Understanding Financial Statements

Presented by Andrew GreenseidPresident, Greenseid Consulting Group, LLC

Agenda

• Overview• Introduction• P&L• Balance Sheet• Cash Flow• Linking the Statements Together• Lemonade, Inc.• Conclusion

Overview

• What are financial statements?• Why are there 3 of them?

• Are there only 3?• What information do they provide?• How are they different from one another?• How does information flow from one to another?

•WHAT QUESTIONS DO YOU HAVE?

Introduction

• Andrew Greenseid• University of Wisconsin – Madison: BA in Philosophy• Carlson School of Management at the University of Minnesota: MBA

with concentrations in Finance and International Business• 19 years of finance experience• Greenseid Consulting Group, LLC formed in 2010

• Financial Modeling• Part-time, temporary Chief Financial Officer

3 Financial Statements

• Income Statement•Balance Sheet•Cash Flow Statement

Income Statement

AKA• Profit and Loss Statement• P&L• Earnings Report• Operating Statement• Revenue StatementEtc….

Income Statement

• Describes the activity of a business over a period of time, usually:• Month• Quarter• Year

• Comprised of• Revenue• Expenses• Interest• Taxes

Sales- Cost of Goods Sold (COGs)= Gross Margin

- Labor Costs- General and Administrative Expenses (G&A)- Depreciation and Amortization (D&A)= Earnings Before Interest and Taxes (EBIT or

Operating Income)

- Interest Expense= Earnings Before Taxes (EBT)

- Taxes= Net Income

Capital vs.Expense

• Capital: assets that lead to the long-term net worth of the business.

Examples: software, equipment, buildings, land, etc.

• Expense: items purchased for use during the year in which they are purchased

Examples: advertising, office supplies, consulting fees, etc.

Lemonade, Inc.

Income Statement

12/31/15 12/31/16 12/31/17Sales $3,000 $2,600 $4,000COGs $1,200 $1,300 $1,825Gross Margin $1,800 $1,300 $2,175

% 60.0% 50.0% 54.4%

Labor $300 $325 $375Benefits $0 $0 $0Payroll Taxes $31 $33 $38Total Labor $331 $358 $413

Advertising $150 $50 $200Professional Services $100 $100 $100Rent $84 $87 $92Utilities $150 $50 $200Depreciation $100 $100 $140Interest (3.5%) $35 $32 $27Total SG&A $949 $777 $1,172

EBT $851 $523 $1,003Taxes (25%) $213 $131 $251Net Income $638 $392 $752

Exercise: Review Income Statements

• What is the same with these companies? What is different?• What jumps out? What requires further investigation?• How are these companies doing? Which is doing better?• What further information do you need?

BBaallaannccee SShheeeett

Assets = Liabilities + Equity

Everything you have = Everything you owe + Everything you own

Personal Balance SheetASSETS

Cash $8,000401K $75,000Car $15,000House $300,000Personal belongings $150,000

Total Assets $548,000

LIABILITIESCredit card bill $3,000Cable, phone, internet, etc $200Utility bills $750Short Term Liabilities $3,950

Student Loan $35,000Mortgage $150,000Long Term Liabilities $185,000

Total Liabilities $188,950

Total Equity $359,050

Liabilities + Equity $548,000

Assets = Liabilities + Equity

Assets – Liabilities = Equity

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Algebra!

Assets Liabilities EquityCash $8,000 -$3,950 $4,050401K $75,000 $0 $75,000Car $15,000 $0 $15,000House $300,000 -$150,000 $150,000Personal belongings $150,000 $0 $150,000Student Loan -$35,000 -$35,000Total $548,000 -$188,950 $359,050

Personal Balance Sheet

- =

AssetsCash

+ Accounts receivable+ Inventory+ Other current assets= Total Current Assets

Furniture, Fixtures & Equipment (FF&E)- Accumulated Depreciation= Net FF&E

Total Assets

LiabilitiesAccounts payable

+ Unearned revenue+ Other current liabilities= Total Current Liabilities

+ Bank Loan+ Other long term liabilitiesTotal Liabilities

EquityCommon stock+ Additional paid-in capital+ Retained earnings+ Current year profit (loss)Total Equity

Total Liabilities + Equity

‘Other’ Examples

Current Assets

• Cash surrender value of life insurance policies

• Advances paid to suppliers

• Advances paid to employees

Current Liabilities

• Principal payments on debt owed within the current year

• Sales tax payable• Lease payments due

within the current year

Long Term Liabilities

• Deferred taxes• Long Term lease debt• Pension obligations• Deferred compensation

ASSETS Cash $2,700,000Accounts Receivable $100,000Inventory $1,000,000Other Current Assets $300,000Total Current Assets $4,100,000

Total FFE/PPE $1,800,000Accumulated Depreciation -$1,200,000

Net FFE/PPE $600,000Total Assets $4,700,000

LIABILITIES Accounts Payable $1,100,000Unearned Revenue $80,000Other Current Liabilities $700,000Total Current Liabilities $1,880,000

Bank Loan $1,400,000Other Long Term Liabilities $140,000Total Liabilities $3,420,000

EQUITY Common Stock $15,000Additional Paid In Capital $478,000Retained Earnings $567,000Current Profit (Loss) $220,000Total Stockholders' Equity $1,280,000

Total Liabilities & Equity $4,700,000

Business Balance Sheet

Business Balance SheetASSETS 12/31/17 12/31/16Cash $2,700,000 $3,000,000Accounts Receivable $100,000 $125,000Other Current Assets $1,000,000 $800,000Total Current Assets $3,800,000 $3,925,000

Total PPE $1,800,000 $2,100,000Accumulated Depreciation -$1,200,000 -$1,900,000

Net PPE $600,000 $200,000

Total Assets $4,400,000 $4,125,000

LIABILITIES 12/31/17 12/31/16Accounts Payable - Trade $1,100,000 $800,000Unearned Revenue $80,000 $254,900Other Current Liabilities $700,000 $750,000Total Current Liabilities $1,880,000 $1,804,900

Bank Loan $1,100,000 $1,200,000Lease Payments LT $100,000 $0Deferred Tax Liability $40,000 $60,100Total Liabilities $3,120,000 $3,065,000

EQUITY Common Stock $15,000 $15,000Additional Paid In Capital $478,000 $478,000Retained Earnings $567,000 $305,000Current Profit (Loss) $220,000 $262,000Total Equity $1,280,000 $1,060,000

Total Liabilities & Equity $4,400,000 $4,125,000

Balance Sheet Ratios

• Current Ratio: Current Assets / Current Liabilities• Quick Ratio: (Current Assets – Inventory) / Current Liabilities• Debt / Equity Ratio = Liabilities / Equity• Debt Service Coverage Ratio = Net Operating Income / Total Debt

Service

Business Balance SheetASSETS 12/31/17 12/31/16Cash $2,700,000 $3,000,000Accounts Receivable $100,000 $125,000Other Current Assets $1,000,000 $800,000Total Current Assets $3,800,000 $3,925,000

Total PPE $1,800,000 $2,100,000Accumulated Depreciation -$1,200,000 -$1,900,000

Net PPE $600,000 $200,000

Total Assets $4,400,000 $4,125,000

LIABILITIES 12/31/17 12/31/16Accounts Payable - Trade $1,100,000 $800,000Unearned Revenue $80,000 $254,900Other Current Liabilities $700,000 $750,000Total Current Liabilities $1,880,000 $1,804,900

Bank Loan $1,100,000 $1,200,000Lease Payments LT $100,000 $0Deferred Tax Liability $40,000 $60,100Total Liabilities $3,120,000 $3,065,000

EQUITY Common Stock $15,000 $15,000Additional Paid In Capital $478,000 $478,000Retained Earnings $567,000 $305,000Current Profit (Loss) $220,000 $262,000Total Equity $1,280,000 $1,060,000

Total Liabilities & Equity $4,400,000 $4,125,000

Balance Sheet

1/1/15 12/31/15 12/31/16 12/31/17ASSETSCash $1,250 $1,038 $970 $1,202A/RInventory $250 $300 $150Total Current Assets $1,250 $1,288 $1,270 $1,352

FF&E $500 $500 $700Accumulated Depreciation -$100 -$200 -$340Net FF&E $400 $300 $360

Total Assets $1,250 $1,688 $1,570 $1,712

LIABILITIESA/P $125 $140 $80Total Current Liabilies $125 $140 $80

Debt $1,000 $975 $850 $700Total Liabilities $1,000 $1,100 $990 $780

EQUITYCommon Stock $250 $250 $250 $250Retained Earnings $338 $330 $682Total Equity $250 $588 $580 $932

Total Liabilities & Equity $1,250 $1,688 $1,570 $1,712Check - - - -

Exercise: Review Balance Sheets

• What is the same with these companies? What is different?• What jumps out? What requires further investigation?• How are these companies doing? Which is doing better?• What further information do you need?

Cash Flow Statement

• Combines information from the Income Statement and the Balance Sheet to describe if there is a net increase or decrease in cash over a period of time.• The change in each Balance Sheet line item is either a source of cash

or a use of cash, e.g.:• Increase in inventory: source or use?• Increase in debt: source or use?• Increase in A/R: source or use?• Increase in A/P: source or use?

Net Income+ Depreciation & amortization+ ∆ A/R+ ∆ A/P+ ∆ Other current assets+ ∆ Other current liabilities= Net cash from operating activities

Capital Expenditures+ ∆ Investments= Net cash from investing activities

Dividends paid+ Sales (repurchase) of stock+ ∆ Debt= Net cash from financing activities

Net change in cash+ Starting cash= Ending Cash

CashFlow

Statement

Cash Flow Statement

• Net Income is the starting point• Depreciation & Amortization (D&A) get added back• Principal Payments not on Income Statement• Dividends not on Income Statement• Cash flows to Balance Sheet

Tying it all together….

• Lemonade, Inc.• Operate for 3 years• Income statement• Balance Sheet• Cash Flow Statement

Income Statement

12/31/15 12/31/16 12/31/17Sales $3,000 $2,600 $4,000COGs $1,200 $1,300 $1,825Gross Margin $1,800 $1,300 $2,175

% 60.0% 50.0% 54.4%

Labor $300 $325 $375Benefits $0 $0 $0Payroll Taxes $31 $33 $38Total Labor $331 $358 $413

Advertising $150 $50 $200Professional Services $100 $100 $100Rent $84 $87 $92Utilities $150 $50 $200Depreciation $100 $100 $140Interest (3.5%) $35 $32 $27Total SG&A $949 $777 $1,172

EBT $851 $523 $1,003Taxes (25%) $213 $131 $251Net Income $638 $392 $752

Balance Sheet

1/1/15 12/31/15 12/31/16 12/31/17ASSETSCash $1,250 $1,038 $970 $1,202A/RInventory $250 $300 $150Total Current Assets $1,250 $1,288 $1,270 $1,352

FF&E $500 $500 $700Accumulated Depreciation -$100 -$200 -$340Net FF&E $400 $300 $360

Total Assets $1,250 $1,688 $1,570 $1,712

LIABILITIESA/P $125 $140 $80Total Current Liabilies $125 $140 $80

Debt $1,000 $975 $850 $700Total Liabilities $1,000 $1,100 $990 $780

EQUITYCommon Stock $250 $250 $250 $250Retained Earnings $338 $330 $682Total Equity $250 $588 $580 $932

Total Liabilities & Equity $1,250 $1,688 $1,570 $1,712Check - - - -

CashFlow

Statement

12/31/15 12/31/16 12/31/17Net Income $638 $392 $752+ Depreciation $100 $100 $140∆ A/R $0 $0 $0∆ Inventory -$250 -$50 $150∆ A/P $125 $15 -$60Cash Flow from Operations $613 $457 $982

∆ FF&E -$500 $0 -$200Cash Flow from Investments -$500 $0 -$200

Dividends Paid -$300 -$400 -$400Change in Debt -$25 -$125 -$150Cash Flow from Financing -325 -525 -550

Change in Cash Flow -$212 -$68 $232

Beginning Cash $1,250 $1,038 $970Ending Cash $1,038 $970 $1,202

Tying it all together

• As Inventory is sold, moves from Balance Sheet to Income Statement• Depreciation (IS) hits Accumulated Depreciation (BS) and

Depreciation add back (CFS)• Net income (IS) flows to Retained Earnings (BS) and Net Income (CFS)• Change in period balance sheet accounts reflected on cash flow

statement• Ending cash calculated on CFS is reflected as actual cash on Balance

Sheet

INCOME STATEMENT BALANCE SHEET CASH FLOW STATEMENT

12/31/15 12/31/16 12/31/17 1/1/15 12/31/15 12/31/16 12/31/17 12/31/15 12/31/16 12/31/17Sales $3,000 $2,600 $4,000 ASSETS Net Income $638 $392 $752COGs $1,200 $1,300 $1,825 Cash $1,250 $1,038 $970 $1,202 + Depreciation $100 $100 $140Gross Margin $1,800 $1,300 $2,175 A/R ∆ A/R $0 $0 $0

% 60.0% 50.0% 54.4% Inventory $250 $300 $150 ∆ Inventory -$250 -$50 $150Total Current Assets $1,250 $1,288 $1,270 $1,352 ∆ A/P $125 $15 -$60

Labor $300 $325 $375 Cash Flow from Operations $613 $457 $982Benefits $0 $0 $0 FF&E $500 $500 $700Payroll Taxes $31 $33 $38 Accumulated Depreciation -$100 -$200 -$340 ∆ FF&E -$500 $0 -$200Total Labor $331 $358 $413 Net FF&E $400 $300 $360 Cash Flow from Investments -$500 $0 -$200

Advertising $150 $50 $200 Total Assets $1,250 $1,688 $1,570 $1,712 Dividends Paid -$300 -$400 -$400Professional Services $100 $100 $100 Change in Debt -$25 -$125 -$150Rent $84 $87 $92 LIABILITIES Cash Flow from Financing -325 -525 -550Utilities $150 $50 $200 A/P $125 $140 $80Depreciation $100 $100 $140 Total Current Liabilies $125 $140 $80 Change in Cash Flow -$212 -$68 $232Interest (3.5%) $35 $32 $27Total SG&A $949 $777 $1,172 Debt $1,000 $975 $850 $700 Beginning Cash $1,250 $1,038 $970

Total Liabilities $1,000 $1,100 $990 $780 Ending Cash $1,038 $970 $1,202EBT $851 $523 $1,003Taxes (25%) $213 $131 $251 EQUITYNet Income $638 $392 $752 Common Stock $250 $250 $250 $250

Retained Earnings $338 $330 $682Total Equity $250 $588 $580 $932

Total Liabilities & Equity $1,250 $1,688 $1,570 $1,712Check - - - -

Q&A