Understanding the
Numbers: Essential for
the Entrepreneur
Understanding
Financial 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
Operating Activities
Sales Revenue
minus
Cost of Goods Sold
equals
Gross Profit
minus
Operating Expenses
equals
Operating Income
Financing Activities
What is the format of an income
statement?
Operating Income
minus
Interest Expense
equals
Earnings Bef Taxes
minus
Income Taxes
equals
Net Income
.
Income Statement
An Example
The Income Statement for Trimble & Associates:
Cost of
borrowing
Income
from
operating
the
business
Income
after
\paying
interest
Sales
Cost of Goods Sold
Gross Profit on Sales
Operating Expenses:
Marketing Expenses
90
General & Admin Expenses
80
Depreciation
30
Total Operating. Expenses
Operating Income
Interest Expense
Earnings Before Tax
Income Tax (25%)
Net Income
$850
550
$300
$200
100
20
80
20
60
Income Statement
Can You Put It Together?
Organize this Income statement
Gross Profit on Sales
Operating Expenses:
Total Op. Exp.
Operating Income
$
Admin. &Sales Exp. $ 18
$
$
Earnings Before Taxes $
Net Income
Cost of Goods Sold $250
$
Depreciation
$
8
Interest Expense
$
6
Sales
$290
Income Taxes(25%) $
2
Put the
pieces
where
they go!!
4. Good
judgment
Here You Go!
Gross Profit on Sales
Operating Expenses:
Total Op. Exp.
Operating Income
$ 40
Cost of Goods Sold $250
Admin. &Sales Exp. $ 18
$ 26
$ 14
Earnings Before Taxes $
8
Net Income
6
$
Depreciation
$
8
Interest Expense
$
6
Sales
$290
Income Taxes(25%) $
2
Balance Sheet
Total
What is the basic format of a balance
assets
sheet?
always
equal
debt plus
• In its simplest form, the Balance Sheet equity.
is:
Total
Assets
=
Outstanding
Debt
+
Owner’s
Equity
Debt & Equity
Balance Sheet
Describe the 3 main parts of a
balance sheet.
• Assets
– What the company owns
Basic
pieces of
the
balance
sheet
• Liabilities (Debt)
– What the company owes
• Owner’s Equity (Net Worth)
– Amount invested by the owners
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
Income Statement for 2007
December 31
January 1
The Income Statement and Balance
Sheet complement each other
YEAR 2007
Balance Sheet
on December
31, 2006
Balance Sheet
on December
31, 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
Owners’
Equity
Owners’
Investment
Owners’
Investment
Cumulative
Profits
Cumulative
Dividends
Retained
Earnings
Retained
earnings: A
concept
that many
students fail
to
understand.
Do you?
Balance Sheet ()
An Example
The Balance Sheet for Trimble & Associates:
ASSETS
DEBT AND EQUITY
Current Assets
Cash
Accounts receiv
Inventories
Total current assets
Fixed assets:
Gross fixed assets
Accum depreciation
Net fixed assets
TOTAL ASSETS
Current Liabilities:
$50 Accounts payable
80 Short-term notes
220 Total current debt
$350 Long-term debt
Total debt:
$960 Common stock
-390 Retained earnings
$570 Total common equity
$920 TOTAL DEBT AND EQUITY
$20
80
$100
200
$300
$300
320
$620
$920
Balance Sheet
Can you put itd together?
Given the information below, can you
ASSETS
arrange theFIRST:
balance sheet?
Remember: ASSETS = LIABILITIES + EQUITY
Assets:
Current Assets
Fixed Assets
TOTAL ASSETS
Gross Fixed Assets
$2,500
Inventories
$ 310
Net Fixed Assets
$2,200
Cash
$
70
Accumulated Depreciation $(300)
$ 2,800
Total Current Assets
$ 600
Accounts Receivable
$ 220
Balance Sheet
Putting it together
NEXT: DEBT & EQUITY
Liabilities:
Current Liabilities:
Owners’ Equity:
TOTAL DEBT&EQUITY $ 2,800
Total Current Liabilities
$ 250
Total Owners’ Equity
$1,750
Accounts Payable
$ 230
Common Stock
$ 900
Short-term Notes
$
Total Debt
$1,050
Long-term debt
$ 800
Retained Earnings
$ 850
20
Balance Sheet
All Together
The complete balance sheet is as follows
Assets:
Current Assets
Liabilities:
Current Liabilities:
Cash
$
Accounts Receivable
70
Accounts Payable
$ 230
$ 220
Short-term Notes
$
Inventories
$ 310
Total Current Liabilities
$ 250
Total Current Assets
$ 600
Long-term debt
$ 800
Total Debt
$1,050
Fixed Assets
Gross Fixed Assets
$2,500
20
Owners’ Equity:
Accumulated Depreciation $ 300
Common Stock
$ 900
Net Fixed Assets
$2,200
TOTAL ASSETS
$ 2,800
Retained Earnings
Total Owners’ Equity
$ 850
$1,750
TOTAL DEBT&EQUITY $ 2,800
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 cashbasis 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-today business activities
• Start with
• Add back
Operating income
Depreciation expense
(a non-cash expense)
• Subtract
income taxes
(to work on an after-tax basis)
• Subtract
capital
increase in net working
Which 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
operations?
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
Change in net
working capital
Cash Flow Statement for Trimble Associates
Operating Activities
Operating income
$ 100
Plus depreciation
30
Less income taxes
(20) $ 110
Change 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 Activities
Less increase in gross fixed assets
$ (100)
Financing Activities
Less interest expenses
$ (20)
Less dividends paid
(15)
Plus incr in short-term notes
20
Plus incr in long-term notes
50
Total Financing Activities
$ 35
Increase (Decrease) in cash
$ 5
Cash Flow Statement
Can You Arrange this Cash Flow Statement?
Operating activities:
Plus
Less
Less
Less
Plus
Cash flows from operations:
Investment activities
Less
Financing activities
Less
Less
Plus
Plus
Total financing activities
Increase (Decrease) in cash
Interest expenses
$(30)
Operating Income
$120
Taxes
$(30)
Increase in gross fixed assets $(90)
$100
Increases in long-term notes
$ 30
Depreciation
$ 40
Increases in short-term
$ 100 notes $ 15
$ receivable
(90)
Increases in accts
$(20)
$ 5payable $ 5
Increases in accounts
$
5
$ 15
Increases in inventories
$(10)
Dividends paid
$(10)