Understanding Financial

Statements

1 Financial Management
 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
• These answer 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.

3 Financial Management
4 Financial Management
 Cash Flow Statement

A Cash Flow Statement (also called the Statement of Cash Flows)

shows how much cash is generated and used during a given time

period. This statement is useful for the managers to manage their cash

in an efficient manner. This is a statement that the firms make in order

to analyze the cash management during a financial year .

5 Financial Management
 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.
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.
 What are
Expenses?
There are two types of expenses:
FIXED COSTS
and
VARIABLE COSTS
 Fixed Costs
• Rent payments
• Salaried employees
• Capital Investments and (some) maintenance
• Utilities (phone, water, electric, etc)
• Insurance
• Taxes
• Advertising
• Others things that do not depend on number of units
produced.
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)
Example:
Placing the revenues at the “top” and the expenses below – you get the
following three-month cash flow statement for a startup:
Jan-00 Feb-00 Mar-00
REVENUES (inflow)
SALES $0.00 $0.00 $1,000.00
INTEREST $239.27 $167.04
RECEIPTS $0.00 $239.27 $1,167.04

EXPENDITURES (outflow)
MATERIALS COST AND MFG. LABOR $0.00 $0.00 $50.00
SALES COMMISSIONS $0.00 $0.00 $100.00
COST OF GOODS SOLD (COGS) $0.00 $0.00 $150.00

GROSS MARGIN $0.00 $239.27 $1,017.04

SALARY AND BENEFITS OF CEO $3,000.00 $3,000.00 $3,000.00

SALARY AND BENEFITS OF ASSISTANT $2,000.00 $2,000.00 $2,000.00
RENT $500.00 $500.00 $500.00
TELEPHONE AND OTHER $75.00 $75.00 $75.00
ADVERTISING $2,000.00 $2,000.00 $2,000.00
EQUIPMENT $20,000.00 $10,000.00 $10,000.00
TOTAL FIXED COSTS $27,575.00 $17,575.00 $17,575.00

MONTHLY CASH FLOW ($27,575.00) ($17,335.73) ($16,557.96)

Cash Flow (cont.)
Jan-00 Feb-00 Mar-00
REVENUES (inflow)
“Receipts” is the sum of SALES $0.00 $0.00 $1,000.00

all the firm’s sales and INTEREST

RECEIPTS $0.00
$239.27
$239.27
$167.04
$1,167.04
interest it collected that EXPENDITURES (outflow)
month MATERIALS COST AND MFG. LABOR $0.00 $0.00 $50.00
SALES COMMISSIONS $0.00 $0.00 $100.00
Gross Margin is the COST OF GOODS SOLD (COGS) $0.00 $0.00 $150.00

Receipts minus the COGS GROSS MARGIN $0.00 $239.27 $1,017.04

SALARY AND BENEFITS OF CEO $3,000.00 $3,000.00 $3,000.00

SALARY AND BENEFITS OF ASSISTANT $2,000.00 $2,000.00 $2,000.00
RENT $500.00 $500.00 $500.00
Total Fixed Costs is the sum TELEPHONE AND OTHER
ADVERTISING
$75.00
$2,000.00
$75.00
$2,000.00
$75.00
$2,000.00
of all the fixed costs EQUIPMENT $20,000.00 $10,000.00 $10,000.00
TOTAL FIXED COSTS $27,575.00 $17,575.00 $17,575.00

MONTHLY CASH FLOW ($27,575.00) ($17,335.73) ($16,557.96)

Monthly Cash flow is the Gross

Margin minus the Total Fixed
Costs
 What’s Missing?

• Cumulative Cash Flow numbers

• Taxes (… and accumulated depreciation)
• Net Earnings
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).
EBI…. what?
THE CHAIN OF EARNINGS

EBIDT (Earnings Before Interest, Depreciation and Tax)

( - accrued depreciation)

EBIT (Earnings Before Interest and Tax)

( - taxes paid once a year)

EBI
( - interest payments on your debt)

TOTAL EARNINGS
16 Financial Management
EBIDT
Your EBIDT (Earnings Before Interest, Depreciation and
Tax) is
Total Revenues – All Costs that are not depreciable
 Calculating Depreciation
1. Continue depreciation on items purchased in earlier years,
using previously established methods
2. Sum up all that fiscal year’s capital expenses
3. Decide which method of Depreciation your firm wants to use.
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
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.
Final Cash Flow Statement
Final Cash
Flow
Statement

21 Financial Management
Cash flow statement extracted from the ITC limited

22 Financial Management
23 Financial Management
24 Financial Management
 Income statement
Income Statement is one of a company’s core financial statements that
shows its profit and loss over a period of time. The profit or loss is
determined by taking all revenues and subtracting all expenses from both
operating and non-operating activities. The income statement is one of three
statements used in both corporate finance (including financial modeling) and
accounting. The statement displays the company’s revenue, costs, gross
profit, selling and administrative expenses, other expenses and income,
taxes paid, and net profit in a coherent and logical manner.

25 Financial Management
Income Statement

• Income Statement
compares the
profitability of the firm to
prior years

• Total (yearly) revenues

minus total (yearly)
expenditures

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27 Financial Management
 Cash Flow versus Income
•Statements
Note that the final Net Earnings number for both the final month of the
cash flow statement is the same as the year-end Net Earnings total for the
Income Statement, reflecting the same time period
29 Financial Management
 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
Example of a Balance Sheet
 The Process of Accounting
• An orderly recording of all financial transactions (by manually or
electronically)
Business document
Business
is prepared, e.g.,
Transactions
order form, invoice

Debits and credits

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

Financial
statements
prepared --
balance sheet &
income
statement
Examples of Actual Financial Statements

Hasbro Annual Report

1) Cover Page
2) Income Statement
3) Balance Sheet (Assets & Liabilities)
4) Cash Flows
5) Notes
6) Notes
7) Notes
Cover Page
Income Statement
Balance Sheet (Assets &
Liabilities)
Cash Flows
Notes
Notes
Notes