Detailed Slides, Financial Statements

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Detailed Slides, Financial Statements

  1. 1. EBD 481 – Fall, 09 Craig S. Galbraith Presentation derived in part from original material developed by Craig Galbraith and various presentations from Alan Barefield, University of Tennessee
  2. 2. <ul><li>Number one reason for small business failure is not understanding financial statements </li></ul><ul><li>Need to know financial statements in order to track and predict success </li></ul><ul><li>Need to develop pro-formas for business plans </li></ul><ul><li>Need to analyze financial performance for valuation </li></ul>
  3. 3. <ul><li>Projection of future financial condition </li></ul><ul><li>3 to 5 year projection </li></ul><ul><ul><li>Why only 3 to 5 year? </li></ul></ul><ul><li>Key issues in pro-forma are </li></ul><ul><ul><li>Consistency with underlying business plan </li></ul></ul><ul><ul><li>Consistency with accounting formats </li></ul></ul><ul><ul><li>Sources for line items </li></ul></ul><ul><ul><li>Assumptions for line items </li></ul></ul><ul><li>Underlying analysis is critical </li></ul><ul><li>Be reasonable </li></ul>
  4. 4. <ul><li>Income or Profit & Loss Statement </li></ul><ul><li>Balance Sheet </li></ul><ul><li>Cash Flow Statement </li></ul><ul><li>Budget Forecast </li></ul>
  5. 5. <ul><li>Provides a summary of the revenues and expenses associated with the period’s operating activities </li></ul><ul><li>Provide information to complete the business and personal income tax returns </li></ul><ul><li>Shows the profitability of the business for lenders and other interested parties </li></ul>
  6. 6. <ul><li>The income or profit and loss statement summarizes the level of revenue and expenses for the business </li></ul><ul><li>Major components include: </li></ul><ul><ul><li>Revenues </li></ul></ul><ul><ul><li>Expenses </li></ul></ul><ul><ul><li>Taxes </li></ul></ul><ul><ul><li>Extraordinary Items </li></ul></ul>
  7. 7. <ul><li>Business revenue can be divided into two categories </li></ul><ul><ul><li>Revenue from current operations – Cash proceeds from the sale of inventory , noncash proceeds from sales, patronage dividends, insurance proceeds, noncash inventory adjustments </li></ul></ul><ul><ul><li>Expenses incurred in the production process should be deducted from revenues to yield a gross profit margin </li></ul></ul>
  8. 8. <ul><ul><li>Capital gains and losses – Gain or loss realized from the sale of intermediate or long-term assets </li></ul></ul><ul><ul><li>Nonbusiness revenue – Income derived from nonbusiness employment, interest and dividend income from nonbusiness investments </li></ul></ul>
  9. 9. <ul><li>Cash operating expenses – Includes expenses paid in cash, expenses that have been incurred but not yet paid (accounts payable), interest expenses </li></ul><ul><li>Noncash expenses includes depreciation and any expenses paid from the last reporting period if the business is reporting on a cash basis </li></ul>
  10. 10. <ul><li>This section includes the specific tax liabilities incurred during the reporting period. Only income and self-employment taxes are reported in this section. Payroll taxes, real estate and real property taxes, etc., are reported under the Expenses section of the income statement </li></ul>
  11. 11. <ul><li>This section includes “once-in-a-lifetime” events that should not be included as a part of the firm’s regular financial activities </li></ul><ul><li>Includes insurance payments from a loss, agricultural disaster payments, etc. </li></ul>
  12. 12. Revenues Business Revenue + Gain from sale of intermediate or LT assets + Non Business Revenues + Noncash revenue adjustments = Total revenue - Cost of goods sold = Gross profit margin
  13. 13. <ul><li>Gross profit margin </li></ul><ul><li>- Cash operating expenses </li></ul><ul><li>- Noncash operating expenses </li></ul><ul><li>= Income from business operations </li></ul><ul><li>+(-) Gain (loss) on depreciable assets </li></ul><ul><li>= Net business income </li></ul><ul><li>+ Nonbusiness revenue </li></ul><ul><li>Non business expenses </li></ul><ul><li>= Income before taxes </li></ul><ul><li>Provisions for taxes </li></ul><ul><li>= Net Income </li></ul>
  14. 14. <ul><li>Summarizes the levels of cash that the business has available to meet current obligations </li></ul><ul><li>Generally divided into monthly or quarterly periods to show when excess cash is available or when borrowing needs to occur </li></ul>
  15. 15. <ul><li>Highlights the financing arrangements necessary to cover cash requirements </li></ul><ul><li>Serves as a benchmark for budgeting activities </li></ul><ul><li>Analyzes the timing of financial borrowing activities </li></ul>
  16. 16. <ul><li>Cash available </li></ul><ul><ul><li>Beginning cash balance </li></ul></ul><ul><ul><li>Cash revenues from sales and accounts receivable </li></ul></ul><ul><ul><li>Other sources of cash </li></ul></ul><ul><ul><ul><li>Proceeds from sale of equipment and other assets </li></ul></ul></ul><ul><ul><ul><li>Nonbusiness wages </li></ul></ul></ul><ul><ul><ul><li>Interest and dividend income </li></ul></ul></ul>
  17. 17. <ul><li>Cash required </li></ul><ul><ul><li>Operating expenses </li></ul></ul><ul><ul><li>Income tax payments </li></ul></ul><ul><ul><li>Intermediate and long-term payments </li></ul></ul><ul><ul><li>Capital expenditures </li></ul></ul><ul><ul><li>Family living expenses </li></ul></ul><ul><ul><li>Cash gifts and donations </li></ul></ul>
  18. 18. <ul><li>Borrowings </li></ul><ul><ul><li>New loans to finance production and capital expenditures </li></ul></ul><ul><li>Other </li></ul><ul><ul><li>Short term loan payments </li></ul></ul><ul><ul><li>Savings – additions and withdrawals </li></ul></ul><ul><ul><li>Ending cash balance for the period </li></ul></ul>
  19. 19. <ul><li>Many persons assert that the budget is simply a projection of the cash flow statement </li></ul><ul><li>However this is not correct </li></ul><ul><li>The budget must incorporate all key financial statements </li></ul><ul><li>Forecasting statements are also called pro forma statements </li></ul>
  20. 20. <ul><li>Details the financial position of a business at a particular point in time </li></ul><ul><li>Assets = Liabilities + Equity </li></ul><ul><li>Tells the reader what the business owns of monetary value and what the business owes to others . </li></ul><ul><li>Personal and business assets and liabilities are frequently reflected on the same statement </li></ul>
  21. 21. <ul><li>The balance sheet indicates the degree to which the business is liquid and solvent </li></ul><ul><li>Liquidity – Can the business’ current liabilities be retired if the current assets are converted to cash? </li></ul><ul><li>Solvency – Can the total liabilities of the business be retired if all assets are converted to cash? </li></ul>
  22. 22. <ul><li>Assets </li></ul><ul><ul><li>Represents the monetary value of what the business owns </li></ul></ul><ul><ul><li>Are normally grouped into three categories denoting how soon they wear out or are sold </li></ul></ul><ul><ul><ul><li>Current – Less than 1 year </li></ul></ul></ul><ul><ul><ul><li>Intermediate – 1 to 10 years </li></ul></ul></ul><ul><ul><ul><li>Long-term – Over 10 years </li></ul></ul></ul>
  23. 23. <ul><li>Cash </li></ul><ul><li>Checking accounts </li></ul><ul><li>Savings accounts </li></ul><ul><li>Accounts receivable </li></ul><ul><li>Inventories </li></ul><ul><li>Supplies </li></ul><ul><li>WIP investments </li></ul><ul><li>Equity in hedging accounts </li></ul><ul><li>Tax refunds </li></ul><ul><li>Unused tax credits </li></ul><ul><li>Prepaid expenses </li></ul><ul><ul><li>Payroll </li></ul></ul><ul><ul><li>Insurance </li></ul></ul><ul><ul><li>Rent </li></ul></ul>
  24. 24. <ul><li>Machinery </li></ul><ul><li>Business vehicles </li></ul><ul><li>Retirement accounts </li></ul><ul><li>Cash value of life insurance </li></ul><ul><li>Household goods </li></ul><ul><li>Personal vehicles </li></ul>
  25. 25. <ul><li>Land </li></ul><ul><li>Buildings and structures </li></ul><ul><li>Personal residences </li></ul><ul><li>Nonbusiness real estate </li></ul>
  26. 26. <ul><li>Liabilities </li></ul><ul><ul><li>Represents the value of the debts owed by the business </li></ul></ul><ul><ul><li>Are normally grouped into three categories denoting how soon they fall due </li></ul></ul><ul><ul><ul><li>Current – Less than 1 year </li></ul></ul></ul><ul><ul><ul><li>Intermediate – 1 to 10 years </li></ul></ul></ul><ul><ul><ul><li>Long-term – Over 10 years </li></ul></ul></ul>
  27. 27. <ul><li>Accounts payable </li></ul><ul><li>Short term notes payable </li></ul><ul><li>Current payments on intermediate or long term notes </li></ul><ul><li>Accrued expenses </li></ul><ul><li>Contingent tax on sale of current assets </li></ul>
  28. 28. <ul><li>Loans to finance intermediate assets less current payments </li></ul><ul><li>Contingent tax on sale of intermediate assets </li></ul>
  29. 29. <ul><li>Business and nonbusiness mortgages less current payments </li></ul><ul><li>Other long-term notes </li></ul><ul><li>Contingent tax on sale of long term assets </li></ul>
  30. 30. <ul><li>Net worth (also called net equity) </li></ul><ul><ul><li>Net worth represents the difference between the total level of assets and the total level of liabilities </li></ul></ul><ul><ul><li>Net worth should be reported on an after-tax basis </li></ul></ul><ul><ul><li>If net worth is positive, the business is solvent (assets can be sold to retire liabilities). If net worth is negative, the business is insolvent </li></ul></ul>
  31. 31. <ul><li>Assets </li></ul><ul><ul><li>Current Assets </li></ul></ul><ul><ul><li>Intermediate Assets </li></ul></ul><ul><ul><li>Long-term Assets </li></ul></ul><ul><li>Liabilities </li></ul><ul><ul><li>Current Liabilities </li></ul></ul><ul><ul><li>Intermediate Liabilities </li></ul></ul><ul><ul><li>Long-term Liabilities </li></ul></ul><ul><li>Net Worth </li></ul>
  32. 32. <ul><li>Expected selling prices </li></ul><ul><li>Expected input prices </li></ul><ul><li>Expected input productivity </li></ul><ul><li>Pro forma operating budget </li></ul><ul><ul><li>Production costs and sales objectives </li></ul></ul><ul><li>Pro forma financial budget </li></ul><ul><ul><li>Cash receipts and disbursements </li></ul></ul><ul><li>Family living budgets </li></ul>
  33. 33. <ul><li>Ratio analysis </li></ul><ul><ul><li>Alleviates the unit of measure problems incurred when comparing raw numbers </li></ul></ul><ul><ul><li>Four different types of ratios can be examined </li></ul></ul><ul><ul><ul><li>Liquidity ratios – can current debts be met </li></ul></ul></ul><ul><ul><ul><li>Solvency ratios – can all debts be met </li></ul></ul></ul><ul><ul><ul><li>Efficiency ratios – how efficient is the operation </li></ul></ul></ul><ul><ul><ul><li>Profitability ratios – how profitable is the operation </li></ul></ul></ul>
  34. 34. <ul><li>Ratios don’t mean anything by themselves </li></ul><ul><li>They must be compared over time and with similar companies </li></ul><ul><li>Look at industry standards through trade magazines, Standard & Poore’s, RMA analysis, etc. </li></ul>
  35. 35. <ul><li>Current assets divided by current liabilities </li></ul><ul><li>Interpretation </li></ul><ul><ul><li>Relatively high ratio values mean that the business is liquid, but cash is not working </li></ul></ul><ul><ul><li>If the current ratio is greater than 1.0, the business is liquid </li></ul></ul><ul><ul><li>If the current ratio is less than 1.0, the business is illiquid </li></ul></ul>
  36. 37. <ul><li>Current assets minus inventories divided by current liabilities </li></ul><ul><li>Interpretation </li></ul><ul><ul><li>Relatively high ratio values mean that the business is liquid, but cash is not working </li></ul></ul><ul><ul><li>If the current ratio is greater than 1.0, the business is liquid </li></ul></ul><ul><ul><li>If the current ratio is less than 1.0, the business is illiquid </li></ul></ul>
  37. 39. <ul><li>Total liabilities divided by total net worth </li></ul><ul><li>Interpretation </li></ul><ul><ul><li>The higher the value, the less solvent the business is </li></ul></ul><ul><ul><li>If less than 1.0, the business is solvent </li></ul></ul><ul><ul><li>If greater than 1.0, the business is insolvent </li></ul></ul>
  38. 41. <ul><li>Total assets divided by total liabilities </li></ul><ul><li>Interpretation </li></ul><ul><ul><li>The higher the value, the more solvent the business </li></ul></ul><ul><ul><li>If greater than 1.0, the business is solvent </li></ul></ul><ul><ul><li>If less than 1.0, the business is insolvent </li></ul></ul>
  39. 43. <ul><li>Value of production divided by total average productive assets </li></ul><ul><li>Interpretation </li></ul><ul><ul><li>The higher the value, the more efficient the business </li></ul></ul><ul><ul><li>The lower the value, the less efficient the business </li></ul></ul>
  40. 45. <ul><li>Total business expenses divided by the value of production </li></ul><ul><li>Interpretation </li></ul><ul><ul><li>The lower the value, the more efficient the business </li></ul></ul><ul><ul><li>The higher the value, the less efficient the business </li></ul></ul>
  41. 47. <ul><li>Net sales divided by net accounts receivables </li></ul><ul><li>Interpretation </li></ul><ul><ul><li>Measures the number of times receivables turn over during the year </li></ul></ul><ul><ul><li>The higher the turnover, the shorter the time between the sale and cash collection </li></ul></ul>
  42. 49. <ul><li>365 divided by the Sales/Receivables Ratio </li></ul><ul><li>Interpretation </li></ul><ul><ul><li>Dividing the sales/receivables ratio into 365 provides the number of days between sales and collections </li></ul></ul><ul><ul><li>The higher the number, the longer it takes the business to collect accounts receivable </li></ul></ul>
  43. 51. <ul><li>Calculated by dividing cost of goods sold by the dollar level of inventory </li></ul><ul><li>Interpretation </li></ul><ul><ul><li>Measures the number of times inventory is turned over during the year </li></ul></ul><ul><ul><li>High inventory can indicate better liquidity or superior merchandising </li></ul></ul>
  44. 52. <ul><li>Interpretation (continued) </li></ul><ul><ul><li>Conversely, high turnover can mean a shortage of needed inventory for sales </li></ul></ul><ul><ul><li>Low inventory turnover can indicate poor liquidity, possible overstocking, obsolescence, or a planned inventory buildup </li></ul></ul><ul><ul><li>Closely examine the reasons behind the value of this ratio with regard to your business </li></ul></ul>
  45. 54. <ul><li>365 divided by the inventory turnover ratio </li></ul><ul><li>Interpretation </li></ul><ul><ul><li>Calculates the average number of days that units are in inventory </li></ul></ul><ul><ul><li>See explanations for high or low numbers in the interpretation for the inventory turnover ratio </li></ul></ul>
  46. 56. <ul><li>Divide cost of goods sold by net accounts payable </li></ul><ul><li>Interpretation </li></ul><ul><ul><li>Measures the number of times payables turn over during the year </li></ul></ul><ul><ul><li>The higher the turnover, the lower the time between purchase and payment </li></ul></ul>
  47. 57. <ul><li>Interpretation (continued) </li></ul><ul><ul><li>A low ratio can indicate: </li></ul></ul><ul><ul><ul><li>Cash shortage </li></ul></ul></ul><ul><ul><ul><li>Invoice disputes with suppliers </li></ul></ul></ul><ul><ul><ul><li>Extended terms of payment provided by suppliers </li></ul></ul></ul><ul><ul><ul><li>Expansion of trade credits with suppliers </li></ul></ul></ul>
  48. 59. <ul><li>365 divided by the payables turnover ratio </li></ul><ul><li>Interpretation </li></ul><ul><ul><li>Calculates the average number of days that trade payables are outstanding </li></ul></ul><ul><ul><li>For possible explanations of a relatively large number of days, see the explanations for the payable turnover ratio </li></ul></ul>
  49. 61. <ul><li>Net sales divided by working capital </li></ul><ul><li>Working capital is calculated by subtracting current liabilities from current assets </li></ul><ul><li>Interpretation </li></ul><ul><ul><li>Measures how efficiently working capital is employed </li></ul></ul>
  50. 62. <ul><li>Interpretation (continued) </li></ul><ul><ul><li>A relatively large ratio could mean that working capital is efficiently employed </li></ul></ul><ul><ul><li>Conversely, it could also mean that the firm is undercapitalized and is in danger of becoming non-liquid </li></ul></ul>
  51. 63. where Working capital = Current Assets – Current Liabilities
  52. 64. <ul><li>Income + loan interest obligations – value of unpaid labor and management – business income taxes divided by total business assets </li></ul><ul><li>Interpretation </li></ul><ul><ul><li>The higher the value, the more profitable the business </li></ul></ul>
  53. 66. <ul><li>Income – value of unpaid labor and management – business income taxes divided by total business net worth </li></ul><ul><li>Interpretation </li></ul><ul><ul><li>The higher the value, the more profitable the business </li></ul></ul>

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