooled by extraordinary items
that make the net income look better than it really is
Extraordinary items should be both unusual in nature and infrequent in occurrence
Examples: Writedowns, restructurings, etc.
Calculating Earnings Per Share
Basic EPS: Net income for period divided by weighted average number shares outstanding.
Diluted EPS: Net income for period divided by weighted average number shares outstanding for period, plus assumption of exercise of all potentially dilutive instruments.
Income Statement and Cash Flows
Income Statement and Cash Flows
Pro Forma Results Expenses against earnings are not
standardized across an industry Selectively defined earnings SEC’s Regulation G (1/03) states that
non-GAAP numbers used in an earnings release must be accompanied by, and reconciled with, the “most directly comparable GAAP number”
Income Statement and Cash Flows
Pro Forma Results
Recommendation: GAAP results should precede pro forma results in earnings releases
Headlines should show GAAP earnings Pro forma has value for many companies Common pro forma: EBITDA “As a matter of form”
Other ‘Nonstandard’ Measures Groupon – Adjusted CSOI or Adjusted
Consolidated Segment Operating Income
Zynga – Bookings Facebook – Monthly active users Pandora – Total listener hours and total
registered users
Income Statement and Cash Flows
Analyzing the Numbers Note changes in amounts year to year,
especially revenues and expenses Note numbers that are significantly larger or
smaller than the previous period Look at trend line for sales/revenues,
operating income and net income. Calculate percentage change for each.
Tie the numbers to the footnotes.
Income Statement and Cash Flows
Income Statement and Cash Flows
Statement of Cash Flows Record of cash provided by cash
sources and of cash consumed by cash uses.
Income Statement and Cash Flows
Cash Flows (cont.) Information about use of cash Information about investing and financing Ability to continue as a going concern Ability to generate future positive cash
flows Ability to meet obligations and pay
dividends
Income Statement and Cash Flows
Cash Flows From operations From investing From financing
Income Statement and Cash Flows
Flexibility Companies have some flexibility in
categories for entries. Total change in cash, however, will not
change. Overwhelming majority of all accounting
standards deal with balance sheet and income statement, not cash flows statement.
Income Statement and Cash Flows
Free Cash Flow Powerful tool for making a company
successful Powerful indicator for investors Cash that is left over after productive
capacity is maintained or expanded Permits expansion, paying down debt,
buying back shares, etc.
Income Statement and Cash Flows
Free Cash Flow (cont.) Several ways to calculate it Companies create their own models Gross way to do it:
Cash from operating activities Minus capital expenditures Equals free cash flow
Income Statement and Cash Flows
American Standard Model
Cash from operating activities Minus capital expenditures Plus proceeds from disposal of property Plus proceeds from sale and
leasebacks Equals free cash flow
Free Cash Models ‘Gross’ method American Standard method VF method
Cash from operating minus cash from investing
Income Statement and Cash Flows
Income Statement and Cash Flows
Techniques Calculate percentage change Trend analysis Common size analysis Ratio analysis