This document provides an overview of financial intelligence and understanding financial numbers. It discusses: 1) How financial numbers tell a story but also involve accounting judgments and estimates, so the numbers do not always represent an entirely accurate financial picture. 2) The importance of asking questions about the numbers to ensure they represent what the user thinks and are not subject to manipulation. 3) Various ways that companies can "cook the books" and manipulate financial reports, such as through revenue recognition, reducing expenses, and balance sheet valuations. Understanding these limitations is important for properly interpreting financial reports.

1. Financial Intelligence
Iyad Mourtada, CMA, CIA, CFE
Knowing what the numbers really mean
1

2. 2

3. Why
do
smart
managers
make
bad
1inancial
decisions?
3

4. Emotional Intelligence
Financial Intelligence
4

5. Neuron (nerve cell) is an electrically excitable
cell that processes and transmits information by
electrical and chemical signaling.
Obtain
Store
Process
Connect
5

6. Financial
Numbers
Financial Information
Gross
Margin = 22%
Operating
Margin = 7.5%
Net
Margin = 2.8%
Financial
Knowledge
6

7. Know
What
Know
nothing
Know
How
Know
Why
The Continuum of Understanding
(Cleveland 1982)
7

8. ALLOCATION OF MENTAL SPACE
8

9. Finance is an Art
“I was very creative with my accounting, but not
creative enough.”
9

10. Financial Numbers
10

11. A bat and a ball cost $1.10 in
total. The bat costs $1 more than
the ball. How much does the ball
cost?
X + Y = 1.10
X:bat
Y:ball X - Y = 1 Y = 0.05
1 + Y + Y = 1.10
11

12. A person's inability to make
sense of the numbers.
Do you know how to
deal with numbers?
12

13. 800
400
400
200
200
100
100
Potential
Customers
Customers
100
13

14. 130
$ Millions
131
132
01/2010 03/2010
129
14

15. 100
$ Millions
120
140
01/2009 03/10
80
Look at the big picture
01/10
15

16. Numbers tell a Story
16

17. Financial
Information
17

18. Figuring out how much a company worth
Share Price X # of Shares
Present Value of Future Cash Flow
18

19. 19

20. Having more information is not always better
20

21. Turning Financial Information
into Financial Knowledge
21

22. A company has more cash today when:
A. Accounts receivable increases.
B. Profit increases.
C. Customers pay their bills sooner.
D. Retained earnings increases.
22

23. Income Statement
- How do you account for any expenses and revenues?
- Who decides how you should account for any expenses and
revenues? The management!
- How do they know? They don’t! They guess. Lots of
accounting decisions are just that – guesses.
23

24. Profit is an Estimate
24

25. - Accountants had to make
judgments decisions when they
record financial transaction
- Financial managers need to
make objective decisions based
on these numbers that they get
from accountants
25

26. - All financial decisions are based on judgment.
- Different methods produce different results.
Accountants should give the most
accurate picture of the company's
performance. (read footnotes)
26

27. Don’t trust the numbers
27

28. It is very important that you ask
questions about the numbers to
make sure that they are what
you think they are.
28

29. - There is always accounting
judgment involved and that can
lead to manipulation
- Manipulation can benefit the
company (It is not illegal)
29

30. - Accounting change that is
material to the bottom line should
be footnoted but who decide what
is material and what isn’t?
Accountants
- GAAP only provide guidelines
30

31. Questions:
Who control your organization?
Are the accountants making the right judgment decisions?
31

32. 32

33. Cooking the Financial Books
Assumptions (What ingredients to include)
Estimates (How much to include)
You may assume that they’re accurate
down to the last dollar. Not true! The
balance in the cash account is exact,
but virtually every other number you
see in a financial report is based on an
estimate.
33

34. Increase Revenue
(Revenue Recognition)
34

35. - Sold equipments on four-year leases, including
service and maintenance.
- Booked all the revenues up front.
- Xerox mis-stated four years' worth of profits,
resulting in an overstatement of close to $6bn.
35

36. Channel Stuffing
Company inflates sales
figures by forcing more
products through a
distribution channel
than the channel is
capable of selling to the
world at large.
36

37. Reduce Expenses
(Matching Principle)
37

38. Income Statement
38

39. - Took a pretax charge -a one-
time write off- of 3.54 billion
against its earnings
- Grow rapidly by buying
other garbage companies.
But didn't know to run them.
- Changed the depreciation
of their 20,000 tracks from
8-10 years to 12-15 years
and did the same for their 1.5
million dumpsters
39

40. Which is more important?
A. How much you make
B. How much you keep
C. How much you borrow
D. How much you spend
Net Profit
40

41. 41

42. Balance Sheet
42

43. By the end of 2003, it was estimated that the company's
total assets had been inflated by around $11 billion
In June 2002, the company admitted it had inflated its
profits by $3.8bn between January 2001 and March 2002.
U n d e r r e p o r t i n g ‘ l i n e
costs’ (interconnection
e x p e n s e s w i t h o t h e r
t e l e c o m m u n i c a t i o n
companies) by capitalizing
these costs on the balance
sheet rather than properly
expensing them.
43

44. Goodwill
Goodwill =
Price paid - net assets (Assets - Liability)
Goodwill = $6 - (5 - 2) = 3
Goodwill could be amortized over a maximum
of forty years or the estimated useful life of the
acquired business.
44

45. !"#$%&'()#*(&+,(&*-.+&/*0-"+#$+&#..(+&
45

46. Brand value accounts for
approximately %30 of the
market capitalization of
the S&P 500
(Millward Brown Optimor, 2007).
46

47. - Bought 600 companies in 2000 and 2001 (undervalued
the assets and increase the goodwill) = Higher profit
- Tyco suffered more than a $9 billion loss in 2002, which
included the asset impairment write-down by over $3
billion, losses of nearly $2 billion for the two restructuring
charges, and over $1 billion from the two goodwill
impairment charges. In all, the net charges totaled nearly
$7 billion of the loss that year.
47

48. Enron established partnerships that
enabled them to move some of their
debt into affiliate companies that
should have been independent but
weren't. Ultimately, the partnerships
were doing the borrowing, which
protected Enron's credit ratings.
If you own more than 50% of a
company it must be consolidated on
the parent company balance sheet,
but if you own less than 50%, it
typically stays off the balance sheet
as an unconsolidated affiliate.
48

49. Cash is King
Warren Buffett
49

50. Profit = Cash
Profit will be turned into cash
Profit without cash
Cash without profit
Cash Flow Statement:
- Cash In
- Cash Out
50

51. !""# !""$
%&'()*+,-./0/)12)34'0/)5,+6)780+&9.:;)<=9.-.9.0'
Net income . ........................................................ $ 465,000 $ 272,000
Adjustments to reconcile net income to net cash provided
by operating activities
Depreciation and amortization.... ............................. 479,000 300,000
Deferred income taxes.. ........................................ 317,000 69,000
Gain on sale of property and equipment ..................... (28,000) (59,000)
Changes in operating assets and liabilities
Accounts receivable ........................................... (3,000) (64,000)
Inventories ..................................................... (34,000) 129,000
Prepaid expenses .............................................. 11,000 32,000
Accounts payable .............................................. 13,000 22,000
Accrued expenses ............................................. 108,000 (110,000)
Net cash provided by operating activities ............ 1,328,000 591,000
%&'()*+,-./0/)12)34'0/)5,+6)>:-0'9.:;)<=9.-.9.0'
Purchase of property and equipment ...................... ...... (1,010,000) (1,430,000)
Proceeds from disposal of property and equipment ............ 38,000 7,000
Purchase of investments ........................................... (22,000) —
Net cash used for investing activities ................. (994,000) (1,423,000)
%&'()*+,-./0/)12)34'0/)5,+6)?.:&:=.:;)<=9.-.9.0'
Additional long-term debt ......................................... 137,000 863,000
Retirement of long-term debt ... .................................. (322,000) (560,000)
Issuance of common stock ........................................ 68,000 466,000
Purchase of treasury stock ........................................ — (18,000)
Dividends paid ..................................................... (154,000) (133,000)
Net cash provided by (used for)
financing activities .................................... (271,000) 618,000
Increase (decrease) in cash and cash equivalents .................. 63,000 (214,000)
%&'()&:/)=&'()0@A.-&B0:9'C)10;.::.:;),5)20&+ ................ 314,000 528,000
%&'()&:/)=&'()0@A.-&B0:9'C)0:/),5)20&+ ........................ $ 377,000 $ 314,000
!""# !""$
%&'()*+,-./0/)12)34'0/)5,+6)780+&9.:;)<=9.-.9.0'
Net income . ........................................................ $ 465,000 $ 272,000
Adjustments to reconcile net income to net cash provided
by operating activities
Depreciation and amortization.... ............................. 479,000 300,000
Deferred income taxes.. ........................................ 317,000 69,000
Gain on sale of property and equipment ..................... (28,000) (59,000)
Changes in operating assets and liabilities
Accounts receivable ........................................... (3,000) (64,000)
Inventories ..................................................... (34,000) 129,000
Prepaid expenses .............................................. 11,000 32,000
Accounts payable .............................................. 13,000 22,000
Accrued expenses ............................................. 108,000 (110,000)
Net cash provided by operating activities ............ 1,328,000 591,000
%&'()*+,-./0/)12)34'0/)5,+6)>:-0'9.:;)<=9.-.9.0'
Purchase of property and equipment ...................... ...... (1,010,000) (1,430,000)
Proceeds from disposal of property and equipment ............ 38,000 7,000
Purchase of investments ........................................... (22,000) —
Net cash used for investing activities ................. (994,000) (1,423,000)
%&'()*+,-./0/)12)34'0/)5,+6)?.:&:=.:;)<=9.-.9.0'
Additional long-term debt ......................................... 137,000 863,000
Retirement of long-term debt ... .................................. (322,000) (560,000)
Issuance of common stock ........................................ 68,000 466,000
Purchase of treasury stock ........................................ — (18,000)
Dividends paid ..................................................... (154,000) (133,000)
Net cash provided by (used for)
financing activities .................................... (271,000) 618,000
Increase (decrease) in cash and cash equivalents .................. 63,000 (214,000)
%&'()&:/)=&'()0@A.-&B0:9'C)10;.::.:;),5)20&+ ................ 314,000 528,000
%&'()&:/)=&'()0@A.-&B0:9'C)0:/),5)20&+ ........................ $ 377,000 $ 314,000
Cash Flow
Statement:
51

52. Jack is looking at Anne, but Anne is
looking at George. Jack is married, but
George is not. Is a married person
looking at an unmarried person?
A. Yes
B. No
C. Cannot be determined
Jack Anne George
Married Unmarried
52

53. Professionals,
who
have
knowledge
and
experience,
may
think
they
can
make
decisions
without
really
using
their
minds.
They
don’t
expect
new
things
and
they
miss
them.
They
look
at
the
details
and
forget
the
big
picture.
53

54. While you might not have all the
answers, you should know what
questions to ask.
54

55. Strategic Financial
Decisions
55

56. www.openthinkingacademy.com
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