What is a Financial Statement?

A financial statement is a quantitative way of showing how a

company is doing.
Three different ways of representing the financial state of a
company:
1. Cash Management (can the company meet its
obligations?)
2. Profitability (Is it making money?) - the income statement
3. Assets versus Liabilities (what is the value of the
company? Who owns what?) - the balance sheet
Each one of these questions is answered by our Financial
Statements.
 The Big Three

 Cash Flow Statements

 Theseanswer the important
managerial question “do I have
enough cash to run my business”
 Income Statements
 This
is the financial sheet that tells you if
your company is profitable or not.
 Balance Sheets
 How much debt do I have? How large
are my assets? This sheet tells you the
answer to these questions.
 Cash Flow
Statements
 A report of all a firm’s transactions that involve
cash
 The key elements are revenues (money flowing
in) and expenses (money flowing out).
 Cash flow statements compare the sum of the
revenues to the sum of the expenses on a
regular time basis – usually monthly.

“Manning Electronics” (Engineering 9) – Did Ms.

Manning have enough cash to buy that piece of
equipment for her boat business?
What are Revenues?

 Sales
 Interest from firm’s investments (e.g., a company
savings account)
 Royalty and Licensing payments for appropriate
use of firm’s intellectual property

Another source of cash inflow, but not a revenue

is the cash the firm receives from borrowing
money.
Variable Costs

 Materials Cost
 Supplies
 Production Wages
 Outside / Contracted labor
 Advertising (*)
 Sales Commissions / Distribution Costs
 Equipment Maintenance
 Other things that depend on the number of units
produced (e.g. royalties paid)
Cumulative Cash Flow -
Cash Balance
 Just like the average person keeps their checking
account balance – a firm also needs to know
their cumulative cash flow or cash balance.
 It is an easy calculation – simply take the
cumulative cash flow from this month and add it
to the previous month’s cash balance.
 Your very first month’s cumulative cash balance is
your first month’s monthly cash flow added to
your start-up capital (probably an initial loan or
first round financing).
 EBIDT

Your EBIDT (Earnings Before Interest Depreciation

and Tax) is
Total Revenues – All Costs that are not
depreciable
EXPENDITURES (outflow)
MATERIALS COST AND MFG. LABOR
Non-depreciable Costs SALES COMMISSIONS
COST OF GOODS SOLD (COGS)

GROSS MARGIN

SALARY AND BENEFITS OF CEO

SALARY AND BENEFITS OF ASSISTANT
RENT
TELEPHONE AND OTHER
ADVERTISING
Capital Equip. (Depreciable Costs) EQUIPMENT
TOTAL FIXED COSTS

EBITD = Revenues – (COGS + Salary + Rent + Phone +

Advertising)
Calculating Depreciation
1. Continue depreciation on items purchased in earlier years,
using previously established methods
2. Sum up all of that fiscal year’s capital expenses
3. Decide which method of Depreciation your firm wants to use
(Straight Line or Accelerated)
4. Determine the useful lifetime for the assets
5. Determine the salvage value
6. Use the formulas to calculate depreciation on new
equipment
7. Add up all depreciation contributions

NOTE: while EBIDT may be a monthly figure – since taxes and

depreciation are only calculated once a year – EBIT, EBI,
and net earnings MUST be Year-End numbers.
Calculating Taxes

 Take the EBIDT and subtract the depreciation –

this yields Earnings Before Interest and Tax
 Then calculate profit (or earnings) before taxes by
subtracting interest expenses.
 Then multiply the profit before taxes by your
effective tax rate – that will give the corporate
income taxes the firm owes.
Cash Flow versus Income
Statements
 Note that the final Net Earnings number for both
the final month of the cash flow statement is
exactly the same as the year-end Net Earnings
total for the Income Statement, reflecting the
same time period Sep-00 Oct-00 Nov-00 Dec-00 Operating Information
REVENUES (inflow)
SALES $22,000.00 $28,000.00 $35,000.00 $46,000.00
INTEREST $39.14 $85.66 $153.62 $246.65 Net Earnings $ 172,593.77
RECEIPTS $22,039.14 $28,085.66 $35,153.62 $46,246.65

EXPENDITURES (outflow) Expenses

MATERIALS COST AND MFG. LABOR $1,100.00 $1,400.00 $1,750.00 $2,300.00 Cost of Goods Sold $ 25,725.00
SALES COMMISSIONS $2,200.00 $2,800.00 $3,500.00 $4,600.00
COST OF GOODS SOLD (COGS) $3,300.00 $4,200.00 $5,250.00 $6,900.00 Total Salary/Benefits $ 60,000.00
Advertising $ 24,000.00
GROSS MARGIN $18,739.14 $23,885.66 $29,903.62 $39,346.65
Rent $ 6,000.00
SALARY AND BENEFITS OF CEO $3,000.00 $3,000.00 $3,000.00 $3,000.00 Other $ 900.00
SALARY AND BENEFITS OF ASSISTANT $2,000.00 $2,000.00 $2,000.00 $2,000.00
RENT $500.00 $500.00 $500.00 $500.00
TELEPHONE AND OTHER $75.00 $75.00 $75.00 $75.00 EBIDT Profits $ 55,968.77
ADVERTISING $2,000.00 $2,000.00 $2,000.00 $2,000.00 Depreciation $ 4,500.00
EQUIPMENT $0.00 $0.00 $0.00 $0.00
Taxes $ 23,160.95
TOTAL FIXED COSTS $7,575.00 $7,575.00 $7,575.00 $7,575.00

MONTHLY CASH FLOW $11,164.14 $16,310.66 $22,328.62 $31,771.65 AFTER TAX PROFIT $ 28,307.82
ENDING CASH BALANCE $20,557.84 $36,868.50 $59,197.12 $90,968.77

EBIDT* PROFITS $11,164.14 $16,310.66 $22,328.62 $31,771.65 Accumulated Interest Expenses $ 6,800.00
CUMULATIVE EBIDT* PROFITS ($14,442.16) $1,868.50 $24,197.12 $55,968.77
Depreciation Expense for Tax Purposes $4,500.00
EBIT Profits $51,468.77 Earnings After Accumulated Interest $ 21,507.82
Taxes $23,160.95
EBI Profits $28,307.82

NET EARNINGS FOR YEAR (PROFIT AFTER TAX) $21,507.82

Comparison (cont.)

 Further the Income Statement’s year-end figures

for COGS, Salary, Rent, Advertising, and sales
should be the 12 month totals of the cash-flows
corresponding to the respective line item
 Likewise, depreciation and taxes should be equal
for that fiscal year
Balance Sheets

 Unlike Cash-Flow and Income Statements,

Balance Sheets lists ASSETS and LIABILITIES

 Examples of Assets include:

 Land and Capital Equipment less accrued
depreciation
 Intellectual Property (if purchased)
 Cash on Hand (which is equal to the year end
Cumulative Cash Balance)
 Accounts Receivable
 Inventory
 Retained Earnings from Previous Years
Balance Sheets (cont.)

 Examples of Liabilities include:

 Short Term Debt (loans)
 Long Term Debt (bond issues, etc)
 Accounts Payable
 Interest Payable
 Taxes Payable

 The difference between Assets and Liabilities is

your EQUITY
 Some Basics of Accounting
 The orderly reporting of the financial activities of a business
 Most commonly visible forms
 Balance Sheets
 Income Statements
 Used by management, investors,
creditors, government to monitor
business activity
The Process of Accounting
 An orderly recording of all financial transactions (by hand or
electronically)

Business document is
Business Transactions
prepared, e.g. order
form, invoice

Debits and credits

posted to accounts in Information entered
a ledger chronologically into a
journal

Financial statements
prepared -- balance
sheet & income
statement
Some Accounting
Concepts
and Terminology
 Dual Aspect Concept
Embodies the notion that
Assets = Equities or
Assets = Liabilities + Owner’s equity
 Need to always record for a transaction
- what gets “credit” for something and what gets “charged”
 Debit (Dr) - arbitrarily the left hand side of an account
 Credit (Cr) - the right hand side
 “To debit” - make a left hand side entry
 “To credit” - make a right hand side entry
Some Accounting
Concepts
and Terminology con’t
 Debit balances must equal credit
balances
 From conventional layout of accounting statements
 Increases in assets are debits (decreases credits)
 Increases in liabilities are credits
 Increases in owner’s equity are credits
 Increases in expenses are debits
 Increases in revenues are credits
 Other Concepts
 Money Measurement Concept - Accounting records show only
facts that can be expressed in terms of money. A company’s
good name does not get reflected on a balance sheet, unless the
company is sold and a value can be put on the good name
(Goodwill)
 Going Concern Concept - There is a presumption of an indefinite
period of operation of a company (no defined end date)
 Cost Concept - Assets entered in accounting records at the price
paid to acquire them and are not re-evaluated (except for
depreciation)
 Conservatism - Always select the least favorable scenario. For
example, research and development
(R & D) is accounted for as a straight expense, rather than an
investment (it might not lead to anything.)
Amortization

 The write-off of intangible long-lived assets (e.g. goodwill,

trademarks, patents)
 Analogous to depreciation
 Term used broadly to cover write-off of costs over a period of
years
Income Statement
Balance Sheet (Assets &
Liabilities)
Cash
Flows
Notes
Notes
Notes
 Fixed Costs

 Rent payments
 Salaried employees
 Capital Investments and (some) maintenance
 Utilities (phone, water, electric, etc)
 Insurance
 Taxes (on property, plant, and equipment)
 Advertising (*)
 Others things that do not depend on number of units
produced.