UNDERSTANDING FINANCIAL STATEMENTS FOR BUSINESS … · Understanding the essential difference...
Transcript of UNDERSTANDING FINANCIAL STATEMENTS FOR BUSINESS … · Understanding the essential difference...
UNDERSTANDING FINANCIAL STATEMENTS FOR BUSINESS LAWYERS, PART 1
& PART 2
First Run Broadcast: October 16 & 17, 2012
1:00 p.m. E.T./12:00 p.m. C.T./11:00 a.m. M.T./10:00 a.m. P.T. (60 minutes)
There are deep interrelationships between financial statements and the documents underlying
business deals. Understanding financial reports – cash flow versus income, tax versus
accounting books, the quality of earnings and analytical ratios – is essential to both due diligence
on a transaction and drafting the operative agreements. Without a confident understanding of
balance sheets and income statements, an attorney cannot help ensure that a client is getting the
benefit of his or her economic bargain. This two-part program will provide you with a practical
guide to financial statements and how they specifically relate to, and sometimes create traps in,
major and routine business transactions, including business mergers, commercial borrowing, and
the sale of business ownership interests.
Day 1 – October 16, 2012:
Most important concepts in business finance and financial statements, and how they
relate to transactional documents
Understanding the components of a company’s capital structure
What does – and doesn’t – a balance sheet tell you?
Understanding the essential difference between earnings v. cash flow/EBIDTA
Relationship of financial statements to reps, warranties, financial covenants
Accounting books v. tax books, and how the difference effects sales of business interests
Day 2 – October 17, 2012:
Understanding ratio analysis in financial statements
Spotting red flags in balance sheets and income statements
Quality of earnings and how that impacts financing a deal and structuring earnouts
How do you better protect investors and parties to a deal
Building regular valuations into business documents
Working with auditors & understanding audit standards
Speaker:
C. Travis Webb is the managing partner of the Denver office of BKD, LLP, a national
accounting and consulting firm. Mr. Webb has nearly 20 years’ experience covering a diverse
set of services such as financial statement audit, Sarbanes-Oxley internal control services,
complex financial modeling and fraud and information technology consulting. He serves a client
base of commercial, service and distribution entities and not-for-profit and governmental
organizations. Mr. Webb received his B.S. in accounting and his M.B.A. from Missouri State
University in Springfield.
VT Bar Association Continuing Legal Education Registration Form
Please complete all of the requested information, print this application, and fax with credit info or mail it with payment to: Vermont Bar Association, PO Box 100, Montpelier, VT 05601-0100. Fax: (802) 223-1573 PLEASE USE ONE REGISTRATION FORM PER PERSON. First Name: _____________________ Middle Initial: _____Last Name: __________________________
Firm/Organization:____________________________________________________________________
Address:___________________________________________________________________________
City:__________________________________ State: _________ ZIP Code: ______________
Phone #:________________________ Fax #:________________________
E-Mail Address: ____________________________________________________________________
I will be attending:
Understanding Financial Statements
for Business Lawyers, Part 1 Teleseminar
October 16, 2012
Early Registration Discount By 10/09/2012 Registrations Received After 10/09/2012
VBA Members: $70.00 Non VBA Members/Atty: $80.00
VBA Members: $80.00 Non-VBA Members/Atty: $90.00
NO REFUNDS AFTER OCTOBER 9, 2012
PLEASE NOTE: Due to New Hampshire Bar regulations, teleseminars cannot be used for New Hampshire CLE credit
PAYMENT METHOD:
Check enclosed (made payable to Vermont Bar Association): $________________ Credit Card (American Express, Discover, MasterCard or VISA) Credit Card # ________________________________________Exp. Date_______ Cardholder: ________________________________________________________
Vermont Bar Association
ATTORNEY CERTIFICATE OF ATTENDANCE
Please note: This form is for your records in the event you are audited Sponsor: Vermont Bar Association Date: October 16, 2012 Seminar Title: Understanding Financial Statements for Business Lawyers, Part 1 Location: Teleseminar Credits: 1.0 General MCLE Luncheon addresses, business meetings, receptions are not to be included in the computation of credit. This form denotes full attendance. If you arrive late or leave prior to the program ending time, it is your responsibility to adjust CLE hours accordingly.
VT Bar Association Continuing Legal Education Registration Form
Please complete all of the requested information, print this application, and fax with credit info or mail it with payment to: Vermont Bar Association, PO Box 100, Montpelier, VT 05601-0100. Fax: (802) 223-1573 PLEASE USE ONE REGISTRATION FORM PER PERSON. First Name: _____________________ Middle Initial: _____Last Name: __________________________
Firm/Organization:____________________________________________________________________
Address:___________________________________________________________________________
City:__________________________________ State: _________ ZIP Code: ______________
Phone #:________________________ Fax #:________________________
E-Mail Address: ____________________________________________________________________
I will be attending:
Understanding Financial Statements
for Business Lawyers, Part 2 Teleseminar
October 17, 2012
Early Registration Discount By 10/10/2012 Registrations Received After 10/10/2012
VBA Members: $70.00 Non VBA Members/Atty: $80.00
VBA Members: $80.00 Non-VBA Members/Atty: $90.00
NO REFUNDS AFTER OCTOBER 10, 2012
PLEASE NOTE: Due to New Hampshire Bar regulations, teleseminars cannot be used for New Hampshire CLE credit
PAYMENT METHOD:
Check enclosed (made payable to Vermont Bar Association): $________________ Credit Card (American Express, Discover, MasterCard or VISA) Credit Card # ________________________________________Exp. Date_______ Cardholder: ________________________________________________________
Vermont Bar Association
ATTORNEY CERTIFICATE OF ATTENDANCE
Please note: This form is for your records in the event you are audited Sponsor: Vermont Bar Association Date: October 17, 2012 Seminar Title: Understanding Financial Statements for Business Lawyers, Part 2 Location: Teleseminar Credits: 1.0 General MCLE Luncheon addresses, business meetings, receptions are not to be included in the computation of credit. This form denotes full attendance. If you arrive late or leave prior to the program ending time, it is your responsibility to adjust CLE hours accordingly.
PROFESSIONAL EDUCATION BROADCAST NETWORK
Speaker Contact Information
Understanding Financial Statements for Business Lawyers,Part 1 & Part 2
Travis WebbBKD, LLP – Denver(o) (303) [email protected]
Matt KlauserBKD, LLP – Kansas City(o) (816) [email protected]
acumen
insight
ideas
attention
reach
expertise
depth
agility
talent
Financial Statements for
Transactional Attorneys
What You Need to Know
Session One
Goals
Improve General Understanding of
Financial Statements
Provide Tips on Challenging the #’s
Share Transactional Observations
2
Presenters C. Travis Webb, CPA
Managing PartnerTravis brings more than 18 years of experience to BKD and our
clients. He serves a client base of commercial, service and
distribution entities and not-for-profit and governmental
organizations. Travis has been a firmwide audit and accounting
technical advisor, a Sarbanes-Oxley internal control consultant,
and a fraud and information technology resource. B.S. degree
from Missouri State University, Springfield.
Mathew Klauser, CPA, CM&AA®
Managing ConsultantMatt provides financial planning, consulting and advisory
services. He assists private equity groups and corporate
acquirers during investment decisions and post-acquisition
integrations. Matt provides guidance in structuring and
negotiating letters of intent, completes in-depth due diligence
procedures and performs net working capital adjustments post-
closing. B.A. degree from Drury University, Springfield,
Missouri.
3
Session One Outline
Understanding Basic Financial Concepts –
Base Lining the Discussion
Stories a Balance Sheet Tells
Earnings vs. Cash Flow vs. EBITDA
4
Session Two Outline
Looking at Capital Structure
Tax Considerations
Reliance on Financials
Ratios and Financial Statement Analysis
Quality of Earnings & Transactional
Lessons
Valuations
5
Typical Legal Audiences
• Business litigation
• Contract disputes (business damage)
• Intellectual property
• Patent, trademark, trade name infringement
• Divorce
• Business interruption
• Bankruptcy
• Transactional
6
UNDERSTANDING
FINANCIALS
7
Rule Makers
FASB and IASB
GAAP and IFRS
The codifications
PCAOB and AICPA
8
Financial Statements
Type
Public vs. Private
NFP & Governmental
Types of Private Financials
Generally Accepted Accounting Principles
(GAAP)
Cash, Tax and Other
9
Financial Harmony
• Like Yin & Yang, there must be harmony
Debit = Credit
• Tells the story of what a company owns,
owes and earns
Assets Revenues & Expenses
Liabilities & Equity Net Results
10
Financial Statement Map
Opinion
Basic Statements
Balance Sheet, Profit & Loss, Cash Flow
Footnotes
Supplementary Information
Consolidating information, detailed expenses,
etc.
11
Basic Statements
Balance Sheet @ 12/31 Profit & Loss - Yr. End 12/31
Assets $100 Revenues $ 100
Liabilities $ 50 Expenses $( 75)
Equity $ 50
Total Liab. & Equity $100 Net Results $ 25
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Basic Statements
Statement of Equity Cash Flows
Beginning Equity $ 25 Results $ 25
Activities
Results $ 25 Operating $ (10)
Other $ – Investing $ (15)
Financing $ 20
Ending Equity $ 50 Net Cash $ 20
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Big Picture Considerations
Balance Sheet
Point in time
Not fair value (necessarily)
Profit & Loss
Performance over time
Activity, but not necessarily cash
Cash Flow Statement
Bridge for Balance Sheet to Profit & Loss
How’s a Company truly funded?
14
Footnotes
Significant Account Policies
Details on Major Line Items
Debt and Capital Asset Disclosures
Risks and Uncertainties
Litigation and Other Exposures
15
Basic Principles
Accrual vs. cash
Cost Basis vs. Fair Value
Matching principle
Consistency
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Management Letters
What else do you need to know…
Defining problems
Material Weakness
Significant Deficiency
Other Deficiencies
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BALANCE SHEET
EXPOSURES
18
Accounts Receivable
Collectability of aged AR
Concern with specific customers?
Rollforward of allowance
Bad debts being replenished to offset
write-offs?
Allowance increase due to economic
uncertainty?
19
Understanding Inventory
When does Inventory not equal Inventory
FIFO, LIFO, Obsolescence, Valuation
Bill and Hold challenges
Cost build up of manufactured inventory
Cost of Goods Sold Variances
20
Capital Assets
Land, Buildings, Equipment, Capital
Leases and Intangibles
Fair Value vs. Stated Value
Types of depreciation
Impairment
Tax basis considerations
21
Accruals and Contingencies
Recognition rules
Vacation accruals
Pensions and Profit Sharing
Reserves and IBNR’s
Revenue recognition – deferrals and
commitments
22
Off Balance Sheet
Contingencies
Leases
23
Other Considerations
Subsidiaries and variable interests
Which assets/liabilities should and should
not be transferred?
Growth financing considered for
companies with large working capital
needs?
24
EARNINGS / CASH FLOW /
EBITDA
25
Basic Considerations
Cash in
Cash out
Cash commitments
26
What Does a Cash Flow
Statement Say?
Direct vs. Indirect
Impact of Working Capital
27
Unfavorable Cash Flow
Trends Transactions based on EBITDA still dependent
on cash flow
Reconcile reported to adjusted financial
statements
Understand changes in discretionary expenses
Working capital trending analysis
Line of credit needs
Cash conversion cycles
28
Session One Outline
Understanding Basic Financial Concepts –
Base Lining the Discussion
Stories a Balance Sheet Tells
Earnings vs. Cash Flow vs. EBITDA
29
Session Two Outline
Looking at Capital Structure
Tax Considerations
Reliance on Financials
Ratios and Financial Statement Analysis
Quality of Earnings & Transactional
Lessons
Valuations
30
QUESTIONS & ANSWERS
31
acumen
insight
ideas
attention
reach
expertise
depth
agility
talent
Financial Statements for
Transactional Attorneys
What You Need to Know
Session Two
Presenters C. Travis Webb, CPA
Managing PartnerTravis brings more than 18 years of experience to BKD and our
clients. He serves a client base of commercial, service and
distribution entities and not-for-profit and governmental
organizations. Travis has been a firmwide audit and accounting
technical advisor, a Sarbanes-Oxley internal control consultant,
and a fraud and information technology resource. B.S. degree
from Missouri State University, Springfield.
Mathew Klauser, CPA, CM&AA®
Managing ConsultantMatt provides financial planning, consulting and advisory
services. He assists private equity groups and corporate
acquirers during investment decisions and post-acquisition
integrations. Matt provides guidance in structuring and
negotiating letters of intent, completes in-depth due diligence
procedures and performs net working capital adjustments post-
closing. B.A. degree from Drury University, Springfield,
Missouri.
33
Session Two Outline
Looking at Capital Structure
Tax Considerations
Reliance on Financials
Ratios and Financial Statement Analysis
Quality of Earnings & Transactional
Lessons
Valuations
34
CAPITAL STRUCTURE
35
Legal Formation
Corporation – C or S Corp or LLC
Partnerships and Joint Ventures
36
Typical Components
Common and other Stock or Partnership /
Member Equity
Additional Paid in Capital
Retained Earnings
Minority Interests
Other Stock Rights
Warrants, options, phantom rights, etc.
37
TAX CONSIDERATIONS
38
Tax Issues to Consider
Flow Thru vs. C Corp
Timing Differences – Understanding the
M’s
Taxes other than income taxes
State nexus and other issues
Uncertain tax positions
39
RELIANCE ON FINANCIALS
40
Typical Levels of Reliance
Tax Returns
Internal Statements
Compiled
Reviewed
Audited
What’s the Quality of Your Review
41
Differentiating Accountant’s
Reports The different levels of reliance
Concept of Materiality
Below the surface – quality of the work
performed
Types of audit opinions
Unqualified vs. Unmodified, etc.
Due Diligence relative to an audit
42
Due Diligence
Purpose of an audit
Accuracy of reported financial statements
Applies materiality
Purpose of due diligence
Accuracy of normalized financial statements
Adjustments must be considered in light of
purchase price multiple
43
Consideration of Fraud
Auditor’s responsibility
Common Concerns
Overstated revenues
Manipulating estimates
Capitalization rather than expense
Misappropriation
44
Interim Financial Statements
Different month-end and year-end closing
procedures?
Can interim statements be relied on for
closing?
Consider impact of posted and passed
audit adjustments from prior years
45
RATIOS AND STATEMENT
ANALYSIS
46
Analyzing Financials
Horizontal (trend) Analysis – Multi-Year
Vertical (ratio) Analysis – Sales / Assets
Watching for trends
Gross margins
Cash Flows
Unusual changes
47
Basic Ratios
Working Capital
Return on assets / equity
Other important ratios
Asset turnover (utilization)
Average receivable collection period
Gross profit %
EBITDA %
48
QUALITY OF EARNINGS &
TRANSACTIONAL LESSONS
49
Proof of Revenues
Provide comfort, particularly if unaudited
Compare net revenues to cash receipts
Evaluate validation needed to gain comfort
50
Things to Watch For…
Nonrecurring expenses
Personal expenses, officer compensation…
Financial related, but not reported
Nonfinancial due diligence
Relationships Vendors, customers, suppliers
Unrecorded agreements Related party transactions
Sales “understandings”
Conservative vs. appropriate
51
Document Considerations
References to GAAP
Current or Future?
Is that what you really want (subject tointerpretation)
Poor terminology
Structuring an LOI
Avoid specific targets – build flexibility andprotection
Working Capital Needs – Post-Close
52
Budgeting
How consistent are historical results with
budgeting – future is often more critical than the
past
Sensitivity of assumptions?
How repeatable are the results?
What’s the impact of a backlog?
How do historical and budgeted results compare
to industry benchmarks?
53
Business Combinations
Understand how financials of an acquirer
are impacted
Historical basis vs. Step Up
Appropriate cut-off
54
VALUATIONS
55
Considerations
Normalized, not reported earnings
Seller aggressive “add-backs”
EBITDA multiples
What’s the “value” of the management
team
Relevant for post-close salaries, etc.?
56
QUESTIONS & ANSWERS
57
Thank You
Contact Us
Travis Webb
Colorado Managing Partner
1700 Lincoln Street
Suite 1400
Denver, CO 80203
303.861.4545
FAX 303.832.5705
Matt Klauser
Managing Consultant
1201 Walnut Street
Suite 1700
Kansas City, MO 64106
816.221.6300
FAX 816.221.6380
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