CFO Insight: This is a primer on how to use financial statements to more effectively operate a privately held business and was used to educate new entrepreneurs at the Valley Economic Development Corporation in Sherman Oaks, CA.

1. Introduction To Financial
Statements
Presented By
Chase Morrison

2. Purpose of Course
• Learn how to read and create financial statements
• Be able to identify the three primary statements
• Learn basic characteristics of each statement
• Gain a fundamental understanding of financial metrics
• Develop ability to create your own financial
statements or projections
• Learn how to apply what you learn using QuickBooks
• Understand how financial statements are interrelated
• Develop some basic benchmarking skills.

3. Who’s Your Instructor?
• Chase Morrison
• Over 25 years working for Fortune 300 companies
• Significant financial planning & analysis experience
• Worked in defense and medical device businesses
• I am a partner with B2B CFO® (over 220 partners WW)
• Provide CFO services to small and midsize businesses
• Services include accounting oversight, financial
reporting, budgeting, forecasting, sales analysis, risk
management, lender relationship maintenance,
accounting system implementation, etc.

4. Why do you need financial statements?
• Secure a bank loan
• Attract investors
• Complete a tax return
• Give you something to talk about with your
accountant
• Impress your friends
• Financial statements are the primary
tool you need to help a business
generate a profit!!!

5. Understanding Balance Sheets
Categorizes what a company owns and what it owes
What a company owns
Assets -- The non-people
related resources needed to
generate revenue, including:
• Cash
• Receivables
• Inventory
• Equipment
• Intellectual Property
=
What it owes (& to whom)
Liabilities – Third-party
obligations:
• Vendors (AP)
• Lenders (Debt)
• Employees (Accruals)
+
Equity – Stakeholder’s
ownership in business
• Owners
• Shareholders
• Partners
Connecting things (or assets)
to…
People (or investors, vendors,
lenders & employees)

6. A few words about cash vs. accrual basis
accounting
• Cash basis accounting – GL only reflects actual receipt and
disbursement of cash.
 Advantages: i) simple, ii) aligns with taxes, iii) requires little
thought
 Disadvantages: i) mismatch of income and expense, ii) under-states
liabilities, iii) unreliable financial analysis tool.
• Accrual basis accounting -- Revenue is recognized when
product or service is delivered (not on cash receipt) and
expense is associated with benefiting period
 Advantages: i) truer representation of business position and
performance, ii) enables more reliable financial analysis, iii) has
more validity with investors and lenders
 Disadvantages: i) more complex, ii) requires more accounting
knowledge, iii) more transactions, iv) will require more costly
personnel to administrate

7. Source of Examples – QuickBooks Sample Files

8. Assets – What a Company Owns
• Resources needed to
generate revenue
• Split into current (to
be used in < 1 year)
and long term (> 1
year)
• Ordered by liquidity
• Asset test: Can you
convert item to cash?
ASSETS
Current Assets
Checking & Savings 25,802
Accounts Receivable 93,752
Inventory 154,754
Prepaids 0
Other Current Assets 20,000
Total Current Assets 294,308
Long Term Assets
Fixed Assets
Equipment 64,700
Depreciation -923
Total Fixed Assets 63,777
Other Assets 0
Total LT Assets 63,777
TOTAL ASSETS 358,084
More Liquid --- Less Liquid

9. Liabilities & Equity – Who a Company Owes
• Liabilities – Claims on company
assets by outsiders
– Like assets, split into current and
long term
– Ordered by when payments are
due
• Equity – Claims on company
assets by stakeholders, after
liabilities are paid
– Two categories: Equity (or paid in
capital) and Retained Earnings
– Paid in capital is the capital
investment made by the
company’s owners
– Retained earnings is the
accumulation of net income, net of
any dividends. Since no dividends
are paid, RE is the sum of the ITD
net income.
LIABILITIES
Current Liabilities
Accounts Payable 91,418
Credit Cards 657
Payroll Liabilities 1,306
Line of Credit 3,739
Total Current Liabilities 97,121
Long Term Liabilities
None
EQUITY
Owner's Equity 166,640
Retained Earnings
Prior Year RE 5,634
Current Year RE 88,690
Total Equity 260,964
TOTAL LIABILITIES & EQUITY 358,084

10. Two quick things we can learn from our
balance sheet
• Quick Ratio – Provides insight into immediate liquidity
problems:
(Cash + Accts Receivable) / (AP + Other Current Liabilities) = QR
($25.8K + $93.8K) / ($91.4K + $4.7K) = 1.23
This indicates that we have 1.23 in fairly liquid cash to pay our
immediate debts, which indicates some modest cushion.
• Current Ratio – Provides insight into longer range solvency:
(Cash + Acct Rec + Inventory + Other Assets) / (AP + Other Current Liab)
= Current Ratio
($25.8K + $93.8K + $154.8K + $20.0K) / ($91.4K +$4.7K) = 3.03
A Current Ration of 3.03 means that there is $3.03 dollars per every
$1.00 of current liabilities, which is a comfortable coverage range. Loan
officers and bankers focus on this metric.

11. Understanding the Profit & Loss (P&L) Statement
• Also know as Income Statement, Statement of
Earnings, and Statement of Operations
• The P&L tells you whether your company is profitable
over a given period of time.
• Extremely useful for validating and managing your
business model
• One may erroneously believe they are “making
money”
• Two part composition of business transactions (1:
promise to pay or revenue recognition, and 2:
settlement or collection)
• The “making money” question is provided on a cash
flow statement

12. So what information does a P&L provide?
• The P&L statement is indispensable because it
answers the following question:
If we take the value of all the goods and services
provided over a specific period of time and compare
that to the costs that were incurred to produce those
goods and services, even for costs that have yet to be
paid, did the value received (or promise to pay) exceed
the cost input?
• Assuming the answer is “yes”, and your customers
settle all your transactions (or pay your invoices)
then the business is going to make money.

13. Source of QB Profit & Loss Statement

14. Typical P&L Composition
Income Statement
Revenue 486,526
Cost of Goods Sold
Standard Cost 267,185
Period Expenses 21,200
Other Adjustment 924
Total Cost of Goods Sold 289,309
Gross Profit 197,218
GP Margin % 40.5%
Operating Expense
Advertising Expense 1,825
Licenses & Fees 710
Car & Truck Expense 13,810
Conferences & Seminars 575
Wages
Salary & Wages 28,725
Employee Benefits 5,175
Total Wages 33,900
Total Operating Expense 106,291
Total Operating Income/(Loss) 90,926
Operating Margin % 18.7%
Other Income/Expense
Interest Expense 2,236
Total Other Income/Expense -2,236
Net Income 88,690
Return On Sales % 18.2%
Revenue: Value of goods and services invoiced or billed
Cost of Goods Sold: Represents cost of goods or
services delivered on revenue row. Includes material,
labor and overhead.
COGS: Net of revenue and cost of goods.
Operating Expense: Related business costs not
directly associated with the product or service.
Examples include distribution, selling, marketing,
administrative and product development expenses.
Operating Income: Net of gross profit and operating
expense.
Other I/E: Income & Expense unrelated to revenue
generating activities
Net Income: Final income after all expenses,
including tax

15. Basic P&L Analysis

16. Understanding Cash Flow Statement
• Reflects how effectively a business is able to convert
profits into cash
• CF statement displays changes that bridge beginning to
ending cash balance for some period, e.g. 2010 to 2011
ASSETS
Current Assets YE 2010 YE 2011
Checking & Savings 77,638 25,802 CF Statement bridges $52K
• Split into three categories
YOY use of cash
– Operating CF: Cash movement pertaining to day-to-day
business operations, such as collecting AR.
– Investing CF: Cash movement pertaining to investing
activities, such as purchasing equipment.
– Financing CF: Cash movement pertaining to financing
activities, such as acquiring debt.
• Two types of CF statements—Direct & Indirect. Focus of
this presentation is Indirect method

17. How to derive cash flow (Indirect)
Prior Current
Period Period Cash Flow Calculation
Net Income/(Loss) $CP +$CP Income/-$CP Loss
Operation CF
Accts Receivable $PP $CP $PP - $CP Asset Increase = CF Use
Inventory $PP $CP $PP - $CP Asset Increase = CF Use
Accts Payable $PP $CP $CP - $PP Liability Decrease = CF Use
Other Accruals $PP $CP $CP - $PP Liability Decrease = CF Use
Total OCF $XXXX
Investing CF
Fixed Assets $PP $CP $PP - $CP Asset Increase = CF Use
Depreciation $CP +CP Add back (Non-Cash Expense)1
Total ICF $XXXX
Financing CF
Debt $PP $CP $CP - $PP Liability Decrease = CF Use
Equity Transactions $PP $CP $CP - $PP Liability Decrease = CF Use
Total FCF $XXXX
TOTAL CASH FLOW CHANGE $XXXX
Notes:
Ignore retained earnings
Ignore cash since the above will bridge the change in cash
1Depreciation is a non-cash expense and is consequently added back to cash flow

18. Source of Cash Flow Data in QB

19. Typical Cash Flow Statement
OCF + ICF + FCF = Periodic Cash Flow (Change in Cash)
Or
Beginning Cash + Change in Cash = Ending Cash
Principal Sources/Uses of Cash: 1) Operations, 2)
selling/buying assets, 3) borrowing/paying back
lenders and investors
OCF: Lenders want to see business generating or plan
to generate OCF cash; otherwise there really is no
business.
ICF: Growing companies may be consuming cash to
purchase fixed assets. Eventually OCF must overtake
ICF.
FCF: Reflects level of dependence on lenders and
investors.

20. Key Financial Metrics1 For Planning & Analysis
• Return on Sales – Net Income / Sales: Profitability Measure
• Return on Assets – Net Income / Assets: Return on Assets
Measure
• Return on Equity – Net Income / Equity: Return on Stakeholder
Investment Measure
• Days Sales Outstanding – AR / Sales * 365 days: Measures
company’s ability to collect
• Days Inventory On Hand – Inventory / COS * 365: Measures
company’s ability to manage inventory
• Days Payable Outstanding – AP / Invoiced Expenses *365:
Measures company’s ability accounts payable
• Cash Cycle – DSO + DIOH: Measures days from 1st check
written to inventory to invoice paid by customer
1More metrics & explanations in appendix

21. Understanding Efficiency
• Days Sales Receivable
((Beg AR + End AR)/2) / Sales * 365
(($12K + $94K)/2) / $487K * 365 = 40 DSR
• Days Inventory On Hand
((Beg Inv + End Inv)/2) / COGS * 365 = DIOH
(($220K + $155K)/2) / $289K * 365 = 236 DIOH
• Days Payable Outstanding (Liability)
((Beg AP + End AP)/2 / Invoice Exp * 365 = DPO
(($3K + $91K)/2) / $395K * 365 = 43 DPO
• Cash Cycle
DSR + DIOH = 40 DSR + 236 DIOH = 276 Days

22. Creating Your Own Financial Statements = Financial
Planning
• Why bother creating a plan?
– Planning is the most powerful thing you can do
– It allows you to see into the future
– Can you have more power than the ability to predict and
influence the future?
– This has the potential to become one of the most powerful tools
your company uses
– It needs to be continuously updated and improved
• What you should have to get started
– Context for your plan (goals & objectives)
– Historical results and the metrics we’ve discussed
– A financial model that closely replicates your business’
• Only create as much detail as will add value to financial
management processes.

23. Financial Planning – Profit & Loss
• Methodologies for planning sales
1) Increase prior-year total units by some % and adjust selling prices
2) Use #1, but do it for each product
3) Forecast sales by customer
• Methodologies for time phasing sales
1) Divide by 12
2) Use last year’s monthly proportions (e.g. if 10% of sales were booked in
February then use that assumption.
• Methodologies for cost of sales
1) Use prior-year % of cost of sales to sales
2) Create standard unit costs and multiply product unit volumes from sales
plan
• Methodologies for expenses
1) % of sales
2) Fixed by month using prior year
3) Expenses as % of another expense
4) Expense by category using vendor detail from prior year

24. Financial Planning – Balance Sheet
• Methodologies for accounts receivable
1) Use DSR methodology, basing projection on most recently quarterly
performance
2) Use aging model (e.g. AR consists of 50% current sales, 30% of last month’s
sales and 20% of two months ago sales)
3) Forecast AR by customer using either of the two approaches above
• Methodologies for inventory
1) DIOH methodology, basing project on cost of sales plan
2) Develop more complex model segregating RM, WIP & FG.
• Methodologies for fixed assets
1) Need plan for acquiring new assets as well as the acquisition value of
existing assets. Add in straight line depreciation for new assets.
• Methodologies for accounts payable
1) Use % applied to total cost of goods sold plus total expenses
2) Actually identify invoiced expense and material, calculate the historical
ratio of AP to those costs and forecast future on that basis
• Be creative in regards to planning other balance sheet accounts that
have a material impact.
• Once P&L and balance sheet are created, cash flow plan

25. What a Financial Plan Looks Like
Actual Plan
Year 2010 Year 2011 Year 2012 Year 2013 Year 2014
Revenue $12 $487 $525 $573 $601
Cost of Goods $6 $289 $310 $344 $343
Gross Profit $6 $197 $215 $229 $259
Operating Expense
Wages $0 $34
Insurance $0 $28
Travel $0 $2
Supplies $0 $3
Professional Services $0 $4
Facilities $0 $11
Depreciation $0 $1
All Other $0 $23
Total Op Expense $0 $106 $110 $109 $132
Op Income $6 $91 $105 $120 $126
Other I/E $0 $2 $2 $2 $2
Net Income $6 $89 $103 $118 $124
- YOY Revenue Growth -- 3919% 8% 9% 5%
- Gross Profit 49% 41% 41% 40% 43%
- Op Profit 47% 19% 20% 21% 21%
- Return on Sales 47% 18% 20% 21% 21%
Assets
Cash $78 $26 $40 $32 $92
Accts Receivable $12 $94 $133 $288 $297
Inventory $220 $155 $195 $215 $211
Other Cur Assets $1 $20 $20 $20 $20
Current Assets $311 $294 $389 $555 $620
Equipment $62 $65 $125 $135 $145
Accum Depr $0 -$1 -$25 -$27 -$29
Total Assets $373 $358 $489 $663 $736
Liabilities & Equity
AP $3 $91 $75 $81 $85
Other Liabilities/Debt $63 $6 $50 $100 $45
Total Liailities $66 $97 $125 $181 $130
Equity $302 $167 $167 $167 $167
Retained Earnings $6 $94 $197 $316 $440
Total Liabilities + Equity $373 $358 $489 $663 $736
- DSO 40 100 200 189
- DIOH 236 230 228 225
- DPO 43 65 65 65
Operating CF
Net Income $6 $89 $103 $118 $124
Accts Receivable -$12 -$82 -$40 -$155 -$9
Inventory -$220 $65 -$41 -$19 $3
Other OCF Assets -$1 -$19 $0 $0 $0
AP $3 $88 -$17 $6 $4
Total OCF -$224 $142 $6 -$50 $123
Investing CF
Fixed Assets -$62 -$3 -$60 -$10 -$10
Accum Depreciation $0 $1 $24 $2 $2
Total ICF -$62 -$2 -$36 -$8 -$8
Financing CF
Debt $63 -$57 $44 $50 -$55
Investing/Draw $302 -$135 $0 $0 $0
Total FCF $364 -$192 $44 $50 -$55
Change In Cash $78 -$52 $14 -$8 $60
Income Statement Balance Sheet Cash Flow Statement

26. Benchmarking
• Benchmarking is a processed used to compare a
company’s financial performance, typically to
other competitors within its industry or possibly
units within the same company.
• Significant variances between the company being
evaluated vs. the benchmark companies provide
opportunity for improvement.

27. Benchmark Data
Client Company Wal-Mart J&J McDonalds Accenture
Fiscal Year ($K) 2008 2009 2010 2011 2010 2010 2010 2010
Revenue $105 $250 $650 $725 $408,085 $61,587 $24,075 $23,094
1-year Growth #N/A 138.1% 160.0% 11.5% 1.7% -0.5% 5.8% -0.3%
3-year CAGR #N/A #N/A #N/A 90.4% 5.8% 0.3% 1.8% 2.5%
Profitability/Operating Efficiency
GM % 27.6% 20.0% 30.8% 31.0% 25.4% 69.5% 40.0% 31.4%
R&D % 19.0% 22.0% 11.5% 10.3% 0.0% 11.1% 0.0% 0.0%
SG&A % 42.9% 26.0% 11.5% 11.7% 19.5% 30.9% 9.0% 18.8%
Operating Income % -34.3% -28.0% 7.7% 9.0% 5.9% 27.5% 31.0% 12.6%
OPAT % -39.0% -30.8% 4.5% 4.8% 5.4% 27.5% 29.1% 12.6%
Net Income % -39.0% -30.8% 2.9% 3.2% 3.7% 21.7% 20.5% 8.9%
Asset Utilization
Operating Cash Cycle (Days) 485 529 427 482 43 162 21 58
DSO (Days) 365 256 225 227 4 58 18 58
DIOH (Days) 120 274 203 256 39 104 3 0
Operating Capital Turnover 0.84 1.43 1.63 1.16 NA NA NA NA
Capital Intensity (Fixed Asset Turnover) 10.50 1.67 2.60 4.14 3.99 4.23 1.09 34.99
Asset Turnover 0.45 0.37 0.62 0.58 2.39 0.60 0.75 1.80
Leverage 1.120 1.405 1.490 1.523 2.42 1.82 2.18 4.53
Debt To Total Capital 0.0% 23.7% 28.1% 26.7% 34.1% 22.9% 44.0% 0.1%
Returns
ROIC -19.6% -12.2% 2.0% 2.1% 14.0% 18.2% 18.9% 72.6%
ROAE -17.5% -11.4% 1.8% 1.9% 8.8% 13.0% 15.5% 16.0%
ROE -19.6% -16.0% 2.7% 2.8% 21.2% 23.6% 33.8% 72.6%

28. Benchmarking Example

29. A Deeper Dive – More layers off the onion
• What is the cost of acquiring a new customer or client?
• How many leads do you average in a typical week?
• How many leads turn into clients (conversion rate)?
• On average, how many touches (email, phone, etc.) does it take to
close a sale?
• If you operate on up sell or cross sell strategies, how often are you
successful?
• Can you profile your average customer?
• What % of your customers did you retain for 1 yr, 2 yrs, 3yrs?
• What is your average dollar sale?
• What were your top 3 advertising campaigns last year?
• What % of your business can be attributable to those campaigns?
• How frequently did we have to reissue and invoice due to an error?
• How many manual payroll checks are issued monthly?
• What is the average cost of “after product care” care (e.g. help desk
for a software product)?

30. Appendix -- A few useful financial ratios
Metric Formula Description
Current Ratio Current Assets / Current Liabilities Measure of overall liquidity
Quick Ratio (Cash + AR) / Current Liabilities Measure of liquid resources available to meet immediate
Days Inventory On Hand (DIOH) (Inventory/COGS) * 365 Measure of inventory turnover.
Days Sales Receivable (DSR) (AR/Sales) * 365 Measure of collections
Days Payables Outstanding (DPO) (Accts Payable/COGS) * 365 Measure of AP payments
Gross Profit Margin Gross Profit / Revenue Measure of revenue that is not paid out as direct spending (raw
material, overhead, direct labor)
Net Profit Margin Net Profit Before Taxes / Sales Measure of how much profit is retained of each revenue dollar
after deducting all expenses other than taxes.
Payroll To Sales (Direct Labor + G&A Payroll) / Sales Measure company payroll as a percentage of sales
Interest Coverage Ratio EBITDA / Interest Expense Measures company’s ability to service debt payments (EBITDA =
Earnings before income taxes, depreciation and amortization)
Debt-To-Equity Ratio Liabilities / Total Equity Measures a company’s leverage ratio as a function of its total
capitalization (balance of money owed to third parties and
stakeholders used to fund assets)
Return on Equity Net Income / Equity Measures effective return of all stakeholders (owners, investors,
partners)
Return on Assets (or Return on
Assets Employed)
Net Income / Assets Measures company’s ability to produce profitable sales using the
available assets.
Fixed Asset Turnover Sales / Gross Fixed Assets Asset management ratio measuring how well fixed assets are being
used to “throw off” sales.