Understanding Financial Statements, And Cash Flows

Understanding Financial Statements, and Cash Flows

By Dr. Gagan Kukreja

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Income Statement SALES - EXPENSES = PROFIT

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Income Statement SALES

Revenue

- EXPENSES = PROFIT

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Income Statement SALES - EXPENSES = PROFIT

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Income Statement SALES

•Cost of Goods Sold

- EXPENSES = PROFIT

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Income Statement SALES - EXPENSES

•Cost of Goods Sold •Operating Expenses

= PROFIT

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Income Statement SALES - EXPENSES

•Cost of Goods Sold •Operating Expenses (marketing, administrative)

= PROFIT

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Income Statement SALES - EXPENSES = PROFIT

•Cost of Goods Sold •Operating Expenses (marketing, administrative)

•Financing Costs

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Income Statement SALES - EXPENSES = PROFIT

•Cost of Goods Sold •Operating Expenses (marketing, administrative)

•Financing Costs •Taxes

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SALES

Income Statement

- Cost of Goods Sold GROSS PROFIT - Operating Expenses OPERATING INCOME (EBIT) - Interest Expense EARNINGS BEFORE TAXES (EBT) - Income Taxes EARNINGS AFTER TAXES (EAT) - Preferred Stock Dividends - NET INCOME AVAILABLE TO COMMON STOCKHOLDERS

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SALES

Income Statement

- Cost of Goods Sold GROSS PROFIT - Operating Expenses OPERATING INCOME (EBIT) - Interest Expense EARNINGS BEFORE TAXES (EBT) - Income Taxes EARNINGS AFTER TAXES (EAT) - Preferred Stock Dividends - NET INCOME AVAILABLE TO COMMON STOCKHOLDERS

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SALES

Income Statement

- Cost of Goods Sold GROSS PROFIT - Operating Expenses OPERATING INCOME (EBIT) - Interest Expense EARNINGS BEFORE TAXES (EBT) - Income Taxes EARNINGS AFTER TAXES (EAT) - Preferred Stock Dividends - NET INCOME AVAILABLE TO COMMON STOCKHOLDERS

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Balance Sheet

Total Assets

=

Outstanding Debt + Shareholders’ Equity

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Balance Sheet

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Balance Sheet Assets

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Balance Sheet Assets

Liabilities (Debt) & Equity

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Balance Sheet Assets Current Assets Cash Marketable Securities Accounts Receivable Inventories Prepaid Expenses

Fixed Assets Machinery & Equipment Buildings and Land

Other Assets

Liabilities (Debt) & Equity Current Liabilities Accounts Payable Accrued Expenses Short-term notes

Long-Term Liabilities Long-term notes Mortgages

Equity Preferred Stock Common Stock (Par value) Paid in Capital Retained Earnings

Investments & patents 17

Assets • Current Assets:

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Assets • Current Assets: assets that are relatively liquid, and are expected to be converted to cash within a year.

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Assets • Current Assets: assets that are relatively liquid, and are expected to be converted to cash within a year. – Cash, marketable securities, accounts receivable, inventories, prepaid expenses.

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Assets • Current Assets: assets that are relatively liquid, and are expected to be converted to cash within a year. – Cash, marketable securities, accounts receivable, inventories, prepaid expenses.

• Fixed Assets:

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Assets • Current Assets: assets that are relatively liquid, and are expected to be converted to cash within a year. – Cash, marketable securities, accounts receivable, inventories, prepaid expenses.

• Fixed Assets: machinery and equipment, buildings, and land.

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Assets • Current Assets: assets that are relatively liquid, and are expected to be converted to cash within a year. – Cash, marketable securities, accounts receivable, inventories, prepaid expenses.

• Fixed Assets: machinery and equipment, buildings, and land. • Other Assets:

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Assets • Current Assets: assets that are relatively liquid, and are expected to be converted to cash within a year. – Cash, marketable securities, accounts receivable, inventories, prepaid expenses.

• Fixed Assets: machinery and equipment, buildings, and land. • Other Assets: any asset that is not a current asset or fixed asset. 24

Assets • Current Assets: assets that are relatively liquid, and are expected to be converted to cash within a year. – Cash, marketable securities, accounts receivable, inventories, prepaid expenses.

• Fixed Assets: machinery and equipment, buildings, and land. • Other Assets: any asset that is not a current asset or fixed asset. – Intangible assets such as patents and copyrights. 25

Financing • Debt Capital:

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Financing • Debt Capital: financing provided by a creditor.

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Financing • Debt Capital: financing provided by a creditors. • Short-term debt:

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Financing • Debt Capital: financing provided by a creditor. • Short-term debt: borrowed money that must be repaid within the next 12 months.

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Financing • Debt Capital: financing provided by a creditor. • Short-term debt: borrowed money that must be repaid within the next 12 months. – Accounts payable, other payables such as interest or taxes payable, accrued expenses, short-term notes & bank overdraft.

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Financing • Debt Capital: financing provided by a creditor. • Short-term debt: borrowed money that must be repaid within the next 12 months. – Accounts payable, other payables such as interest or taxes payable, accrued expenses, short-term notes.

• Long-term debt:

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Financing • Debt Capital: financing provided by a creditor. • Short-term debt: borrowed money that must be repaid within the next 12 months. – Accounts payable, other payables such as interest or taxes payable, accrued expenses, short-term notes.

• Long-term debt: loans from banks or other sources that lend money for longer than 12 months. 32

Financing • Equity Capital:

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Financing • Equity Capital: shareholders’ investment in the firm.

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Financing • Equity Capital: shareholders’ investment in the firm. • Preferred Stockholders:

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Financing • Equity Capital: shareholders’ investment in the firm. • Preferred Stockholders: receive fixed dividends, and have higher priority than common stockholders in event of liquidation of the firm.

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Financing • Equity Capital: shareholders’ investment in the firm. • Preferred Stockholders: received fixed dividends, and have higher priority than common stockholders in event of liquidation of the firm. • Common Stockholders:

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Financing • Equity Capital: shareholders’ investment in the firm. • Preferred Stockholders: received fixed dividends, and have higher priority than common stockholders in event of liquidation of the firm. • Common Stockholders: residual owners of a business. They receive whatever is left after creditors and preferred stockholders are paid. 38

Free Cash Flows Free cash flow: Cash flow that is free and available to be distributed to the firm’s investors (both debt and equity investors)

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Free Cash Flows Firm’s Operating Free cash flows

Cash flows generated through the firm’s operations and investments in assets

=

=

Firm’s Financing Free cash flows

Cash flows paid to - or received by - the firm’s investors (creditors & stockholders) 40

Calculating Free Cash Flows: An Operating Perspective After-tax cash flow from operations less investment in net operating working capital less investments in fixed and other assets

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Calculating Free Cash Flows: An Operating Perspective After-tax cash flow from operations less investment in net operating working capital less investments in fixed and other assets

Operating income + depreciation - cash tax payments

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Calculating Free Cash Flows: An Operating Perspective After-tax cash flow from operations less investment in net operating working capital less investments in fixed and other assets

[Change in current assets]

-

[change in non-interest bearing current liabilities]

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Calculating Free Cash Flows: An Operating Perspective After-tax cash flow from operations less investment in net operating working capital less investments in fixed and other assets

Change in gross fixed assets, and any other assets that are on the balance sheet.

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Calculating Free Cash Flows: A Financing Perspective Interest payments to creditors

=

-

change in debt principal

-

dividends paid to stockholders

-

change in stock Financing Free Cash Flows 45