This document outlines an agenda for a seminar on understanding, analyzing, and using financial statements. The schedule includes breaks throughout a full day session from 9:00am to 4:00pm. The presenter will cover key concepts like the four main financial statements, accounting principles and assumptions, and how to interpret items like assets, liabilities, equity, revenues and expenses. Financial accounting will be distinguished from managerial accounting. Details like revenue recognition, depreciation, and the matching principle will be explained.

1. Understanding, Analyzing
and Using Financial
Statements
Presented by:
Wade Farquhar

2. Taking the Mystery out of
Financial Statements

3.  9:00 Seminar begins
10:00 Break
11:00 Break
12:00 Lunch
 1:00 Afternoon session begins
 2:00 Break
 3:00 Break
 3:50 Complete evaluations
 4:00 Dismiss
Today’s Schedule:

4. Link for this and other
presentations:
www.LeanTeams.ca

5. Balance sheet.
What we will cover today:
Key terms and core concepts for financials.
Financial ratios.
Income statement.
Cash flow.
2
3
4
5
6
1
Reporting standards and mechanisms.

6. Why do you want to know how to
analyze and use financial
statements?

7. Businesses that plan
and track against their plan grow
30% faster.

8. Basic Principles

9. What is GAAP?
Generally Accepted Accounting
Principles
A widely accepted set of rules,
conventions, standards, and procedures
for reporting financial information, as
established by the Financial Accounting
Standards Board.

10. Separate entity – activity is separate
from owners or other business.
Ongoing concern – the company is
assumed to continue into the future.
Money as a unit of measurement.
Basic Assumptions
Periodicity – activity is broken down
into cycles of short duration.

11. Historical cost is verifiable and objective
measurement.
Revenue recognition takes place when an exchange
transaction has occurred.
The matching principle means that costs should be
matched with related revenues in the same period.
Full disclosure requires that information be sufficient
for the user to make decisions.
Accounting Principles
Conservativism requires bad news to be recognized
early and good news… late.

12. Accrual accounting records expenses when incurred
(according to the matching principle) and revenues
the sale is made.
Materiality is the principle that judgement be used
in determining how transactions are to be handled.
Objective evidence requires that interpretations be
supported and verifiable.
Accounting Principles
Consistency requires that decisions (especially
subjective interpretations) be consistent.

13. Credit rating.
Contractual commitments.
Quality of products.
Effectiveness of R&D.
Non-Disclosed Items
Integrity of employees.
Preparer’s biases.

14. The cost to produce a product or deliver a service.
The sales price of a product or service.
Gross and net margins on a product or service.
Budgets.
Internal Uses
Variances.
Whether to make or buy a product.

15. Investors.
Vendors.
Banks.
Financial Analysts.
External Users
Government regulatory agencies (the SEC).

16. Financial Accounting
Vs.
Managerial Accounting.

17. Mainly concerned with aggregate numbers.
Oriented towards outside parties.
Tells the financial history of a company.
Indicates general trends.
Does not specify about how results were achieved.
Financial Accounting

18. Managerial accounting is proactive in nature,
whereas many of the actions based on standard
accounting are reactive in nature.
Managerial accounting provides information at the
product, department, or business level.
Managerial accounting provides real-time
information to increase the speed of the
feedback cycle.
Managerial Accounting

19. 4 Key Financial Statements
1
2
3
4
The Balance Sheet
The Income Statement
Statement of Owners Equity
Statement of Cash Flow

20. Equity
Future benefit obtained or owned by a company.
Liabilities
Assets
Investment by owners
Distribution to owners
Retained
earningsRevenues
Expenses
Gains
Losses
Future sacrifices arising from present
obligations.
Decreases in net assets resulting from transfers
from a company to an owner.
Increases in net assets resulting from transfers
to a company by an owner.
Value that remains in a company after deducting
its liabilities.
Changes in net assets from transactions from
non-owner sources.
Increases in assets by delivering goods or
services.
Increases in net assets from transactions other
than revenues or investments by owners.
Asset outflows from delivering goods or services.
Decreases in net assets from transactions other
than expenses or distributions to owners.

22. The devil is in the details.

23. The Balance Sheet
Assets = Liabilities +
Equity

24. How does a company purchase an item?
1
One of two ways:
Purchased items are assets, therefore:
2
Financing.
It uses the owners money to make the purchase.
Assets = Liabilities +
Equity

25. Intangible assets – items that have value but that
have no physical existence.
Current assets – to be consumed or converted
within one year.
Fixed assets – long term investments that help a
company generate profits for more than one year.
Other assets – tangible assets not used in the
company’s ongoing operations.
Assets

26. Patents – lifespan of 17 years granted by government.
Copyrights – the life of the author plus 50 years.
Trademarks – not to exceed 40 years.
Leases – when prepaid create an intangible asset.
Intangible Assets
Licenses – spread out over the cost of the license.
Goodwill – no verifiable cost basis… except in the
case of an acquisition.

27. Depreciation and
Amortization
The beginning of the “art”
of finance

28. Depreciate fixed assets, amortize intangible assets.
They are not the same thing… but they function
in the same way.
The cost of an item is allocated out in many chunks
over a period of time.
Depreciation and amortization schedules are
often defined by the biases of a company.
Depreciation and Amortization

29. Capitalized expenditure – an expense that is recognized
over many periods rather than when cash is paid out.
Salvage value – the expected (estimated) value of an item
once it has used up its utility to a company.
Accumulated depreciation – the cumulative sum of all
the years’ worth of wearing out that has occurred in an item.
Gross fixed asset – the purchase price of an item including
all costs to put the item into service.
Key Terms
Book value – Purchase price minus accumulated
depreciation, also known as Net Fixed Asset Value.

30. Depreciation is a deductible expense.Therefore increasing the
amount decreases the taxable income.
Startups often use it to reduce taxes in order to free up money
for investment in future years.
When items are purchased with loans, the tax savings can be
used to make additional payments toward loan principals.These
additional payments reduce the overall interest paid.
Why use accelerated depreciation?
Cash received sooner is more valuable than cash received later.

31. Companies can increase earnings by spreading out depreciation
over a longer period of time.
This is a valuable tool for publicly traded companies that want
to show high earnings to boost stock prices.
This effect is compounded by the fact that depreciated amounts
are the same size over time, rather than larger up front.
Why use straight-line depreciation?
This is a commonly used tactic, in various forms, for publicly
traded companies to commit fraud or drive the business into
bankruptcy.

32. Liabilities
+
Owners Equity
+

33. Current liabilities are satisfied within one year,
generally from the sale of current assets or
Liabilities are the rights of others to the money,
products or services of the company.
There are two general types of liabilities:
Long-term liabilities will not be satisfied within one
year.
Liabilities

34. Retained earnings are the accumulated earnings
of a company that are not redistributed to owners.
Capital stock, sometimes called preferred
stock is a broad description of the owners’
interest in a corporation.
Additional amount paid in capital is the amount
over and above the stock par value that owners
put into the corporation.
Treasury stock is stock that has been re-acquired
by the corporation and is being held.
Equity

35. Equity is the claim of owners on a company’s
assets.
Another way to look at it is that equity always
equals a company’s assets minus its liabilities.
Equity

36. Master T Account

37. The Income Statement
A manager’s best friend

38. Discloses a company’s profit or loss during a
specified period of time.
Can be called the Profit and Loss (P&L) or
statement of operations.
The person using the statement must be aware of
the accounting basis used by the company.
What is profit?
Income Statement

39. Net income – gross profit minus operating
expenses.
Profit is not total sales.
Gross profit – a company’s total sales minus direct
costs.
EBITDA – Earnings before interest, taxes,
depreciation, and amortization.
Profit
Profit is always an estimate.

40. Cash basis:
Revenue is recorded when payment is received
and expenses are recorded when paid.
Accrual basis:
Revenue is allocated to the period or periods it
is earned, regardless of when it is collected.
Cash vs. Accrual
Expenses are applied to the period in which they
are incurred rather than when they are paid.

41. Sales
Cost of goods sold (direct costs)
Operating expenses
Other income and expenses – income and expenses from
sources other than the principal activity of the business.
Net income
Key Elements

42. When a product or service is enjoyed it means that
the “earning process is complete.”
Revenue is recognized when products or services
are received by the buyer.
Benefits from a product or service can be received or
enjoyed all at once or over a period of time.
When the earning process is complete it means
that there has been a “transfer of rights.”
Revenue Recognition

43. January February March April May June
Invoice for
mo. of
services
Service Example
Six month service agreement
When is the revenue recognized?

44. January February March April May June
Invoice for
mo. of
services
Journal
entry
withdrawin
g 5 months
Journal
entry
recognizing
1 month
Journal
entry
recognizing
1 month
Journal
entry
recognizing
1 month
Journal
entry
recognizing
1 month
Journal
entry
recognizing
1 month
Service Example
Six month service agreement
When is the revenue recognized?

45. January February March April May June
Invoice for
mo. of
services
Invoice for
mo. of
services
Invoice for
mo. of
services
Invoice for
mo. of
services
Invoice for
mo. of
services
Invoice for
mo. of
services
Service Example
Six month service agreement
When is the revenue recognized?

46. Activity February March April May June
Income
Sell
inventory
item with
markup
Expense
Purchase
inventory
item
Product Example
Inventory part purchase and resale
When is the expense recognized?

47. Activity February March April May June
Income
Sell
inventory
item with
markup
Expense
Purchase
inventory
item
Product Example
Inventory part purchase and resale

48. Net Sales
Gross Sales - Sales Discounts
- Sales returns and allowances
= Net Sales

49. Can include cost of services when labor is being
resold.
Expenses to manufacture or purchase merchandise
that has been sold.
Takes into account materials costs, labor, and
factory expenses.
Cost of Goods Sold (COGS)

50. Example
$600,000 + $700,000
- $25,000_____________________
$1,275,000
- $25,000_____________________
$1,250,000

51. In selling prices.
Begin modeling different outcomes with changes:
In quantities of units sold.
In cost of goods as purchase units are
increased/decreased.
Gross Profit Ratio

52. Administrative supplies costs.
Office salaries (oftentimes all salaries).
Depreciation expenses.
Rent expenses.
Insurance.
Tax expenses.
Operating Expenses

53. Expense Allocation
Where the game is won…
or lost

54. Revenues $1,000,000
Cost of sales -750,000
Gross margin 250,000
Administration -100,000
Profit before taxes 150,000
Taxes -50,000
Net Profit $100,000
Standard Income Statement

55. • This works if all the activities of the organization are
similar in profitability.
• Assumes all costs will vary equally with changes in
revenues.
• In complex situations it does not provide enough
information for monitoring, planning or taking
corrective action.
Issues:

56. Product Line A Product Line B Total
Revenue $750,000 $250,000 $1,000,000
Cost of Sales $520,000 $230,000 $750,000
Gross margin $230,000 $20,000 $250,000
Administration $100,000
EBITA $150,000
Taxes 50,000
Net profit $100,000

57. Product Line A Product Line B Total
Revenue $750,000 $250,000 $1,000,000
Cost of Sales $520,000 $230,000 $750,000
Gross margin $230,000 $20,000 $250,000
Administration $70,000 $30,000 $100,000
EBITA $150,000
Taxes 50,000
Net profit $100,000

58. 0%
20%
40%
60%
80%
100%
120%
New Construction Remodelling
COGS % to Income Earned
% of Total Income % COGS/Income

59. $-
$2,000.00
$4,000.00
$6,000.00
$8,000.00
$10,000.00
$12,000.00
$14,000.00
New
Construction
Labor
Remodel
Labor
New
Construction
Materials
Remodel
Materials
New
Construction
Subcontracting
Remodel
Subcontracting
New
Construction
Other
Remodel Other
Gross Profit Analysis: Income to COGS
Income Cost

60. Statement of Owners
Equity
Retained Earnings

61. Master T Account

62. Two Paths
Stay in the company
(investment)
Exit the company
(distribution or dividend)
Earnings

63. Equity
Investments by owners (stock)
+ Retained earnings
=Total
Equity

64. Statement of
Cash Flow

65. Wait a second, we already talked
about profit.
Profit is cash, right?

66. $300k
Startup
expenses
Cash in
the bank
Profitable Enterprise Inc.
February AprilJanuary March
Invoice all customers on 60 day terms.

67. $300k
Startup
expenses
Cash in
the bank
Profitable Enterprise Inc.
February AprilJanuary March
Invoice all customers on 60 day terms.

68. Money in, and
Money out
Cash flow is:

69. Investing activities – purchases and sales of
assets, other companies’ debts and equity.
Operating activities – Transactions related to
providing goods and services and paying expenses
to generate revenues.
Financing activities – Issuance of capital stock,
debt securities, dividend payments, debt repayment
3 Sources of Cash

70. Collections from
customers
Money
Out
Payments to employees
Other operating disbursements
Receipts of
interest and
dividends on
investments
Operatin
g
activities
Source: Bushee, Bryan. Introduction to Financial Accounting. Wharton School of
BusinessOnline, 2015.
Money In
Payments to suppliers
Payments of interest and tax

71. Divestitures
Money
Out
Acquisitions of PP&E
and intangibles
Sale of
investments
Investing
activities
Source: Bushee, Bryan. Introduction to Financial Accounting. Wharton School of
BusinessOnline, 2015.
Money In
Acquisition of business
Purchase of investments
Sale of PP&E
and intangibles

72. Issuance of new
stock
Money
Out
Purchase of treasury stock
Borrowing
money
Financing
activities
Source: Bushee, Bryan. Introduction to Financial Accounting. Wharton School of
BusinessOnline, 2015.
Money In
Payment of dividends
Payment of principal on debt
Reissuing
treasury stock

73. Statement of cash flow format:
Net cash from operating
activities.
+ Net cash from financing activities.
+ Net cash from investing
activities.
The Statement of Cash Flows
Non-cash transactions are also disclosed at the
bottom of the statement.
Net change in cash balance.

74. The direct method
The indirect method
Two ways to figure cash flow:

75. Rarely used for operating activities.
Lists all major operating cash receipts
and payments by source/use of funds.
Always used for financing and investing
activities.
The Direct Method

76. Cash collected from customers (ARs).
Interest and dividends received.
Other operating receipts.
Cash paid to employees and suppliers.
Interest payments.
Income tax payments.
The Direct Method Discloses

77. Begins with net income and reconciles that amount to
net cash flow.
Removes non-cash items from net income.
Only used for operating activities.
Adds in additional cash flows not included in net
income.
The Indirect Method
Most companies use this method for calculating cash
flows related to operating activities.

78. Deferrals of past operating receipts and payments.
Accruals of expected future operating receipts and
payments.
Non-cash gains and losses.
Changes in receivables, inventories, and other operating
current assets and liabilities.
The Indirect Method Excludes

79. Operating cash minus cash for long-term investments.
Which figure is used for “operating cash flow?”
Cash from operations before interest
EBIT + Depreciation
EBITDA
Net income adjusted for depreciation and
other non-cash items – increase in working
capital.
Free Cash Flow (FCF)

80. Financial Ratios.

81. Activity – operations efficiency.
Leverage – how company uses debt.
Liquidity – important for lenders.
Profitability – important for investors.
Four Main Categories

82. Horizontal Analysis
Compares internal company results year over
year.
Compares time period results as a percentage of
net sales.
Vertical Analysis
Two Main Methods:

83. Ratios are comparisons of one number to another.
Ratios must be compared to a benchmark.
Compare the same firm across time (time
series).
Compare a different firm or to the industry
(cross-sectional analysis).
Ratios are contextual.
Ratio analysis does not provide answers; it
helps you ask better questions.
Source: Bushee, Bryan. Introduction to Financial Accounting. Wharton School of
BusinessOnline, 2015.

84. Ratios have multiple definitions.
There is not GAAP standard for ratio analysis.
You must use the same definition to make
valid comparisons.
Choosing the appropriate benchmark is important.
Major changes in the company make time series
comparisons difficult.
Differences in strategy or structure distort
cross-sectional analyses.
Misusing Ratios

85. Is $10 mil. in net profit a good or bad thing?
It depends on the amount of capital invested to
achieve that result.
ROE = Net return/average shareholders’ equity.
The numerator shows how much return the
company generated for shareholders.
The denominator shows the shareholders’ investment.
This is the best measure for ROI.
Return on Equity (ROE)

86. Operating performance
Return on Assets (ROA) = Net income/Avg. assets
Measures how effectively managers use
company resources (assets) to make profit.
Financial leverage
How much do managers use debt to increase the
company’s assets for given level of investment.
Leverage = Avg. assets/Avg. equity
Two Drivers of ROE

87. Profitability
How much profit does the company earn on each
dollar of sales.
Return on sales (ROS) = Net income/sales
Efficiency
How much sales does the company generate
based on its available resources.
Asset turnover (ATO) = Sales/Avg. assets
Two Drivers of ROA

88. Return on Equity
Operating Performance X Financial Leverage
ROE = Net income/assets X Assets/equity

89. Benchmarking.

90. A tool to measure your business against your
competitors within your region and industry.
You can compare your revenues, costs, average
days to collect, average days to pay, etc.
Have you ever wondered how your competitors
operate?
To see the company website that provides this
service click here.
Benchmarking

91. Businesses that plan
and track against their plan grow
30% faster.

92. Evaluating Capital
Investments
How do you know when it
is a good time to invest?

93. Net PresentValue (NPV)
Puts a value on tomorrow’s cash inflows from an
investment in today’s dollars.
Calculates the interest rate below which an
investment is a good idea.
Internal Rate of Return
Two Methods:

94. Net Present Value
Initial Cost
Value of
Future
Revenues
Is it a good deal?

95. Annual Reports

96. Expense allocation.
Estimates and assumptions.
Revenue recognition.
Depreciation and amortization schedules (this
includes salvage value and useful life estimates.
Annual Report Footnotes

97. Skim the highlights – written by the managers.
Read the footnotes.
Skip the letter to shareholders.
Then go back to the financial statements and
read them with a whole new set of eyes.
Reading an Annual Report

98. Accounting policies – choices made which would be important in
interpreting results.
Related party transactions – such as between the company
and a shareholder, officer, or subsidiary.
Subsequent events – relevant events that happened
between when financials were prepared and report issued.
Doubt concerning continued existence – any information
contrary to “going concern” must be disclosed.
Contingent liabilities – potential liabilities, such as a pending
lawsuit not certain enough to record yet.
Significant risks and uncertainties – nature of operations,
use of estimates, high concentrations.
Disclosure Requirements

99. Unqualified opinion
Sometimes called a “clean” opinion, is that all
material aspects are presented fairly in
conformity with GAAP.
Will state the issues or disclosures that the auditor
cannot grant an unqualified opinion.This could be
as a result of non-conformity with GAAP.
Qualified opinion
Qualified vs. Unqualified

100. Earnings per share – Actual earnings on each share
of stock.This is ROE/number of shares outstanding
and helps see dilutive effects.
Interim reporting – required when companies
are required to report on a semi-annual or
quarterly basis.
Segment disclosures – required so that the reader
may become more aware of risks that
management sees within the company.
Special Disclosures
MD & A – gives readers management’s opinion
on the results of the company.

101. The Securities Exchange Act of 1934
Public Utility Holding Company Act of 1935
Trust Indenture Act of 1939
Investment Company Act of 1940
Investment Advisors Act of 1940
Securities Investor Protection Act of 1970
The SEC Enforces:

102. 1. Business
2. Properties
3. Legal Proceedings
4. Submission of Matters to a Vote
5. Market for Registrant’s Common Equity and Related
Stockholder Matters
6. Selected Financial Data
7. Management’s Discussion and Analysis
Form 10-K

103. 8. Financial Statements and Supplementary Data
9. Changes in/Disagreements With Accountants
10. Directors and Officers of the Registrant
11. Executive Compensation
12. Security Ownership
13. Certain Relationships & Transactions
14. Exhibits/Financial Statement Schedules
Form 10-K, cont.

104. 1. Financial Statements
2. Management’s Discussion and Analysis
3. Legal Proceedings
4. Changes in Securities
5. Defaults Upon Senior Securities
6. Submission of Matters to a Vote of Security Holders
7. Other Information
Form 10-Q

105. Government Accounting

106. Regulated by the Government Accounting Standards Board
Many similarities between private and government accounting.
Annual reports are different due to the external users of the
report:
Citizenry – taxpayers, voters, and service recipients.
Oversight bodies – commissions, councils, boards, and
executives responsible for taking corrective action.
Investors and creditors – municipal securities
investors and underwriters, insurers, etc.
Government Accounting

107. Determining finance-related laws – bond covenants,
grant restrictions, tax limits.
Evaluating efficiency and effectiveness – service
costs, efforts and accomplishments.
Comparing results with budgets – so that
accountability can be maintained in the future.
Goals of Govt. Accounting
Assessing results – the entity’s financial
position and ability to continue to provide
services.

108. They are fiscal and accounting entities with a
self-balancing set of accounts segregated for
the purpose of carrying on specific activities or
attaining certain objectives in accordance with
special regulations, restrictions, or limitations.
Governmental accounting systems are organized
and operated as “funds.”
Fund Accounting

109. Special Revenue Funds for specific revenue sources
restricted to expenditures for specific purposes.
Capital Projects Funds for acquiring or constructing
major capital facilities.
General Fund for all financial resources except
those in another fund.
Governmental Funds
Debt Service Funds for general long-term debt
principal and interest.

110. Internal Service Funds for financing between
agencies or departments of the government.
Enterprise Funds for operations similar to private
businesses or where determination of revenue,
expenses and/or net income is appropriate.
Proprietary Funds

111. Nonexpendable Trust Funds
Pension Trust Funds
Expendable Trust Funds
Agency Funds
Fiduciary Funds
Assets held in a trustee capacity, including:

112. Encumbrances
An encumbrance, which is unique to governmental accounting, is
the reservation of a portion of an applicable appropriation that is
made because a contract has been signed or a purchase order
issued.
The encumbrance is usually recorded in the accounting system
to prevent overspending the appropriation.

113. Audits.

114. 1. Proposal
2. Engagement letter
3. The importance of internal controls
4. Audit schedule:
• Physical inventory
• Confirmation of receivables
• Field work
5. Divide preparation of audit work-papers
Preparing for an Audit

115. Audited Statements
Here is what it means:
“An independent accountant has applied a variety of techniques to
obtain evidential matter sufficient to express an informed opinion
about whether the financial statements conform with GAAP. The
accountant must comply with professional standards and conduct
the examination in accordance with Generally Accepted Auditing
Standards.”

116. Reviewed Statements
Here is what it means:
“An independent accountant has performed inquiry and analytical
procedures sufficient to provide a reasonable basis for expressing
limited assurance that there are no material modifications that
should be made to the statements in order for them to be in
conformity with GAAP or, if applicable, with another comprehensive
basis of accounting.”

117. Compiled Statements
Here is what it means:
“An independent accountant presents in the form of financial
statements for a nonpublic company, information that is the
representation of management (or owners) of the client without the
accountant undertaking to express any assurance on the
statements.”

118. Audit risk and materiality
Reliance on internal controls
Errors and irregularities
Related party transactions
Illegal acts
Going concern
Audit Challenges

119. Title
Addressee
Introductory Paragraph
Scope Paragraph
Opinion Paragraph
Signature
The Auditor’s Report
Date

120. Internal Auditing
Per the Institute of Internal Auditors and internal audit is “an
independent, objective assurance and consulting activity designed to
add value and improve an organization’s operations. It helps an
organization accomplish its objectives by bringing a systematic,
disciplined approach to evaluate and improve the effectiveness of
risk management, control, and governance processes.

121. Evaluate and improve the effectiveness of risk
management, control, and governance processes.
Evaluate emerging technologies.
Examine global issues.
Analyze opportunities.
Assess risks, controls, ethics, quality, economy, and
efficiency.
Internal Audit Goals

122. The reliability and integrity of information.
Compliance with policies and regulations.
Economical and efficient use of resources.
Safeguarding of assets.
Operational goals and objectives.
Internal Auditor’s Role
Review:

123. Financial Audits
Have accurate financial statements as their
objective.
Have compliance and/or operational
improvements as their objective.
Operational Audits
Comparing Audits

124. … AND
YOU’RE
DONE!
Thank you.

125. Link to this
presentation:
www.LeanTeams.ca/resources
Wade Farquhar

126. To download this
presentation