Understanding the Numbers: Essential for

the Entrepreneur

UnderstandingFinancial Statements

• Goal: Understand the financial consequences of decisions

• What are the three basic financial (or accounting) statements?– Income Statement– Balance Sheet– Cash Flow Statement

The Goal: Making Good Financial Decisions

3 types of financial statements

Income Statement

Sales Revenue

Cost of Goods Sold

Operating Expenses

Gross Profit

Operating Income

Interest Expense

Operating Income

Earnings Bef Taxes

Income Taxes

Net Income

Op

erat

ing

Act

ivit

ies

Fin

anci

ng

Act

ivit

ies

minus

minus

minus

minus

equals

equals

equals

equals

What is the format of an income statement?

.

Income StatementAn Example

The Income Statement for Trimble & Associates:

Sales $850

Cost of Goods Sold 550

Gross Profit on Sales $300

Operating Expenses:

Marketing Expenses 90

General & Admin Expenses 80

Depreciation 30

Total Operating. Expenses $200

Operating Income 100

Interest Expense 20

Earnings Before Tax 80

Income Tax (25%) 20

Net Income 60

Income from operating the business

Income after \paying interest

Cost of borrowing

Income Statement Can You Put It Together?

Cost of Goods Sold $250

Depreciation $ 8

Sales $290

Income Taxes(25%) $ 2

Admin. &Sales Exp. $ 18

Interest Expense $ 6

Organize this Income statement Put the pieces where they go!!4. Good judgment

Gross Profit on Sales $

Operating Expenses:

Total Op. Exp. $

Operating Income $

Earnings Before Taxes $

Net Income $

Gross Profit on Sales $

Operating Expenses:

Total Op. Exp. $

Operating Income $

Earnings Before Taxes $

Net Income $

Here You Go!

Cost of Goods Sold $250

Depreciation $ 8

Sales $290

Income Taxes(25%) $ 2

Admin. &Sales Exp. $ 18

Interest Expense $ 6

Depreciation $ 8

Sales $290

Income Taxes(25%) $ 2

Admin. &Sales Exp. $ 18

Interest Expense $ 6

Cost of Goods Sold $25040

26

14

8

6

Balance Sheet

What is the basic format of a balance sheet?

• In its simplest form, the Balance Sheet is:

Total assets always equal debt plus equity.

Total Assets

Owner’s Equity

Outstanding Debt

Debt & Equity

= +

Balance Sheet

Describe the 3 main parts of a balance sheet.

• Assets– What the company owns

• Liabilities (Debt)– What the company owes

• Owner’s Equity (Net Worth)– Amount invested by the owners

Basic pieces of the balance sheet

Continue

What does the balance sheet tell us?

• A Snapshot of a company’s financial position at a specific point in time

How is it different from an income statement?

• The Income Statement covers a period in time (Jan 1 – Dec 31, 2007)

• The Balance Sheet represents a specific moment (December 31, 2007)

Balance Sheet Income Statement and Balance Sheet

The Income Statement and Balance Sheet complement each other

Jan

uar

y 1

Dec

emb

er 3

1

Balance Sheet on December 31, 2006

Balance Sheet on December 31, 2007

YEAR 2007

Income Statement for 2007

Balance Sheet

What are the 3 types of assets?• Current assets, consisting of?

• What is the nature of current assets?

They are cash or moving toward cash.

Balance Sheet

• Fixed assets include:– Machinery and Equipment– Buildings and Land

• The cost of a depreciating fixed asset is recorded in the balance sheet as an asset (not an expense) and depreciated over its useful life.

• Other assets include such things as:– Patents– Copyrights– Goodwill

OK, enough about assets.

Now let’s look at how they are financed

Balance Sheet Debt or Liabilities

What is debt?• Financing provided by a creditor

• Debt is divided in two parts:– Current debt or short-term

liabilities– Long-term debt

Where does debt

come from?

Balance Sheet Owners’ Equity

What is owners’ equity?• Money invested by the owners, as the

esidual owners.

• Equity consists of what?– Amount invested when purchasing

ownership in the business– Retained Earnings: All the profits

retained in the company (profits not paid out in dividends to the owners)

Owners have 2 ways to invest in a business:•Buy stock•Reinvest all or part of the firm’s profits

Balance Sheet Owners’ Equity

Let’s say it again! Retained Earnings is the accumulated profits (gains-losses) of the business, less the dividends paid to stockholders since the firm was created

Owners’ Equity

Cumulative Profits

Owners’ Investment

Cumulative Dividends

Retained Earnings

Owners’ Equity

Owners’ Investment

Retained earnings: A concept that many students fail to understand. Do you?

Balance Sheet () An Example

ASSETS DEBT AND EQUITY Current Assets Current Liabilities:

Cash $50 Accounts payable $20

Accounts receiv 80 Short-term notes 80

Inventories 220 Total current debt $100

Total current assets $350 Long-term debt 200

Fixed assets: Total debt: $300

Gross fixed assets $960 Common stock $300

Accum depreciation -390 Retained earnings 320

Net fixed assets $570 Total common equity $620

TOTAL ASSETS $920 TOTAL DEBT AND EQUITY $920

The Balance Sheet for Trimble & Associates:

Balance Sheet Can you put itd together?

Given the information below, can you arrange the balance sheet?Remember: ASSETS = LIABILITIES + EQUITY

Cash $ 70

Accounts Receivable $ 220

Inventories $ 310

Total Current Assets $ 600

Gross Fixed Assets $2,500

Accumulated Depreciation $(300)

Net Fixed Assets $2,200

Assets:Current Assets

Fixed Assets

TOTAL ASSETS $ 2,800

FIRST: ASSETS

Cash $ 70

Accounts Receivable $ 220

Inventories $ 310

Total Current Assets $ 600

Gross Fixed Assets $2,500

Accumulated Depreciation $(300)

Net Fixed Assets $2,200

Balance Sheet Putting it together

Common Stock $ 900

Long-term debt $ 800

Total Owners’ Equity $1,750

Total Debt $1,050

Total Current Liabilities $ 250

Short-term Notes $ 20

Accounts Payable $ 230

Liabilities:Current Liabilities:

Owners’ Equity:

TOTAL DEBT&EQUITY $ 2,800

NEXT: DEBT & EQUITY

Retained Earnings $ 850

Common Stock $ 900

Long-term debt $ 800

Total Owners’ Equity $1,750

Total Debt $1,050

Total Current Liabilities $ 250

Short-term Notes $ 20

Accounts Payable $ 230

Retained Earnings $ 850

Balance Sheet All Together

The complete balance sheet is as followsAssets:Current Assets

Fixed Assets

TOTAL ASSETS $ 2,800

Liabilities:Current Liabilities:

Owners’ Equity:

TOTAL DEBT&EQUITY $ 2,800

Cash $ 70

Accounts Receivable $ 220

Inventories $ 310

Total Current Assets $ 600

Gross Fixed Assets $2,500

Accumulated Depreciation $ 300

Net Fixed Assets $2,200

Common Stock $ 900

Long-term debt $ 800

Total Owners’ Equity $1,750

Total Debt $1,050

Total Current Liabilities $ 250

Short-term Notes $ 20

Accounts Payable $ 230

Retained Earnings $ 850

Cash Flow Statement

“Cash is King!!Cash flow problems is a major reason for small firms failing—even at times when

the business is profitable.

Run out of cash

and your business will fail!

CASH IS KING is not some cliché, but a principle you cannot afford to violate!

Cash Flow Statement Accrual versus Cash Accounting

• What is the difference between accrual-basis accounting and cash-basis accounting?

• So what?

Cash Flow Statement

“What question does the cash flow statement answer?

“Where did the cash come from and where did the

cash go?”

Cash Flow Statement

Where does the information come from to prepare a cash flow statement?•Income statement•All the changes in the balance sheets from the beginning of the year to the end of the year

– Except changes in accumulated depreciation and retained earnings

Cash Flow Statement

• Cash inflows and outflows result from three activities:– Operating Activities:

Cash flow from normal operations– Investment Activities:

Cash flow related to the investment in or sale of assets

– Financing activities:

Cash flow related to financing the firm

Three activities cause cash to increase or decrease

Cash Flow Statement Operating Activities

• Cash flow from operations consists of the net flow of cash from day-to-day business activities

• Start with Operating income• Add back Depreciation expense

(a non-cash expense)

• Subtract income taxes(to work on an after-tax basis)

• Subtract increase in net working capitalWhich consists of:

– Increase in A/R (a use of cash)– Increase in inventories (a use of cash)– Decrease in A/P (a source of cash)

What is cash flow from opera- tions?

Cash Flow Statement Investment Activities

• Investment activities consist of – The purchase or sale of fixed assets

(change in gross fixed assets)– The purchase or sale of other long-term

assets (changes in goodwill, patents, etc.)

What is cash flow from investment activities?

Cash Flow Statement Financing Activities

Financing activities include:– Paying dividends and interest expense– Increasing or decreasing short-term and

long-term debt• Increase: borrowing more money• Decrease: paying off debt

– Owners invest more or less in business • Buy more stock• Company buys owner’s stock back

What is cash flow from financing activities?

Cash Flow Statement Cash Flow Statement for Trimble AssociatesOperating Activities

Operating income $ 100Plus depreciation 30Less income taxes (20) $ 110Change in net working capital:Less increases in A/R $ (5)Less increases in inventories (40)Plus increases in A/P 5 (40)Cash flows from operations $ 100

Investment ActivitiesLess increase in gross fixed assets $ (100)

Financing ActivitiesLess interest expenses $ (20)Less dividends paid (15)Plus incr in short-term notes 20Plus incr in long-term notes 50Total Financing Activities $ 35

Increase (Decrease) in cash $ 5

Cha

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Cash Flow Statement Can You Arrange this Cash Flow Statement?

Operating activities:

PlusLessLessLessPlusCash flows from operations:

Investment activitiesLess

Financing activitiesLessLessPlusPlusTotal financing activities

Increase (Decrease) in cash

Operating Income $120

Depreciation $ 40

Taxes $(30)

Increases in accts receivable $(20)

Increases in inventories $(10)

Increases in accounts payable $ 5

Increase in gross fixed assets $(90)

Interest expenses $(30)

Increases in short-term notes $ 15

Increases in long-term notes $ 30

Dividends paid $(10)

$100

$ 5

$ 100

$ (90)

$ 5

$ 15