The DEC Education: Understanding Financials

The DEC

Fundamentals of Financial Statements

September 24, 2013

Debra L. von Storch

Page 2 The DEC - Fundamentals of Financials

Objectives

► Obtain an understanding of core financial constructs needed to project cash flow, revenue, expenses, income statement (pro forma) and a balance sheet.

► Discuss pitfalls and key issues to address in projections.► Establish best practices for calculating key assumptions

associated with startup financial projections.

Page 3

Financial Statements

► Income Statement (profit and loss) and Statement of Cash Flows – focus is “flows” of activities over the period

► Balance Sheet – accounts at a specific point in time

The DEC - Fundamentals of Financials

Income Statement

Revenues- ExpensesNet Income

Statement of Retained Earnings

Beginning RE+ Net Income

- DividendsEnding RE

Balance Sheet

Cash+ Other Assets

Total Assets

Total liabilities+ Stock

+ Retained Earnings

Total Liabilities and Equity

Cash Flows

Inflows- Outflows

Ending cash balance


Compilation of financial statements

► Financial statements are interdependent► Income statement► Balance sheet► Statement of cash flows

► Income statement and balance sheet report revenues as they are earned and expenses as they are incurred – accrual basis accounting

► Cash flow statement converts the accrual basis of accounting to cash basis


Compilation of financial statements

► Bottom line – cash is king! Follow the cash► Accounts receivable may not be collected immediately► Accounts payable are often dictated by suppliers’ terms (number

of DSO, etc.)

► Tip – review your cash flow at least monthly, using a report that presents side by side numbers for two or more periods.► Track changes in cash position


Income Statement

► Income statement reflects the enterprise’s► Income► Expenses► Gains► Losses

► The summation of these transactions is “net income” or “net loss” which is often referred to as “bottom line”

► Date of statement is for a defined period of time and captures the impact of the transactions during such period


Income Statement - Model

Jan '13 Feb '13 Mar '13 Apr '13 May '13 Jun '13 July '13 Aug '13 Sept '13 Oct '13 Nov '13 Dec '13 FY '13

Revenue -

15,000

20,000

25,000

30,000

40,000

45,000

50,000

55,000

60,000

70,000

80,000

490,000

Cost of goods sold -

(12,000)

(16,000)

(18,750)

(22,500)

(30,000)

(31,500)

(35,000)

(38,500)

(39,000)

(45,500)

(52,000)

(340,750)

Gross profit -

3,000

4,000

6,250

7,500

10,000

13,500

15,000

16,500

21,000

24,500

28,000

149,250

Operating expenses, excl depr

-

(8,000)

(8,000)

(8,000)

(8,000)

(8,000)

(12,000)

(12,000)

(12,000)

(12,000)

(12,000)

(12,000)

(112,000)

Depreciation expense -

-

(1,818)

(1,818)

(1,818)

(1,818)

(1,818)

(1,818)

(1,818)

(1,818)

(1,818)

(1,818)

(18,180)

Net Income -

(5,000)

(5,818)

(3,568)

(2,318)

182

(318)

1,182

2,682

7,182

10,682

14,182

19,070


Income Statement - Ratios

► Income statement ratios for managing your enterprise► Gross margin – gross profit in relation to revenue► Operating expenses as a % of revenue► EBITDA – earnings before interest, taxes, depreciation,

amortization► EBITDA margin – EBITDA in relation to revenue

Jan '13 Feb '13 Mar '13 Apr '13 May '13 Jun '13 July '13 Aug '13 Sept '13 Oct '13 Nov '13 Dec '13 FY '13Gross margin n/a 20.0% 20.0% 25.0% 25.0% 25.0% 30.0% 30.0% 30.0% 35.0% 35.0% 35.0% 30.5%Opex as a % of revenue n/a 53.3% 40.0% 32.0% 26.7% 20.0% 26.7% 24.0% 21.8% 20.0% 17.1% 15.0% 22.9%

EBITDA n/a

(5,000)

(4,000)

(1,750) (500)

2,000

1,500

3,000

4,500

9,000

12,500

16,000

37,250

EBITDA margin n/a -33.3% -20.0% -7.0% -1.7% 5.0% 3.3% 6.0% 8.2% 15.0% 17.9% 20.0% 7.6%


Balance Sheet

► Overview of the enterprise’s total assets and liabilities at a particular date

► Indicative of the health of your financial affairs► ASSETS = LIABILITIES + OWNER’S EQUITY


Balance Sheet

► Components of the balance sheet► Cash – money on deposit in bank accounts► Accounts receivable► Inventory► Prepaid assets► Fixed assets – property, plant and equipment; long-life tangible,

productive operating assets► Accrued liabilities – amounts for the costs of unpaid expenses► Loans – amounts borrowed on interest-bearing liabilities► Stock – amounts of capital invested in the enterprise by the owner

or other shareholders► Retained earnings – amounts remaining in the owners’ equity

account


Balance sheet - model Jan '13 Feb '13 Mar '13 April '13 May '13 June '13 July '13 Aug '13 Sept '13 Oct '13 Nov '13 Dec '13 FY '13

Cash

500,000

277,000

268,000

247,250

254,000

247,250

181,250

181,750

177,750

178,250

185,250

134,750

134,750

Accounts receivable

15,000

20,000

35,000

25,000

30,000

40,000

45,000

50,000

55,000

60,000

70,000

70,000

Inventory

12,000

12,000

16,000

18,750

22,500

30,000

31,500

35,000

38,500

39,000

45,500

45,500

Prepaids

-

2,000

2,000

2,500

2,500

2,500

2,500

2,500

2,500

2,500

2,500

2,500

2,500

Current assets

500,000

306,000

302,000

300,750

300,250

302,250

253,750

260,750

265,250

274,250

286,750

252,750

252,750

Fixed assets

-

200,000

198,182

196,364

194,546

192,728

190,910

189,092

187,274

185,456

183,638

181,820

181,820

Total Assets

500,000

506,000

500,182

497,114

494,796

494,978

444,660

449,842

452,524

459,706

470,388

434,570

434,570

Accounts payable

8,000

8,000

8,000

8,000

8,000

8,000

12,000

12,000

12,000

12,000

12,000

12,000

Accrued expenses

-

3,000

3,000

3,500

3,500

3,500

3,500

3,500

3,500

3,500

3,500

3,500

3,500

Current liabilities

-

11,000

11,000

11,500

11,500

11,500

11,500

15,500

15,500

15,500

15,500

15,500

15,500

Debt

-

-

-

-

-

-

-

-

-

-

-

-

-

Total liabilities

-

11,000

11,000

11,500

11,500

11,500

11,500

15,500

15,500

15,500

15,500

15,500

15,500

Equity

500,000

495,000

489,182

485,614

483,296

483,478

433,160

434,342

437,024

444,206

454,888

419,070

419,070

Total liabilities and equity

500,000

506,000

500,182

497,114

494,796

494,978

444,660

449,842

452,524

459,706

470,388

434,570

434,570

Beginning equity

-

500,000

495,000

489,182

485,614

483,296

483,478

433,160

434,342

437,024

444,206

454,888

-

Net income

(5,000)

(5,818)

(3,568)

(2,318)

182 (318)

1,182

2,682

7,182

10,682

14,182

19,070

Capital infusion

500,000

-

-

-

-

-

-

-

-

-

-

-

500,000

Distributions

-

-

-

-

-

-

(50,000)

-

-

-

-

(50,000)

(100,000)

Ending equity

500,000

495,000

489,182

485,614

483,296

483,478

433,160

434,342

437,024

444,206

454,888

419,070

419,070


Statement of Cash Flows

► Shows the total change in cash, and the reason for change

► Three categories of cash flows:► Operating► Investing► Financing

► Statement helps to predict an entity’s ability to ► Generate future cash flows► Predict ability to pay debts and dividends► Explains difference between accrual basis net income and cash

flows► Shows significant non-cash transactions which will impact future

cash flow


Statement of Cash Flows - Operating

► Transactions that involve producing and selling goods and services

► Inflows: selling goods and services► Outflows: inventory, salaries, taxes, interest, other

expenses


Statement of Cash Flows - Investing

► Transactions that involve acquiring and disposing of long-term assets

► Inflows: sale of plant assets, sale of investments, collection of loans

► Outflows: purchase of plant assets, purchasing investments, lending funds


Statement of Cash Flows - Financing

► Transactions that involve raising capital from debt and equity sources, returning capital to these sources, and making distributions to owners

► Inflows: selling stock, issuing bonds, notes, mortgages► Outflows: purchasing treasury stock, paying dividends,

repaying principal on borrowings, distributions


Cash flow statement - model Jan '13 Feb '13 Mar '13 April '13 May '13 June '13 July '13 Aug '13 Sept '13 Oct '13 Nov '13 Dec '13 FY '13

Net income

-

(5,000)

(5,818)

(3,568)

(2,318)

182 (318)

1,182

2,682

7,182

10,682

14,182

19,070

Add: depreciation expense

-

-

1,818

1,818

1,818

1,818

1,818

1,818

1,818

1,818

1,818

1,818

18,180

Change in AR

-

(15,000)

(5,000)

(15,000)

10,000

(5,000)

(10,000)

(5,000)

(5,000)

(5,000)

(5,000)

(10,000)

(70,000)

Change in inventory

-

(12,000)

-

(4,000)

(2,750)

(3,750)

(7,500)

(1,500)

(3,500)

(3,500) (500)

(6,500)

(45,500)

Change in prepaids

-

(2,000)

- (500)

-

-

-

-

-

-

-

-

(2,500)

Change in AP

-

8,000

-

-

-

-

-

4,000

-

-

-

-

12,000

Change in accruals

-

3,000

-

500

-

-

-

-

-

-

-

-

3,500

Cash flow from operations

-

(23,000)

(9,000)

(20,750)

6,750

(6,750)

(16,000)

500

(4,000)

500

7,000 (500)

(65,250)

Capital expenditures

-

(200,000)

-

-

-

-

-

-

-

-

-

-

(200,000)

Cash flow from investing

-

(200,000)

-

-

-

-

-

-

-

-

-

-

(200,000)

Equity infusion

500,000

-

-

-

-

-

-

-

-

-

-

-

500,000

Distributions

-

-

-

-

-

(50,000)

-

-

-

-

-

(50,000)

(100,000)

Cash flow from financing

500,000

-

-

-

-

(50,000)

-

-

-

-

-

(50,000)

400,000

Net cash flow

500,000

(223,000)

(9,000)

(20,750)

6,750

(56,750)

(16,000)

500

(4,000)

500

7,000

(50,500)

134,750

Beginning cash

-

500,000

277,000

268,000

247,250

254,000

197,250

181,250

181,750

177,750

178,250

185,250

-

Ending cash

500,000

277,000

268,000

247,250

254,000

197,250

181,250

181,750

177,750

178,250

185,250

134,750

134,750

Change in cash

500,000

(223,000)

(9,000)

(20,750)

6,750

(56,750)

(16,000)

500

(4,000)

500

7,000

(50,500)

134,750


Best practices

► Use separate cash accounts in your enterprise► General operating account

► Used to process the majority of your normal, day-to-day transactions such as paying vendors and receiving customer payments

► Payroll account► Processes payroll activity

► Investment account► Park excess cash balances to generate return on investment

► Restricted cash account► Cash that is “set aside” for a particular use or purpose


Keep in mind . . .

► Cash is king!► Practice cash management

► Balance amount of cash on hand, on a regular basis► Ensure you have sufficient cash to meet obligations► Invest excess cash to earn a return

► Establish cash controls► Cash receipts – deposit regularly and record promptly► Cash payments – paper trail for all disbursements (receipts,

purchase orders, etc.)► Separation of duties – no single person responsible for all

functions (writing checks, making deposits, preparing bank reconciliations)


Keep in mind . . .

► Impact of growth on cash flow► Actions that raise cash flow

► Decreasing accounts receivable and inventory► Increasing accounts payable and accrued expenses payable

► Actions that lower cash flow► Increasing accounts receivable and inventory► Decreasing accounts payable and accrued expenses payable

► Depreciation expense is not a cash outlay

Ernst & Young LLP

Assurance | Tax | Transactions | Advisory

About Ernst & Young

Ernst & Young is a global leader in assurance, tax, transaction and advisory services. Worldwide, our 167,000 people are united by our shared values and an unwavering commitment to quality. We make a difference by helping our people, our clients and our wider communities achieve their potential.

Ernst & Young refers to the global organization of member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit www.ey.com

© 2013 Ernst & Young LLP Published in India. All Rights Reserved.

This publication contains information in summary form and is therefore intended for general guidance only. It is not intended to be a substitute for detailed research or the exercise of professional judgment. Neither EYGM Limited nor any other member of the global Ernst & Young organization can accept any responsibility for loss occasioned to any person acting or refraining from action as a result of any material in this publication. On any specific matter, reference should be made to the appropriate advisor

Economy & Finance

The DEC Education: Understanding Financials