Understanding Financial Statements

Chris Droussiotis
June 2011
 Table of Contents

 Accounting Definitions, Terms and Concepts

 Using Financial Statements
 Financial Ratio Analysis

These slides could be obtain via the Instructor’s Web page at

www.celeritymoment.com

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 Accounting Definitions and Concepts

A = Assets

A = L + NW L = Liabilities
NW = Net Worth

Own Owe Keep (Value Creation)

How did you pay for the Assets that you own

Similar Concepts in Other Areas of Finance:

• Consumer finance: Value of the House = Mortgage + Equity
• Corporation Value: Enterprise Value = Net Debt + Equity

3 • Investments: Value of the Investment: Margin Loan + Equity

 Accounting Definitions and Concepts

Book Value Vs Market Value

Book Value Market Value

 Accounting  Finance
 Fixed Assets  Financial Assets
 Corporate Taxation  Investment Taxation

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 Accounting Definitions and Concepts

Income Vs Cash

The Perfect World:

Every business is run like a lemonade Stand

Income Statement Cash Flow Statement

Lemonade Sales Profit $ 80.00

Sold 100 cups @ $1 each $ 100.00
Expenses Plus Money that we owe $0.00
Box of 100 Cups $ 5.00 Less Money owed to us $0.00
Lemonade concetrate $ 5.00
4 Gallons of Water $ 10.00
Total Expenses $ 20.00 Net Working Capital $0.00
Net Income (Profit) $ 80.00 Cash $ 80.00

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 Accounting Definitions and Concepts

Income Vs Cash

Not So Perfect World:

The world of IOUs

Income Statement Cash Flow Statement

Lemonade Sales Profit $ 80.00

Sold 100 cups @ $1 each $ 100.00

Expenses Plus Money that we owe $0.00

Box of 100 Cups $ 5.00 Less Money owed to us -$1.00
Lemonade concetrate $ 5.00
4 Gallons of Water $ 10.00
Total Expenses $ 20.00 Net Working Capital -$1.00

Net Income (Profit) $ 80.00 Cash $ 79.00

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 Financial Statements – Other Terms

 General Accepted Accounting Standards (GAPP)

 Who Needs Financial Statements?
 IRS and Tax Authorities
 Public Investors ( regulated by Securities and Exchange Commission (SEC)
 Financial Analysts – performance review
 Banks and Financial Institutions
 Management and Owners
 Statements (Public Filing10K, 10Q)
 Income Statement
 Balance Sheet Statement
 Cash Flow Statement

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 Income Statement

 Measurement of Profit and Loss over a Period of Time

 Top Line to Bottom Line
 Revenue (Sales) Less Expenses = Profit or Loss

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 Income Statement

Income Statement (000's) 2009 2010

50 Revenues by Geography
51 U.S. 800,000 920,000
52 Europe 120,000 140,000
53 Asia 40,000 50,000
54 Total Revenue 960,000 1,110,000
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56 Cost of Revenues by Geography
57 U.S. 220,000 270,000
58 Europe 100,000 115,000
59 Asia 25,000 35,000
60 Total Cost of Revenue 345,000 420,000
62 Gross Profit 615,000 690,000
63
64 Operating Expenses
65 Administrative & General 145,000 165,000
66 Marketing Expenses 75,000 80,000
67 Other Operating Expenses 10,000 12,000
68 Total Operating Expenses 230,000 257,000
69
70 EBITDA 385,000 433,000

72 Depreciation & Amortization 60,000 65,000

74 EBIT 325,000 368,000
76 Interest Expense 130,000 120,000
78 EBT 195,000 248,000
80 Taxes 40% 78,000 99,200

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81
82 Net Income 117,000 148,800
 Balance Sheet Statement

 It shows us on a snap shot the Wealth of the Company

 The statement is set-up in Order of Liquidity

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 Balance Sheet Statement

Balance Sheet (000's) 2009 2010 $ Change % Change

6 Current Assets
7 Cash 45,000 65,800 20,800 46.2%
8 Accounts Receivable 45,000 60,000 15,000 33.3%
9 Inventories 35,000 40,000 5,000 14.3%
10 Prepaid Expenses 10,000 9,000 (1,000) -10.0%
11 Total Current Assets 135,000 174,800 39,800 29.5%

13 Property and Equipment

14 Land 2,500,000 2,500,000 - 0.0%
15 Building 450,000 550,000 100,000 22.2%
16 Furniture & Equipment 50,000 75,000 25,000 50.0%
17 Total Gross P&E 3,000,000 3,125,000 125,000 4.2%
18 Less Accumulated Depreciaition (300,000) (365,000) (65,000) 21.7%
19 Net P&E 2,700,000 2,760,000 60,000 2.2%

21 Long-Term Investments 200,000 250,000 50,000 25.0%

23 Total Assets 3,035,000 3,184,800 149,800 4.9%

25 Liabilities and Owners Equity

27 Current Liabilities
28 Accounts Payable 35,000 40,000 5,000 14.3%
29 Accrued Income Taxes 12,000 10,000 (2,000) -16.7%
30 Accrued Expenses 10,000 8,000 (2,000) -20.0%
31 Current Portion of Long Term Debt 20,000 10,000 (10,000) -50.0%
32 Total Current Liabilities 77,000 68,000 (9,000) -11.7%

34 Long-Term Debt: 1,200,000 1,180,000 (20,000) -1.7%

36 Deferred Income Taxes 12,000 17,000 5,000 41.7%

38 Total Liabilties 1,289,000 1,265,000 (24,000) -1.9%

40 Owners' Equity
41 Common Stock 1,000,000 1,000,000 - 0.0%
42 Paid-in-Capital - 25,000 25,000
43 Retained Earnings 746,000 894,800 148,800 19.9%

11 44

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Total Owners' Equity

Total Liabilities & Owner's Equity

1,746,000

3,035,000
1,919,800

3,184,800
173,800

149,800
10.0%

4.9%
 Cash Flow Statement

 It shows the Company’s Cash Inflow and Outflow over a period of time

 Differences between Income Statement and Cash Flow Statement

 Timing Differences (Working Capital Activities)
 Capital Expenses Vs Operating Expenses (Investment Activities)
 Financing Expenses not included in the Income Statement (Financing
Activities)

 Represents the changes from last Year’s Balance Sheet to this Year’s
Balance Sheet
 Asset goes Up = Cash Negative
 Asset goes down = Cash Positive
 Liability goes up = Cash Positive
 Liability goes down = Cash Negative
 Owner’s Equity goes up = Cash Positive
 Owner’s Equity goes down = Cash Negative
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 Cash Flow Statement Adjusting Income to Cash

Balance Sheet (000's) 2009 2010 $ Change

Current Assets Cash Flow Statement (000's) 2010

Cash 45,000 65,800 20,800
Accounts Receivable 45,000 60,000 15,000 Net Income 148,800
Inventories 35,000 40,000 5,000
Prepaid Expenses 10,000 9,000 (1,000) Plus Depreciation 65,000
Total Current Assets 135,000 174,800 39,800 Plus Deffered Taxes 5,000
Property and Equipment Cash Income 218,800
Land 2,500,000 2,500,000 -
Building 450,000 550,000 100,000
Furniture & Equipment 50,000 75,000 25,000
Total Gross P&E 3,000,000 3,125,000 125,000
Less Accumulated Depreciaition (300,000) (365,000) (65,000)
Net P&E 2,700,000 2,760,000 60,000

Long-Term Investments 200,000 250,000 50,000

Total Assets 3,035,000 3,184,800 149,800

Liabilities and Owners Equity

Current Liabilities
Accounts Payable 35,000 40,000 5,000
Accrued Income Taxes 12,000 10,000 (2,000)
Accrued Expenses 10,000 8,000 (2,000)
Current Portion of Long Term Debt 20,000 10,000 (10,000)
Total Current Liabilities 77,000 68,000 (9,000)

Long-Term Debt: 1,200,000 1,180,000 (20,000)

Deferred Income Taxes 12,000 17,000 5,000

Total Liabilties 1,289,000 1,265,000 (24,000)

Owners' Equity
Common Stock 1,000,000 1,000,000 -
Paid-in-Capital - 25,000 25,000
Retained Earnings 746,000 894,800 148,800
Total Owners' Equity 1,746,000 1,919,800 173,800

13 Total Liabilities & Owner's Equity 3,035,000 3,184,800 149,800

 Cash Flow Statement Working Capital Activities

Balance Sheet (000's) 2009 2010 $ Change

Current Assets
Cash 45,000 65,800 20,800
Accounts Receivable 45,000 60,000 15,000
Inventories 35,000 40,000 5,000
Prepaid Expenses 10,000 9,000 (1,000) Cash Flow Statement (000's) 2010
Total Current Assets 135,000 174,800 39,800

Property and Equipment Net Income 148,800

Land 2,500,000 2,500,000 -
Building 450,000 550,000 100,000
Plus Depreciation 65,000
Furniture & Equipment 50,000 75,000 25,000 Plus Deffered Taxes 5,000
Total Gross P&E 3,000,000 3,125,000 125,000
Less Accumulated Depreciaition (300,000) (365,000) (65,000) Cash Income 218,800
Net P&E 2,700,000 2,760,000 60,000
Working Capital Activities
Long-Term Investments 200,000 250,000 50,000
Change in Accounts Receivable (15,000)
Total Assets 3,035,000 3,184,800 149,800
Change in Inventory (5,000)
Liabilities and Owners Equity Change in Prepaid Expenses 1,000
Current Liabilities Change in Accounts Payable 5,000
Accounts Payable 35,000 40,000 5,000 Change in Accrued Income Taxes (2,000)
Accrued Income Taxes 12,000 10,000 (2,000)
Accrued Expenses 10,000 8,000 (2,000) Change in Accrued Expenses (2,000)
Current Portion of Long Term Debt 20,000 10,000 (10,000)
Total Current Liabilities 77,000 68,000 (9,000)
Total Change in Working Capital (18,000)
Long-Term Debt: 1,200,000 1,180,000 (20,000) Operating Cash Flow (OCF) 200,800
Deferred Income Taxes 12,000 17,000 5,000

Total Liabilties 1,289,000 1,265,000 (24,000)

Owners' Equity
Common Stock 1,000,000 1,000,000 -
Paid-in-Capital - 25,000 25,000
Retained Earnings 746,000 894,800 148,800

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Total Owners' Equity 1,746,000 1,919,800 173,800

Total Liabilities & Owner's Equity 3,035,000 3,184,800 149,800

 Cash Flow Statement Investment Activities

Balance Sheet (000's) 2009 2010 $ Change

Current Assets Cash Flow Statement (000's) 2010

Cash 45,000 65,800 20,800
Accounts Receivable 45,000 60,000 15,000 Net Income 148,800
Inventories 35,000 40,000 5,000
Prepaid Expenses 10,000 9,000 (1,000)
Plus Depreciation 65,000
Total Current Assets 135,000 174,800 39,800 Plus Deffered Taxes 5,000
Cash Income 218,800
Property and Equipment
Land 2,500,000 2,500,000 -
Building 450,000 550,000 100,000 Working Capital Activities
Furniture & Equipment 50,000 75,000 25,000 Change in Accounts Receivable (15,000)
Total Gross P&E 3,000,000 3,125,000 125,000
Less Accumulated Depreciaition (300,000) (365,000) (65,000)
Change in Inventory (5,000)
Net P&E 2,700,000 2,760,000 60,000 Change in Prepaid Expenses 1,000
Long-Term Investments 200,000 250,000 50,000
Change in Accounts Payable 5,000
Change in Accrued Income Taxes (2,000)
Total Assets 3,035,000 3,184,800 149,800 Change in Accrued Expenses (2,000)
Liabilities and Owners Equity Total Change in Working Capital (18,000)
Current Liabilities Operating Cash Flow (OCF) 200,800
Accounts Payable 35,000 40,000 5,000
Accrued Income Taxes 12,000 10,000 (2,000)
Accrued Expenses 10,000 8,000 (2,000)
Investment Activities
Current Portion of Long Term Debt 20,000 10,000 (10,000) Capital Expenditures (125,000)
Total Current Liabilities 77,000 68,000 (9,000)
Investments (Change) (50,000)
Long-Term Debt: 1,200,000 1,180,000 (20,000) Total Financing Activities (175,000)
Deferred Income Taxes 12,000 17,000 5,000
Cash Available for Debt Service (CAFDS) 25,800
Total Liabilties 1,289,000 1,265,000 (24,000)

Owners' Equity
Common Stock 1,000,000 1,000,000 -

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Paid-in-Capital - 25,000 25,000
Retained Earnings 746,000 894,800 148,800
Total Owners' Equity 1,746,000 1,919,800 173,800

Total Liabilities & Owner's Equity 3,035,000 3,184,800 149,800

 Cash Flow Statement Financing Activities

Balance Sheet (000's) 2009 2010 $ Change Cash Flow Statement (000's) 2010
Current Assets
Cash 45,000 65,800 20,800
Net Income 148,800
Accounts Receivable 45,000 60,000 15,000 Plus Depreciation 65,000
Inventories 35,000 40,000 5,000 Plus Deffered Taxes 5,000
Prepaid Expenses 10,000 9,000 (1,000)
Total Current Assets 135,000 174,800 39,800 Cash Income 218,800
Property and Equipment Working Capital Activities
Land 2,500,000 2,500,000 -
Change in Accounts Receivable (15,000)
Building 450,000 550,000 100,000
Furniture & Equipment 50,000 75,000 25,000 Change in Inventory (5,000)
Total Gross P&E 3,000,000 3,125,000 125,000 Change in Prepaid Expenses 1,000
Less Accumulated Depreciaition (300,000) (365,000) (65,000)
Net P&E 2,700,000 2,760,000 60,000
Change in Accounts Payable 5,000
Change in Accrued Income Taxes (2,000)
Long-Term Investments 200,000 250,000 50,000 Change in Accrued Expenses (2,000)
Total Assets 3,035,000 3,184,800 149,800 Total Change in Working Capital (18,000)

Liabilities and Owners Equity Operating Cash Flow (OCF) 200,800

Current Liabilities
Investment Activities
Accounts Payable 35,000 40,000 5,000
Accrued Income Taxes 12,000 10,000 (2,000) Capital Expenditures (125,000)
Accrued Expenses 10,000 8,000 (2,000) Investments (Change) (50,000)
Current Portion of Long Term Debt 20,000 10,000 (10,000)
Total Current Liabilities 77,000 68,000 (9,000)
Total Financing Activities (175,000)

Long-Term Debt: 1,200,000 1,180,000 (20,000) Cash Available for Debt Service (CAFDS) 25,800
Deferred Income Taxes 12,000 17,000 5,000
Financing Activities
Total Liabilties 1,289,000 1,265,000 (24,000) ST Debt Payments (10,000)
Owners' Equity LT Payments (20,000)
Common Stock 1,000,000 1,000,000 - Equity Contribution 25,000
Paid-in-Capital - 25,000 25,000
Total Financing Activities (5,000)
Retained Earnings 746,000 894,800 148,800

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Total Owners' Equity 1,746,000 1,919,800 173,800 Free Cash Flow 20,800
Total Liabilities & Owner's Equity 3,035,000 3,184,800 149,800
 Cash Flow Statement Recap

Cash Flow Statement (000's) 2010

86 Net Income 148,800 Balance Sheet (000's) 2009 2010 $ Change

87 Plus Depreciation 65,000
88 Plus Deffered Taxes 5,000 Retained Earnings 746,000 894,800 148,800
89 Cash Income 218,800

91 Working Capital Activities

92 Change in Accounts Receivable (15,000)
93 Change in Inventory (5,000)
94 Change in Prepaid Expenses 1,000
95 Change in Accounts Payable 5,000 Timing Differences
96 Change in Accrued Income Taxes
97 Change in Accrued Expenses
(2,000)
(2,000)
(Working Capital
98 Total Change in Working Capital
99
(18,000) Activities)
100 Operating Cash Flow (OCF) 200,800

102 Investment Activities

103 Capital Expenditures (125,000)
104 Investments (Change)
105 Total Financing Activities
(50,000)
(175,000)
Investment Activities
106
107 Cash Available for Debt Service (CAFDS) 25,800

109 Financing Activities

110 ST Debt Payments (10,000)
111
112
LT Payments
Equity Contribution
(20,000)
25,000
Financing Activities
113 Total Financing Activities (5,000)
115 Free Cash Flow 20,800
Balance Sheet (000's) 2009 2010 $ Change
117 Beginning Cash 45,000

17 119 Ending Cash 65,800 Current Assets

Cash 45,000 65,800 20,800
 Financial Analysis

 Management Discussion and Analysis (MD&A)

 Equity & Bond Research – Wall Street Analysts

 The Financial Statements could be used by analysts to project the

Company’s performance and valuation

 For an effective performance of the Company, you need to ask the three
following questions:
1. How is the Company doing versus Last Year
2. How is the Company doing versus its competitors / piers/ market
3. How is the Company doing versus expectations

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 Financial Ratio Analysis

 Trend Analysis
2010 Definition

Trend Analysis Ratios

U.S. Revenue Growth 15.0% (Rev 2010/Rev 2009) -1
Europe Revenue Growth 16.7%
Asia Revenue Growth 25.0%
Total Revenue Growth 15.6%

EBITDA Growth 12.5% (EBITDA 2010/EBITDA 2009) -1

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 Financial Ratio Analysis

 Liquidity Ratio
 How well the Company manages Cash

2010 Definition
Liquidity Ratios
Current Ratio 2.57x CA/CL
Quick ratio 1.85x (Cash + A/R) / CL
Accounts Receivable Turnover (ART) 21.14x Revenue/Avg AR
Accounts Receivable Days 17.26 365 / ART

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 Financial Ratio Analysis

 Solvency Ratio
 How well the Company manages Debt

2010 Definition
Solvency Ratios
LTD / Total Capitalization 38.1% LTD / (LTD + Equity)
EBITDA / Interest (Coverage Ratio) 3.61x EBITDA / Interest
LTD / EBITDA (Leverage Ratio) 2.73x LTD / EBITDA

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 Financial Ratio Analysis

 Activity and Operating Ratios

 It measures productivity and efficiency for running the business

2010 Definition
Activity Ratios / Operating Ratios
Inventory Ratio (IR) 11.20x Cost of Revenues/Avg Inventory
Inventory Ratio - Days 32.59 365 / IR

Please note that there are a lot of ratios establish by specialization (i.e. for a Hotel
company is Occupancy Rate or for a Cable company is revenue per subscriber)

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 Financial Ratio Analysis

 Profitability Ratio
 How profitable is the company

2010 Definition
Profitability Ratios
Gross Margin 62.2% Gross Margin / Revenues
EBITDA Margin 39.0% EBITDA / Revenue
EBIT Margin 33.2% EBIT / Revenue
Return on Assets (ROA) 4.8% NI / Avg Assets
Gross Return on Assets 11.8% EBIT / Avg Assets
Return on Equity (ROE) 8.1% NI / Avg Equity

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