Presented by: Cheryl Heusser, CPA

Reading and Understanding

Financial Statements

The Basic Internal Financial Statements

1) Balance Sheet2) Income Statement

Balance Sheet

Assets The means used to operate the business Create future cash flows

Liabilities The Company’s financial obligations that is a source of

support for the assets Require future cash flows

Equity Another source of support for the assets Assets minus Liabilities

Assets = Liabilities + Equity

Balance Sheet – In Depth

Assets Examples

Cash Accounts receivable Investments Inventory Prepaid expenses Equipment Patents/trademarks/copyrights Notes receivable

Balance Sheet – In Depth

Assets Current vs. Noncurrent

Current – Company expects to convert to cash within one year

Noncurrent – Company does not expect to convert to cash within one year

Balance Sheet – In Depth

Liabilities Examples

Accounts payable Accrued expense Deferred revenue Lines of credit Notes payable

Balance Sheet – In Depth

Liabilities Current vs. Long-term

Current – Company expects to pay off within the year

Long-term – Company obligations with maturity dates greater than one year

Balance Sheet – In Depth

Equity Sometimes called “Shareholders’ Equity” or “Net Book

Value” Calculated as follows:

The amount owners invested +/-The Company’s earnings or losses since

inception +Any additional contributions from owners –Any distributions or withdrawals made by

owners If the above calculation is negative, then the Company

will have a deficiency instead of equity

Balance Sheet – In Depth

Time Frame

Balance sheets represent a snapshot of a company’s standing

A balance sheet as of 12/31/2009 represents the company’s assets, liabilities and equity on that date

Income Statement

Shows revenue and expenses that occurred over a specific time period

Presents income over a period of time rather than as of a certain date

Income Statement

Revenues Gross income generated through operations

Cost of Sales Costs directly related to generating revenues

General and Administrative Expenses Operating expenses related to running the

business Other Income and Expenses

Interest and other non-operating revenues and expenses

Accrual Versus Cash

Accrual basis Revenues and expenses are recognized in the

period they relate to Matches revenues and expenses

Cash basis Revenues are recognized when cash is received Expenses are recognized when payments are

made Modified cash basis

Hybrid – will often capitalize certain expenses (i.e. - equipment)

Analyzing Financial Statements

Financial Statement Ratios

Ratios can be used to evaluate the health of an individual company or to compare different companies

Which ratio to use is best determined a case by case basis

Common Financial Statement Ratios Working Capital =

Current Assets - Current Liabilities

Current Ratio =

Current Assets / Current Liabilities

Measures the Company’s efficiency and its short-term financial health

Common Financial Statement Ratios Debt-to-Equity Ratio =

Total LiabilitiesShareholders’ Equity

Measures a company’s financial leverage The higher the ratio, the more

aggressive the Company is in financing its growth with debt

Common Financial Statement Ratios Days sales =

Average trade receivables (net)Total sales

Measures the average number of days to collect on accounts receivable

* 365

Common Financial Statement Ratios Rate of return on assets =

Net incomeAverage total assets

Measures overall profitability of the Company relative to its total assets

Common Financial Statement Ratios Debt service coverage ratio =

Annual net operating incomeAnnual debt service payments (principal

and interest)

Measures the amount of cash available to meet annual interest and principal payments on debt (debt service).

Analyzing Financial Statements

EBITDA Earnings Before Interest, Taxes,

Depreciation and Amortization

Valuation Concepts

Income approach Market approach Asset based approach

Income Approach Methods

Discounted net cash flow Discounted future earnings Capitalization of net cash flow Capitalization of earnings

Market Approach Methods

Price/earnings Price/dividends Price/gross cash flow Price/revenues

Asset Approach Methods

Net Asset Value Adjusted Net Asset Value Liquidation Value Excess Earnings

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