Unlocking Financial Statements - Day 2

Online Seminar
Day 2
July 20, 2010
Unlocking Financial Statements

The Income Statement
Understanding Financial Statements

Accrual vs. Cash
Accrual method
Income Statement
Balance Sheet
Cash method
Statement of Cash Flows

Accrual Method
Records revenues as soon as the “sale” occurs
Records expenses as soon as the bill is received
IE, transactions enter the financial records when they occur, not when cash changes hands
Accrual method, therefore, shows “scores,” not real spendable dollars

About These Numbers: They’re Squishy
Goods will not necessarily be paid for
Goods are not necessarily going to be kept
Inventory might be out of date, obsolete or unsellable
Status of some inventory may be uncertain
Intangible assets are estimates

About These Numbers: They’re Squishy (cont.)
Machinery or other fixed assets might be obsolete or falling apart long before the so-called useful life is up
Goodwill
Impairment
Bottom line: In many ways, statements are a collection of estimates.

Because They’re Squishy
You need to know the rules and assumptions used to create the numbers

Income Statement or ...
Statement of earnings
Statement of operations
Statement of income and comprehensive income

Income Statement
Covers a period of time, typically a year or quarter
Reports income from ongoing activities
Reports income from activities beyond management’s control (comprehensive income)
Involves estimates

Basic Income Statement
Sales or revenues
Expenses
Taxes
Net income or profit

Income Statement
Sales or revenues
Cost of goods sold
Gross profit
Operating expenses
Sales, general and administrative
Depreciation, amortization
Operating profit
Other income/expenses
Interest
Income taxes
Net income or profit

Cost of Goods Sold
Expenses incurred in the cost of manufacturing or creating or acquiring the product the company sells.

Cost of Goods Sold
Manufacturer: What the company pays for inventory, i.e. raw materials and supplies used to make its product(s). Includes price of raw materials plus cost of turning it into a product, and transportation costs, i.e. direct factory labor, overhead costs, energy costs. Inventory is largest percent of CGS for manufacturer.

Cost of Goods Sold
Retailer: What the company pays suppliers for the products it sells on its shelves. Only the cost of merchandise purchased for resale, not the cost of providing the service to customers.
Service business: Since it doesn’t make or sell a product per se, typically find a modest CGS.

SGA
Includes office expenses, accounting, shipping department, advertising, R&D, depreciation and other expenses that can’t be directly attributed to particular items for sale.
Often includes depreciation and amortization.

Other Income/Expenses
Discontinued items
Unusual/extraordinary items
Changes in accounting principle
Impairment charge
Sale of investment
Minority interest

Thinking Inside the Box
Revenues
Minus cost of goods sold
Equals gross profit
Minus operating expenses
Equals operating profit
Minus or plus other expenses/income
Minus or plus interest expenses/income
Minus income taxes
Net income

Inside the Box Earnings
Sales or revenues
Cost of goods sold
Gross profit
Operating expenses
Sales, general and administrative
Depreciation, amortization
Operating profit

Earnings Per Share
Basic earnings per share (Bloomberg)
Diluted earnings per share (Wall Street Journal, fully diluted)

Pro Forma Results
Expenses against earnings are not standardized across an industry
Selectively defined earnings
Common pro forma: EBITDA
Recommendation: GAAP results should precede pro forma results in earnings releases
Headlines should show GAAP earnings

Pro Forma Results
SEC’s Regulation G (1/03) states that non-GAAP numbers used in an earnings release must be accompanied by, and reconciled with, the “most directly comparable GAAP number”
Pro forma has value for many companies
“ As a matter of form”

Unlocking Financial Statements - Day 2

by Reynolds Center for Business Journalism on Jul 19, 2010

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Unlocking Financial Statements - Day 2 — Presentation Transcript