How to Read Financial Statements. Presented by Ed Knight

Transcription

1 How to Read Financial Statements Presented by Ed Knight

2 Conference Intentions 1. Become comfortable with financial information. 2. Participate in your organization. 3. Improve personal finance.

3 Today s Agenda Cash vs. accrual accounting Key definitions to speak the language Balance sheet, income statement, and cash flow Break-even analysis Ratios

4 Cash vs. Accrual Accounting Accrual accounting: Recognizes transactions when they occur Recognizes income when goods are shipped or services are rendered Recognizes an expense when the business is obligated to pay it

5 Cash vs. Accrual Accounting Cash accounting: Records transactions, sales, or payments when money actually changes hands Recognizes income when money is actually received Recognizes an expense when it s actually paid

6 Cash vs. Accrual Accounting» Why differences are important: The accrual method shows the flow of business income and debts more accurately, but doesn t show cash reserves. The cash method provides a more accurate picture of how much actual cash your business has, but may be misleading in terms of long-term profitability. Cash accounting can distort a company s accounting picture by incorrectly reflecting actual activity.

7 GAAP (Generally Accepted Accounting Principles) GAAP: Standard framework of guidelines for financial accounting Accountants must follow in recording and summarizing transactions, and preparation of financial statements. The terms they re using, the way the financial documents are set up, and the rationale behind it Emphasis on the term general

8 Key Definitions Assumption sheet: An attachment to any key financial document explaining the rationale behind numbers Leverage: The relationship between assets and the debt on those assets Liquidity: The relationship between assets owned and how quickly those assets can be converted to cash

9 Balance Sheet Assets Liabilities Owners Equity The balance sheet shows: 1. Assets 2. Outstanding liabilities 3. Owners or shareholders equity

10 Balance Sheet

11 Balance Sheet

12 Income Statement It is sometimes called: Statement of operations Profit and loss (P&L) statement Statement of activities» If a balance sheet is like a photograph, an income statement is like a video.» Usually done monthly

13 Income Statement Income Grants Sales Income Statement Taxes Donation

14 Income Statement An income statement compares a relationship between income and outflow over a given period of time. Always shown on an accrual accounting basis

15 Income Statement

16 Income Statement Shows earned income only Separates payroll and non-payroll expenses Done monthly, quarterly, and at year-end Indicates how the business is run day in and day out, month in and month out

17 Cash Flow Statements

18 Cash Flow Statements» Show actual money coming in and going out» Designed to maximize the use of money when we have it before we need it and minimize the cost of money when we need it before we have it

19 3 Key Financial Statements 1. Balance sheet 2. Income statement 3. Statement of cash flow

20 Calculating Payback» Use the payback method to determine whether the purchase of a new copier would be a good financial decision. ASSET FACTS Purch. Price = $15,000 Useful Life = 5 Years Salvage Value = -0- Cash Value = $8,000/Yr (Generated Savings) Annual Depreciation Payback Period 3 Years $15,000 0 = = $3,000 = = 5 Years Total Cost of Investment Annual Net Cash Flow $15,000 $8,000 $3,000 The copier would pay for itself in 3 years! The copier would pay for itself in 3 years!

21 Financial Ratios

22 Financial Ratios Profitability: Current ratio Quick ratio

23 Financial Ratios Current ratio: Ideal ratio is better than 1:1 Current Assets Current Liabilities Current Ratio

24 Financial Ratios Quick ratio: Borrow short-term money Will be lower than 1:1 Cash Marketable Securities + A/R Current Liabilities Quick Ratio

25 Financial Ratios Debt to equity ratio: Determines how solvent a business is A ratio of more than 3 is considered highly leveraged.

26 Financial Ratios Day sales outstanding (DSO): If your standard terms are 30 days, but you calculate DSO of 45 or 50 days, then your average collection is 45 to 50 days, not 30 days. Average A/R Net Sales X 365 DSO Ratio

27 Financial Ratios» Inventory turnover ratio: Cost of Goods Sold Average Inventory Inventory Turnover Ratio» Asset turnover ratio: How profitable your assets are» ROA and ROE: Return on assets Return on equity

28 Financial Ratios» Gross profit margins and operating profit margins: What are your product costs? What are your overhead costs?» Return of sales (ROS) net profit margins» Ratios

29 In Conclusion Important terms and definitions: GAAP Accrual vs. cash accounting Leverage, liquidity, and assumption sheets Understand the 3 key financial statements balance sheet, income statement, and cash flow statement. Look at the relationship between numbers, the ratios.