"The Income Statement and Cash Flows" in Minneapolis 2011

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Jimmy Gentry presents "The Income Statement and Cash Flows" in Minneapolis on Oct. 4, 2011 at the Star Tribune during the Reynolds Center's free workshop, "Business Journalism Boot Camp."

For more information about free training for business journalists, please visit businessjournalism.org.

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  • "The Income Statement and Cash Flows" in Minneapolis 2011

    1. 1. Business Journalism Boot Camp <ul><ul><ul><ul><ul><li>The Income Statement </li></ul></ul></ul></ul></ul><ul><ul><ul><ul><ul><li>And Cash Flows </li></ul></ul></ul></ul></ul><ul><ul><ul><ul><ul><li>Oct. 4, 2011 </li></ul></ul></ul></ul></ul>
    2. 2. <ul><li> Donald W. Reynolds National Center </li></ul><ul><li>For Business Journalism </li></ul><ul><li>At Arizona State University </li></ul>Income Statement and Cash Flows
    3. 3. <ul><li>James K. Gentry, Ph.D. </li></ul><ul><li>Clyde M. Reed Teaching Professor </li></ul><ul><li>School of Journalism and Mass Communication </li></ul><ul><li>University of Kansas </li></ul><ul><li>[email_address] </li></ul>Income Statement and Cash Flows
    4. 4. Types of Companies <ul><li>Public </li></ul><ul><li>Private </li></ul><ul><ul><li>Financial statements conforming to public company statements </li></ul></ul><ul><li>Non-profits </li></ul>Income Statement and Cash Flows
    5. 5. Important Terms <ul><li>Unaudited </li></ul><ul><li>Audited </li></ul><ul><li>Accountants </li></ul><ul><li>Certified Public Accountants (CPAs) </li></ul><ul><li>GAAP, FASB, AICPA, PCAOB </li></ul>Income Statement and Cash Flows
    6. 6. Assessing a Company <ul><li>Context </li></ul><ul><li>Trends </li></ul><ul><li>Rules </li></ul><ul><li>Outsiders </li></ul><ul><li>Insiders </li></ul>Income Statement and Cash Flows
    7. 7. Annual Report (or 10-K) <ul><li>Auditor ’s report: Clean, qualified? </li></ul><ul><li>MD&A or Management ’s Discussion and Analysis </li></ul><ul><li>Financial statements and footnotes </li></ul><ul><li>Management ’s letter if annual report </li></ul>Income Statement and Cash Flows
    8. 8. MD&A <ul><li>Must read it </li></ul><ul><li>Often a source of good information and insights </li></ul><ul><li>Densely written </li></ul><ul><li>Explains financial information </li></ul><ul><li>SEC says it wants greater transparency </li></ul>Income Statement and Cash Flows
    9. 9. Goal of Accounting <ul><li>Record, classify and report financial transactions. To provide managers across the organization with information that facilitates: </li></ul><ul><ul><li>Control of activities and expenditure </li></ul></ul><ul><ul><li>Refinement of operational plans </li></ul></ul><ul><ul><li>Accountability </li></ul></ul><ul><ul><li>Reporting on project outcomes </li></ul></ul><ul><ul><li>Writing of bids for new funds </li></ul></ul>Income Statement and Cash Flows
    10. 10. Goal of Finance <ul><li>Maximize shareholder wealth as reflected in market price of the stock </li></ul><ul><li>Achieving this goal requires financial manager to focus on economic profit, not accounting profit </li></ul>Income Statement and Cash Flows
    11. 11. Financial Decisions <ul><li>Long-term investment decisions </li></ul><ul><ul><li>Capital budgeting: Assets company wants to hold </li></ul></ul><ul><li>Long-term financing decisions </li></ul><ul><ul><li>Capital structure: Funds for long-term investments </li></ul></ul><ul><li>Working capital management decisions </li></ul><ul><ul><li>Net working capital </li></ul></ul>Income Statement and Cash Flows
    12. 12. Generally Accepted Accounting Principles <ul><li>Guidelines based on theory and practice </li></ul><ul><li>Evolved over time </li></ul><ul><li>Procedures, concepts and standards </li></ul>Income Statement and Cash Flows
    13. 13. GAAP: Assumptions <ul><li>Periodicity </li></ul><ul><li>Going concern </li></ul><ul><li>Economic entity </li></ul><ul><li>Monetary unit </li></ul>Income Statement and Cash Flows
    14. 14. GAAP: Principles <ul><li>Full disclosure </li></ul><ul><li>Matching </li></ul><ul><li>Historical cost </li></ul><ul><li>Revenue realization </li></ul><ul><li>Consistency </li></ul>Income Statement and Cash Flows
    15. 15. GAAP: Underlying Considerations <ul><li>Materiality </li></ul><ul><li>Industry practices </li></ul><ul><li>Conservatism </li></ul>Income Statement and Cash Flows
    16. 16. Cash or Operating Cycle <ul><li>Cash </li></ul><ul><li>Purchase inventory </li></ul><ul><li>Produce product </li></ul><ul><li>Sell product </li></ul><ul><li>Cash </li></ul>Income Statement and Cash Flows
    17. 17. Cash or Operating Cycle (cont.) <ul><li>“ Cash” </li></ul><ul><ul><li>Cash </li></ul></ul><ul><ul><li>Receivables </li></ul></ul><ul><ul><li>Debt </li></ul></ul><ul><li>Inventory </li></ul><ul><ul><li>Raw materials </li></ul></ul><ul><ul><li>Work in progress </li></ul></ul><ul><ul><li>Finished goods </li></ul></ul>Income Statement and Cash Flows
    18. 18. Cash or Operating Cycle (cont.) <ul><li>Sell product </li></ul><ul><ul><li>Accounts receivable </li></ul></ul><ul><ul><li>Cash </li></ul></ul><ul><li>Cash </li></ul><ul><ul><li>Collect receivables as cash </li></ul></ul><ul><li>Pay off payables </li></ul><ul><li>Start over </li></ul>Income Statement and Cash Flows
    19. 19. Accrual Method <ul><li>Records revenues as soon as the “sale” occurs </li></ul><ul><li>Records expenses as soon as the bill is received </li></ul><ul><li>IE, transactions enter the financial records when they occur, not when cash changes hands </li></ul><ul><li>Accrual method, therefore, shows “scores,” not real spendable dollars </li></ul>Income Statement and Cash Flows
    20. 20. About These Numbers: They ’re Squishy <ul><li>Goods will not necessarily be paid for </li></ul><ul><li>Goods are not necessarily going to be kept </li></ul><ul><li>Inventory might be out of date, obsolete or unsellable </li></ul><ul><li>Status of some inventory may be uncertain </li></ul><ul><li>Intangible assets are estimates </li></ul>Income Statement and Cash Flows
    21. 21. About These Numbers: They ’re Squishy (cont.) <ul><li>Machinery or other fixed assets might be obsolete or falling apart long before the so-called useful life is up </li></ul><ul><li>Goodwill </li></ul><ul><li>Accounting conventions </li></ul><ul><li>Timing issues </li></ul><ul><li>Bottom line: In many ways, statements are a collection of estimates. </li></ul>Income Statement and Cash Flows
    22. 22. Because They ’re Squishy <ul><li>You need to know the rules and assumptions used to create the numbers </li></ul>Income Statement and Cash Flows
    23. 23. Income Statement or ... <ul><li>Statement of earnings </li></ul><ul><li>Statement of operations </li></ul><ul><li>Statement of income and comprehensive income </li></ul>Income Statement and Cash Flows
    24. 24. Income Statement <ul><li>Covers a period of time, typically a year or quarter </li></ul><ul><li>Reports income from ongoing activities </li></ul><ul><li>Reports income from activities beyond management ’s control (comprehensive income) </li></ul><ul><li>Involves estimates </li></ul>Income Statement and Cash Flows
    25. 25. Basic Income Statement <ul><li>Sales or revenues </li></ul><ul><li>Expenses </li></ul><ul><li>Taxes </li></ul><ul><li>Net income or profit </li></ul>Income Statement and Cash Flows
    26. 26. Income Statement <ul><li>Sales or revenues </li></ul><ul><li>Cost of goods sold </li></ul><ul><li>Gross profit </li></ul><ul><li>Operating expenses </li></ul><ul><ul><li>Sales, general and administrative </li></ul></ul><ul><ul><li>Depreciation, amortization </li></ul></ul><ul><li>Operating profit </li></ul><ul><li>Other income/expenses </li></ul><ul><li>Interest </li></ul><ul><li>Income taxes </li></ul><ul><li>Net income or profit </li></ul>Income Statement and Cash Flows
    27. 27. Cost of Goods Sold <ul><li>Expenses incurred in the cost of manufacturing or creating or acquiring the product the company sells. </li></ul>Income Statement and Cash Flows
    28. 28. Cost of Goods Sold <ul><li>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. </li></ul>Income Statement and Cash Flows
    29. 29. Cost of Goods Sold <ul><li>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. </li></ul><ul><li>Service business: Since it doesn ’t make or sell a product per se, typically find a modest CGS. </li></ul>Income Statement and Cash Flows
    30. 30. SGA <ul><li>Includes office expenses, accounting, shipping department, advertising, R&D, depreciation and other expenses that can ’t be directly attributed to particular items for sale. </li></ul><ul><li>Often includes depreciation and amortization. </li></ul>Income Statement and Cash Flows
    31. 31. Other Income/Expenses <ul><li>Discontinued items </li></ul><ul><li>Unusual/extraordinary items </li></ul><ul><li>Changes in accounting principle </li></ul><ul><li>Impairment charge </li></ul><ul><li>Sale of investment </li></ul><ul><li>Minority interest </li></ul>Income Statement and Cash Flows
    32. 32. Thinking Inside the Box <ul><li>Revenues </li></ul><ul><li>Minus cost of goods sold </li></ul><ul><li>Equals gross profit </li></ul><ul><li>Minus operating expenses </li></ul><ul><li>Equals operating profit </li></ul><ul><li>Minus or plus other expenses/income </li></ul><ul><li>Minus or plus interest expenses/income </li></ul><ul><li>Minus income taxes </li></ul><ul><li>Net income </li></ul>Income Statement and Cash Flows
    33. 33. Inside the Box Earnings <ul><li>Sales or revenues </li></ul><ul><li>Cost of goods sold </li></ul><ul><li>Gross profit </li></ul><ul><li>Operating expenses </li></ul><ul><ul><li>Sales, general and administrative </li></ul></ul><ul><ul><li>Depreciation, amortization </li></ul></ul><ul><li>Operating profit </li></ul>Income Statement and Cash Flows
    34. 34. ‘ One-Time’ Gains That Reoccur <ul><li>Don ’t be fooled by extraordinary items that make the net income look better than it really is </li></ul><ul><li>Extraordinary items should be both unusual in nature and infrequent in occurrence </li></ul><ul><li>Examples: Writedowns, restructurings, etc. </li></ul>Income Statement and Cash Flows
    35. 35. Calculating Earnings Per Share <ul><li>Basic EPS: Net income for period divided by weighted average number shares outstanding. </li></ul><ul><li>Diluted EPS: Net income for period divided by weighted average number shares outstanding for period, plus assumption of exercise of all potentially dilutive instruments. </li></ul>Income Statement and Cash Flows
    36. 36. Pro Forma Results <ul><li>Expenses against earnings are not standardized across an industry </li></ul><ul><li>Selectively defined earnings </li></ul><ul><li>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” </li></ul>Income Statement and Cash Flows
    37. 37. Pro Forma Results <ul><li>Recommendation: GAAP results should precede pro forma results in earnings releases </li></ul><ul><li>Headlines should show GAAP earnings </li></ul><ul><li>Pro forma has value for many companies </li></ul><ul><li>Common pro forma: EBITDA </li></ul><ul><li>“ As a matter of form” </li></ul>Income Statement and Cash Flows
    38. 38. Other ‘Nonstandard’ Measures <ul><li>Groupon – Adjusted CSOI or Adjusted Consolidated Segment Operating Income </li></ul><ul><li>Zynga – Bookings </li></ul><ul><li>Facebook – Monthly active users </li></ul><ul><li>Pandora – Total listener hours and total registered users </li></ul>Income Statement and Cash Flows
    39. 39. Analyzing the Numbers <ul><li>Note changes in amounts year to year, especially revenues and expenses </li></ul><ul><li>Note numbers that are significantly larger or smaller than the previous period </li></ul><ul><li>Look at trend line for sales/revenues, operating income and net income. Calculate percentage change for each. </li></ul><ul><li>Tie the numbers to the footnotes. </li></ul>Income Statement and Cash Flows
    40. 40. Statement of Cash Flows <ul><li>Record of cash provided by cash sources and of cash consumed by cash uses . </li></ul>Income Statement and Cash Flows
    41. 41. Cash Flows (cont.) <ul><li>Information about use of cash </li></ul><ul><li>Information about investing and financing </li></ul><ul><li>Ability to continue as a going concern </li></ul><ul><li>Ability to generate future positive cash flows </li></ul><ul><li>Ability to meet obligations and pay dividends </li></ul>Income Statement and Cash Flows
    42. 42. Cash Flows <ul><li>From operations </li></ul><ul><li>From investing </li></ul><ul><li>From financing </li></ul>Income Statement and Cash Flows
    43. 43. Flexibility <ul><li>Companies have some flexibility in categories for entries. </li></ul><ul><li>Total change in cash, however, will not change. </li></ul><ul><li>Overwhelming majority of all accounting standards deal with balance sheet and income statement, not cash flows statement. </li></ul>Income Statement and Cash Flows
    44. 44. Free Cash Flow <ul><li>Powerful tool for making a company successful </li></ul><ul><li>Powerful indicator for investors </li></ul><ul><li>Cash that is left over after productive capacity is maintained or expanded </li></ul><ul><li>Permits expansion, paying down debt, buying back shares, etc. </li></ul>Income Statement and Cash Flows
    45. 45. Free Cash Flow (cont.) <ul><li>Several ways to calculate it </li></ul><ul><li>Companies create their own models </li></ul><ul><li>Gross way to do it: </li></ul><ul><ul><li>Cash from operating activities </li></ul></ul><ul><ul><li>Minus capital expenditures </li></ul></ul><ul><ul><li>Equals free cash flow </li></ul></ul>Income Statement and Cash Flows
    46. 46. American Standard Model <ul><li>Cash from operating activities </li></ul><ul><li>Minus capital expenditures </li></ul><ul><li>Plus proceeds from disposal of property </li></ul><ul><li>Plus proceeds from sale and leasebacks </li></ul><ul><li>Equals free cash flow </li></ul>Income Statement and Cash Flows
    47. 47. Free Cash Models <ul><li>‘ Gross’ method </li></ul><ul><li>American Standard method </li></ul><ul><li>VF method </li></ul><ul><ul><li>Cash from operating minus cash from investing </li></ul></ul>Income Statement and Cash Flows
    48. 48. Techniques <ul><li>Calculate percentage change </li></ul><ul><li>Trend analysis </li></ul><ul><li>Common size analysis </li></ul><ul><li>Ratio analysis </li></ul>Income Statement and Cash Flows

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