Warren Buffett's Tips to Speed-Read 10Ks

Analyze a 10K in an hour or less by looking for numbers that matter for earnings.

Warren Buffett can read an annual report in 45 minutes.

How can mere mortals like us do the same?

Here's Buffett's famous owner earnings formula:

owner earnings = reported earnings + depreciation, amortization +/- other non-cash charges — average annual maintenance capex +/- changes in working capital.

I'll explain how this formula can improve your annual report reading.

Search the annual report in this order: financial statements, footnotes, accounting policy, and management discussion and analysis (MD&A).

This method is a shortcut, and there is a lot more information in the report, but this is a great way to start so you can make effective investment decisions quickly.

Reading a 10K from top to bottom will take a week to finish, and it is a tiring chore.

When reading the financial statements, start by flipping between the footnotes and management analysis.

Try reading the report in this order:

• Financial statements

• Footnotes

• Accounting policy

• Management analysis

It is so you can get the complete picture of the company's performance.

You're moving from a high-level overview to the details before moving on to the analysis.

Read The Revenues And Operating Segments

I used to skip reading the revenues section in the footnotes because it took time to understand revenue accounting policy.

But, after reading many 10Ks, I understood their importance. I learned you must be cautious about what companies report because only some things you read are true.

Since we calculate Earnings as revenues minus expenses, it makes sense to analyze revenues first.

The first key is understanding the revenue recognition policy. The fastest way to know if a company is juicing its earning is to understand how it accounts for its revenues. The matching principle in accrual accounting is designed to match a revenue event, like a sale, with the expenses associated with achieving that sale.

The two usually don't happen simultaneously, so one or the other is accrued as accounts payable or accounts receivable. The matching principle intends to make things more clear as to how revenues are achieved and how much they cost.

There have been many accounting scandals around companies that booked revenues too soon, like on a letter of intent or less, to make quarterly targets. All too often, these revenues never materialize. So dig into the numbers and associated notes in the financial statements and ensure the company reports solid revenue, expenses, and net income.

The more confusing it is, the more likely management doesn't want you to understand. So this attempted obfuscation is a giant red flag.

The second tip is to read the operating segments carefully because it reveals where and how a company makes cash.

Usually, companies provide numbers to help calculate the operating profit of each business segment, which is more accurate than relying on the parent company's operating profit. However, sometimes, companies don't provide you with any segment data — my tip is to avoid these companies.

Here's an example of why operating segment analysis is essential. Amazon's retail (online and store) runs at 2% operating margins while their Web services, AWS, run at 34%. This difference shows that Amazon retail competes in a tight market with skinny margins. But it can still be a worthwhile investment considering its cloud performance. You can calculate a blended rate by pro-rating the size of each segment.

Read the expenses

Analyzing a company's expenses is more demanding than studying revenues because costs are usually displayed as jumbled.

Expenses can be rolled up into line items like Research and Development, Marketing, Sales, and General Administration.

Or, you get one long list of company expenses.

I prefer to see company expenses separated by operating segments to understand why some areas are more profitable than others.

You will only get this sometimes; too much information can impair analysis.

So, even if expenses aren't clear in the footnotes, see if the management discussion and analysis (MD & A) has anything to say or even if there is anything to say.

Read Plant, Property, and Equipment

Even though it might seem inconsequential, I've learned to analyze this financial section in the 10K. It's a small section of the footnotes, but it plays a large part in the company.

You can forecast the growth and demise of a company depending on how much stuff it has.

If a company has too many buildings and pieces of equipment and needs more return on investment coupled with increased debt, then you can expect a negative future for the company.

Depreciation and Amortization are found on the cash flow statement in the operations section.

What you're getting out of the plant, property, and equipment section is whether or not the company's depreciation and amortization policies make sense with the depreciation and Amortization reported.

Depreciation and Amortization should at least roughly equal new investments in the company, or the company is dwindling.

If the investment figure is higher than Depreciation and Amortization, then the company is on net investing more, indicating that it is growing.

If you have a tech company with a high depreciation rate, does it make sense to you?

Accounting knowledge will tell you that tech companies tend to have higher Amortization of their software than the depreciation of equipment, especially if we're talking about a software company.

Combining industry and accounting knowledge will help you understand if what you're reading is true or garbage.

Figure out the strategy to guess capital expenditure.

According to Buffett, capital expenditure should match depreciation and Amortization at least dollar for dollar for a company to maintain its competitive advantage.

I always needed clarification on what this meant.

But, thinking about it more made me realize that companies that do not match their capital expenditure with their depreciation and Amortization have either slowed down or have no money.

Companies don't need to match capital expenditure and depreciation and amortization dollar for dollar, but it's a sign something will come — either in the form of new mergers or divestments.

You can find the capital expenditures in the cash flow section, but it won't necessarily give you an idea of the company's true capital expenditure.

The reason is that capital expenditures are investments now that will produce profits in the future.

While operating expenses are seen as expenses just to run the business for the financial year.

Calculating the 5-year average capital expenditure is an indicator of future performance.

A better way is to understand how a company plans to maintain its competitive advantage.

For instance, if the company has changed its strategy from building more manufacturing plants to business acquisitions, then you take an educated guess that future years' capital expenditures will significantly increase.

Reading the management discussion and analysis section of the 10K will help you determine where future capital investments will go and give you an idea of how much capital expenditure will be needed.

Fill in the gaps

Once you have a working understanding of the company, all you need to do now is review the other sections to help fill in the gaps in your understanding.

For instance, if an oil company has made a loss for the year, find the impairment figure to see if it makes sense.

If a company is making massive acquisitions, check how much debt was acquired and investigate if issuing shares would significantly dilute your returns.

On the other hand, if you're looking at a product company, check its inventory and calculate whether or not the merchandise is moving fast enough for your liking.

This sequence is a great way to read an annual report or 10K.

Financial Analysis Course: How to Read a 10-K

I'll teach you how to analyze a

• Balance sheet

• Income Statement

• Cash Flow Statement

1️⃣ Balance sheet

A balance consists of the following elements:

• Current Assets

• LT Assets

• Current Liabilities

• LT Liabilities

• Shareholders Equity

It shows you what the company owns and owes.

This statement is based on a simple formula:

Assets = Liabilities + Equity

2️⃣ Income Statement

An income statement shows you the income and expenses of a company.

Revenue

- COGS

= Gross Profit

- Operating Expenses

= Operating Income

- Non-Operating Income/Expenses

= Pre-Tax Income

- Taxes

= Net Income

3️⃣ Cash Flow Statement

The Cash Flow Statement consists of 3 elements:

• Cash Flow from Operating Activities

• Cash Flow from Investing Activities

• Cash Flow from Financing Activities

It shows you the cash that enters and leaves a company.

Cash Flow from Operating Activities

Net Income

+ Non-Cash Changes

+/- Changes in Working Capital

= Cash Flow from Operations

Cash Flow from Investing Activities

- Capital Expenditures

- Acquisitions

+ Proceeds from the sale of investments

= Cash Flow from Investments

Cash Flow from Financing Activities

+/- Borrow/Repay Debt

+/- Issue/Repurchase of stocks

- Pay Dividends

= Cash Flow from Financing

How to Read a 10-K in 10 Steps: Master Corporate Financial Analysis

Course Introduction

Welcome to the most practical investment skill you'll ever learn. Reading a company's 10-K filing isn't just about numbers—it's about understanding the true story behind any public company. While most investors rely on headlines and analyst opinions, you're about to gain the superpower of reading primary sources.

Why This Matters

Jim Rogers, the legendary commodities investor, once said: "If you get interested in a company and you read the annual report, you will have done more than 98% of the people on Wall Street." This course will put you in that elite 2%.

The 10-K is your window into corporate truth. Unlike marketing materials or investor presentations, the 10-K is written for legal compliance and clarity. Think of it as the "courtroom truth" version of how a business really operates.

What You'll Learn

By the end of this course, you'll be able to:

• Navigate any 10-K filing with confidence and efficiency

• Identify red flags that could signal financial trouble

• Understand the real risks facing any business

• Analyze financial statements like a professional investor

• Spot the difference between management spin and reality

• Make informed investment decisions based on primary data

The 10-Step Framework

Step 1: Understanding the 10-K's Purpose

Every public company must file this annual report with the SEC. It's not marketing—it's compliance. This fundamental difference means you're getting unvarnished truth about the business.

Step 2: Business Overview Analysis

Start with Item 1. Read slowly and ask yourself: "Can I explain this business model in one paragraph?" If you can't, the company either lacks focus or you need to dig deeper. Warren Buffett's rule applies: never invest in what you don't understand.

Step 3: Risk Factor Deep Dive

Item 1A contains pure gold—every material risk the company faces. Read these as if you're investing your life savings. Highlight risks that could destroy the business. Remember Charlie Munger's wisdom: "Invert, always invert."

Step 4: Legal Proceedings Examination

Don't overlook Item 3. One major lawsuit can wipe out years of profits. When in doubt, research the cases independently. Trust, but verify.

Step 5: Financial Statement Mastery

The three core statements—Income Statement, Balance Sheet, and Cash Flow Statement—are your navigation tools. Print them, annotate them, compare them across years. Look for consistency and red flags.

Step 6: Margin Analysis Over Revenue Growth

Growth is seductive, but sustainable businesses grow profitably. Focus on gross margin, operating margin, and net income trends. Declining margins often signal competitive pressure, even in a growing revenue environment.

Step 7: Capital Structure Assessment

The balance sheet reveals how the company finances itself. Heavy borrowing, low cash reserves, or excessive goodwill can signal trouble. Healthy balance sheets create antifragility—sick ones invite disaster.

Step 8: Cash Flow Reality Check

Remember: earnings are opinions, cash is truth. The cash flow statement reveals whether the business actually generates cash or just books accounting profits. Pay special attention to operating cash flow and capital expenditures.

Step 9: Management Discussion Analysis

This is where leadership tells their story. Look for alignment between their narrative and the financial data. Does their explanation match the numbers, or does it sound like spin?

Step 10: Year-over-Year Comparison

Wisdom compounds through contrast. Reading one 10-K is helpful—reading five years' worth is powerful. Track changes over time to identify patterns and trends.

Course Structure

Each module combines:

• Theory: Why each section matters

• Practice: Real-world examples using actual 10-K filings

• Application: Hands-on exercises with current companies

• Pro Tips: Advanced techniques used by professional analysts

Tools and Resources

You'll receive:

• 10-K analysis checklist

• Financial ratio calculator templates

• Red flag identification guide

• Links to SEC database for practice

• Recommended further reading list

Your Investment Edge

Most investors make decisions based on:

• News headlines (often outdated)

• Analyst recommendations (potentially biased)

• Social media sentiment (emotional and unreliable)

• Technical charts (backward-looking)

You'll make decisions based on:

• Primary source documents

• Comprehensive risk assessment

• Multi-year trend analysis

• Management credibility evaluation

• Fundamental business understanding

Final Motivation

Charlie Munger didn't become wise by browsing headlines. He read thousands of pages, carefully, year after year. Warren Buffett has read every Berkshire Hathaway annual report multiple times.

If you want to compound your capital, start by compounding your understanding. The 10-K is your gateway to investment wisdom.

Ready to join the ranks of informed investors? Let's begin your journey to financial literacy mastery.

"The best investment you can make is in your own abilities. Anything you can do to develop your own abilities or business is likely to be more productive." - Warren Buffett

Accounting is the procedure of data entry and recording, summarizing, analyzing, and reporting financial data. The end product of accounting is the three financial statements: Income Statement, Balance Sheet, and Cash Flow Statement.

FIVE BASIC ACCOUNTING PRINCIPLES:

1: Revenue Recognition:

→ Revenue is recorded at the time of the transaction.

2: Matching Principle:

→ Assets are recorded at their acquisition cost.

3: Historical Cost:

→ Fiscal Year Income is compared with Calendar Year Expense.

4: Full Disclosure:

→ Full disclosure of all relevant info is made available.

5: Objectivity Principle:

→ Information in books should be true, relevant, & accurate.

5 CATEGORIES OF ACCOUNTING:

1: Assets:

→ All Tangible & Intangible items owned by the company.

2: Liabilities:

→ Amounts the company owes to others.

3: Equity:

→ Net Worth of Entity: Assets - Liabilities

4: Expenses:

→ Amount paid purchases made in business.

5: Income:

→ Amount earned by the company from the sale of goods.

JOURNAL VS LEDGER:

→Journal Entries consist of Debits & Credits, the totals of which should be equal

→Journal entries are then transferred to the appropriate Ledger Accounts

FINANCIAL STATEMENTS:

1: Income Statement:

→ Shows profit or loss during the period.

2: Balance Sheet:

→ A company's assets, liabilities, and equity at a point in time.

3: Statement of Cash Flow:

→ Shows the inflow and outflow of cash during the period.

DOUBLE ENTRY SYSTEM

→ Each Accounting Entry will have two sides - Debit and Credit.

THREE FIELDS OF ACCOUNTING:

→ Financial Accounting: Preparing the Financial Statements.

→ Managerial Accounting: Prepare reports for internal use.

→ Cost Accounting: Measure the performance of resources.

The Accounting Cycle

The Accounting Process, Visualized:

Step 1: Identify transactions

→Identify and document all financial transactions that occur within the accounting period.

Step 2: Prepare journal entries:

→Create journal entries to record the details of each transaction, including the accounts affected and the corresponding debits and credits.

Step 3: Record journal entries:

→Enter the journal entries into the general ledger, the central repository for all financial transactions.

Step 4: Prepare trial balance:

→Summarize the balances of all accounts in the general ledger to ensure that the debits equal the credits.

Step 5: Make adjusting entries:

→Make necessary adjustments to the accounts to ensure the accuracy of the financial statements, such as recording accrued expenses or prepaid income.

Step 6: Review adjusted trial balance:

→Verify that the adjusted trial balance reflects the correct account balances after making the adjustments.

Step 7: Produce financial statements:

→Generate financial statements, including the income statement, balance sheet, and cash flow statement, to provide an overview of the company's financial performance and position.

Step 8: Post closing entries:

→Close temporary accounts, such as revenue and expense accounts, to start the next accounting period with zero balances.

Step 9: Review post-closing trial balance:

→Confirm that the post-closing trial balance only includes permanent accounts and that the debits still equal the credits.

Step 10: Prepare journal entries:

→Prepare journal entries for the next accounting period to continue recording new transactions.

The basics of accounting

This PDF will teach you everything you need to know

Here's what you'll learn:

- Accounting Cycle & Accounting Equation

- List of Accounts and Its Classification

- Accounting Principles

- Journal Entries, Adjusting Entries, & Closing Entries

- Financial Statements

13 Accounting Principles

Accounting is the language of business.

If you want to read financial statements, you MUST understand these 13 principles:

ACCOUNTING PRINCIPLES

→ The rules, benchmarks, and procedures in the accounting field companies should follow while reporting financial statements. In the United States, the common set of accounting standards is GAAP (Generally Accepted Accounting Principles).

ECONOMIC ENTITY

→The Owner & business are two different entities with separate liabilities.

REVENUE RECOGNITION

→ Revenue should be recognized using the accrual basis of accounting.

CONSERVATISM

→When there are two acceptable options for reporting, the less favorable option should be chosen.

CONSISTENCY

→The usage of methods and principles should be consistent until another method proves to be better.

HISTORICAL COST

→Assets should be recorded based on their original purchased value.

FULL DISCLOSURE

→All important information should be disclosed within the financial statements or as a footnote.

GOING CONCERN

→Business is assumed to carry on forever with no intention of liquidation.

MATCHING CONCEPT

→All debits should have a matching credit, and all credits should have a matching debit.

MATERIALITY

→Any information which will have a significant impact should be reported on the financial statements.

MONETARY UNIT

→Transactions that carry a monetary value should be recorded in terms of a monetary currency (Eg, Dollars)

RELIABILITY

→Transactions should only be recorded that can be proven & have significant evidence.

REVENUE TIMING

→ Revenues will be recognized at the time of the transactions regardless of whether payment has been made.

TIME PERIOD

→There should be a standardized time period for the reporting of the financial statements (Ex: Monthly, Quarterly, or Annually)

Do any of these principles need further explanation? If so, let me know in the comments section.

Accruals and Provisions

The Confusing Duo of Accounting. Let's Demystify!

Understanding the difference between accruals and provisions is fundamental for accurate accounting and financial reporting.

It is common for business owners or even us accountants to need clarification on the two.

But it doesn't have to be that way.

Not, at least, after the information I have put together to demystify the confusion.

This is what you will find in the excellent PDF attached:

1- The Confusion

2- The Reason for the Confusion

3- Why Understanding the Difference is Important?

4- Impact of Incorrect Classification?

5- The Concept

6- The Purpose

7- The Recognition

8- The Estimation

9- The Timing

10- The Reversal

11- The Adjustments

12- The Examples

13- The Impact on Cash Flow

14- The Accounting Treatment Process Flow

Cost Accounting Formulas

This PDF teaches you everything you need to know

Here's what you'll learn:

- Total Cost (TC)

- Average Cost (AC)

- Marginal Cost (MC)

- Contribution Margin (CM)

- Gross Profit (GP)

- Break-Even Point (BEP)

- Return On Investment (ROI)

- Cost of Goods Sold (COGS)

- Overhead Allocation

- Cost Variance

- Price Variance

- Labor Efficiency Variance

- Predetermined Overhead Rate (POR)

- Economic Order Quantity (EOQ)

- Cost of Quality (COQ)

- Production Volume Variance

- Margin of Safety

- Availability

- Reorder Point

- Takt Time

GAAP vs non GAAP

If accounting is the language of business, as we often teach, understanding its high-level concepts is essential.

Yet, when listening to insiders or stock market veterans, they often use industry jargon and alphabet soup acronyms without explaining what each means.

In today’s lesson, we will tackle one of accounting’s most confusing terms, which is crucial to understand when going through a company’s financial statements: GAAP, which stands for generally accepted accounting principles.

GAAP accounting is a commonly accepted set of rules and procedures designed to govern corporate accounting and financial reporting within the United States.

GAAP rules were jointly established by the Financial Accounting Standards Board (FASB) and the Governmental Accounting Standards Board (GASB).

GAAP rules are applied to profitable corporations (overseen by the FASB) and government and non-profit organizations (regulated by the GASB).

This raises an important question: Why do companies report non-GAAP results if GAAP rules are for corporations?

Non-GAAP refers to accounting practices that do not comply with the GAAP standards. As a result, these metrics aren’t audited and don’t have a standardized reporting format.

Many companies report non-GAAP results to shareholders (in addition to their GAAP results) to add important color and nuance to their numbers that the GAAP standard misses.

However, it’s important to note that non-GAAP numbers can also disguise weaknesses in a company’s results.

Therefore, a discerning investor must carefully comb through the numbers, comparing the GAAP with the non-GAAP results, to see an accurate picture of companies’ finances.

Excel is a versatile and indispensable tool for finance and investment professionals. Its importance cannot be overstated, as it is used in a wide range of financial tasks, from data analysis to financial modeling and reporting.

1. Financial Analysis and Reporting: Excel enables finance professionals to sort, analyze, and visualize data to identify trends, perform variance analysis, and forecast future financial scenarios. It supports using pivot tables, advanced formulas, and various graphing tools, which are crucial for creating detailed financial reports.

2. Financial Modeling: Excel is widely used for financial modeling, allowing analysts to build models that can predict income, budgeting, cash flow, and other financial projections. Using advanced functions and creating flexible, dynamic models is critical to making informed business decisions.

3. Excel Proficiency is a Game-changer for finance professionals, significantly boosting productivity by saving time. The ability to automate tasks with macros, handle complex calculations with ease, and manage large datasets efficiently are just a few ways Excel streamlines financial tasks.

4. Excel is not just a tool; it's a universal language in the finance industry. Mastery of Excel is often a prerequisite for many finance roles, making it an indispensable skill for job proficiency and career advancement.

5. Decision Making: Excel helps finance professionals in decision-making processes by providing a platform to work through various financial scenarios and analyze potential outcomes. What-if analysis and sensitivity tables are instrumental in this regard.

6. Accuracy and Precision: Excel's precision in handling financial data is critical. A single error can result in significant financial discrepancies; thus, the ability to use Excel to manage and cross-check numbers accurately is vital.

7. Integration and Compatibility: Excel can integrate with many business applications and databases, making it an effective tool for consolidating information from various sources for financial analysis and reporting.

Knowing Excel in finance is not just about understanding the basic features; it involves a deep understanding of its advanced capabilities, which are essential in the sophisticated world of finance.

Excel proficiency is a foundational skill that enables finance professionals to perform their roles effectively and efficiently, whether running regressions, building a discounted cash flow model, or analyzing complex datasets.

Download the MBA ASAP Ultimate Excel Handbook and level up your skill set.

Vlookup vs. Hlookup vs Xlookup

Learn the most popular Excel functions and which ones to use when

Lookup functions are REALLY popular in Excel.

Because they allow you to “lookup” a value from a dataset based on the criteria that you enter.

Most people only focus on Vlookup without realizing that there is a far more powerful lookup function called Xlookup.

Let’s explore these three lookup functions and become a pro:

VLOOKUP

How it works → Searches VERTICALLY in the first column of a specified range and returns a value in the same row from a column you specify.

Syntax → =VLOOKUP(lookup_value, table_array, col_index_num, [range_lookup])

Pros →Easy to use for vertical lookups, Supported in all versions of Excel.

Cons → Limited to vertical searches, Searches must start in the first column of the range.

My take → VLOOKUP is probably the most common lookup function, but it’s sooo limited. Learn to ditch this function and focus on XLOOKUP!

HLOOKUP

How it works → Searches HORIZONTALLY in the first row of a specified range and returns a value in the same column from a row you specify.

Syntax → =HLOOKUP(lookup_value, table_array, row_index_num, [range_lookup])

Pros → Useful for horizontal lookups, Supported in all versions of Excel.

Cons → Limited to horizontal searches, Inefficient with large datasets.

My take → HLOOKUP isn’t as popular as VLOOKUP but is very similar. As mentioned above, while this may get the job done, there is a bigger and better option with XLOOKUP.

XLOOKUP

How it works → Searches for a value in an array or range in EITHER DIRECTION and returns a value from a corresponding array or range.

Syntax → =XLOOKUP(lookup_value, lookup_array, return_array, [if_not_found]

Pros → Can search in any direction, Allows for the return of an array, and provides an option for a default value if no match is found, which is very efficient.

Cons → Only available in Excel for Office 365, Excel 2019, and later versions, can be complex.

My take → XLOOKUP solves all the issues that VLOOKUP and HLOOKUP have, and it will gradually take over the Excel lookup universe.

What makes this even more powerful is nesting another XLOOKUP inside your XLOOKUP, which allows you to find the value with both your X and Y axes.

Becoming intimately familiar with financial statements and how they are interconnected and flow is the critical skill set for corporate finance.   

Financial statements also underlay Discounted Cash Flow analysis, NPV, IRR, and all the valuation techniques of finance.  We will now spend some time thoroughly understanding financial statements.

Intro to Financial Statements

• What are financial statements?

• The 3 Financial Statements:

• Income Statement

• Balance Sheet

• Cash Flow

  
  

Understanding Financial Statements   

When you have completed this section you will have a solid understanding of Financial Statements and you will be able to draw meaningful conclusions from their contents.  This knowledge can be highly impactful for the quality of your career, job prospects, and life.   

Financial Statements are the basic language of money and business. Everyone should have a basic understanding of Financial Statements: what they are and what information they provide.  It’s a competency that can open up opportunities and vistas that are closed off otherwise.        

Executives like the CEO, COO, and CFO routinely share and discuss financial data with marketing, operations, and other direct reports and personnel within an organization.  They also compile and share financial information with stakeholders outside the firm such as bankers, investors and the media.    

But how much do you really understand about finance and the numbers? A recent investigation into this question concluded even most managers and employees don’t understand enough to be useful. Check out the quiz in this section to see how you stack up.  I will offer the quiz again at the end of the course so you will be able to gauge how your level of financial competency has improved.    

Three Main Financial Statements   

There are three main financial statements and they are linked together to provide a picture of the financial position and health of an enterprise. They represent the end product of accounting, meaning they are the reports generated by accounting covering all of the transactions of a company.   

The three basic financial statements are the   

• Balance Sheet: which shows firm's assets, liabilities, and net worth on a stated date   

• Income Statement: also called profit & loss statement or simply the P&L: which shows how the net income of the firm is arrived at over a stated period, and    

• Cash Flow Statement: which shows the inflows and outflows of cash due to the firm's activities during a stated period.    

Knowing how to read and understand financial statements is a business skill you can’t ignore. It can help working your way up the corporate ladder by communicating with others in your company and understanding the big picture.  It is also a useful skill in order to understand where your efforts and work can make the most impact.    

When you are thinking about possibly changing jobs and working for a company you can check their financials and make sure they are a healthy organization.  If you are considering starting your own company you will need to have financials prepared by your accountant in order to talk to investors, bankers and vendors.    

If you want to invest wisely in the stock market, analyze the competition or benchmark your performance, you can look up the financials of any publicly traded company at the Securities and Exchange Commission website’s’ EDGAR filings and get an idea of how they are doing.  Check out any public company’s most recent 10K filing there.  A 10K is the Annual Report of the company and its most important business and financial disclosure document.          

The Most Important Finance Job

The most important set of tasks that a CFO (Chief Financial Officer) has is the oversight, management, and preparation of financial statements.  Financial reporting with financial statements happens regularly, at least every quarter and once a year for audited financials.  Once you complete a set of financial statements, you are working on the preparation of the next set. 

Next we will go over each of the financial statements individually and how they are interrelated.  You will find lots more information in the books and other downloadable documents that accompany this course.

Financial ratios, the next section, are derived from accounting information and rely on an understanding of financial statements. The eBook attached to this section provide a primer on the subject. Download and check out MBA ASAP Understanding Financial Statements before you go through this section of lectures.  It will get you up to speed on this critical business skill quickly. Also download and review the attached Financial Statement Glossary of Terms.

Imagine being a business owner and not understanding how much your company’s assets are worth.

Or being a CFO who didn’t know the difference between net income and free cash flow.

While these scenarios are nearly unbelievable, it is just as vital for investors to understand how financial statements work as it is for company executives.

Every investor needs to be able to read and analyze the three financial statements companies provide to their shareholders:

1. Income Statement

2. Balance Sheet

3. Cash Flow Statement

Let’s briefly review the purpose of these statements, why they’re essential, and the basic information each reveals.

The Balance Sheet Explained Simply

The master equation: Assets = Liabilities + Shareholder Equity

TIME: The Balance Sheet records a Point in Time

ACCOUNTING METHOD: Accrual

3 Main Sections:

ASSETS: What the company Owns

LIABILITIES: What the company Owes to creditors

EQUITY: The net value of the owner's claim

ASSETS

They are listed in order of liquidity (how quickly it can be turned into cash).

CURRENT ASSETS: Expected to be used in <1 year

→Cash

→Marketable Securities

→Accounts Receivable

→Inventory

→Other Current Assets

LONG-TERM ASSETS: Expected to be last >1 year

→Long-Term Investments

→Fixed Assets

→Goodwill

→Other Long-Term Assets

LIABILITIES

Listed in order of when they are expected to be paid off.

CURRENT LIABILITIES: Expected to be paid in <1 year

→Payables & Accrued Expenses

→Short-Term Debt

→Other Current Liabilities

LONG-TERM LIABILITIES: Expected to be paid in >1 year

→Long-Term Debt

→Other Long-Term Liabilities

SHAREHOLDER'S EQUITY

CAPITAL RAISED FROM INVESTORS

→Preferred Stock

→Common Stock & Additional Paid-In Capital

PROFITS RETAINED BY THE COMPANY

→Retained Earnings

→Treasury Stock

Balance Sheet Basics 

The Balance Sheet is a condensed statement that shows the financial position of an entity on a specified date, usually the last day of an accounting period.         

Among other items of information, a balance sheet states

• What Assets the entity owns,    

• How it paid for them,   

• What it owes (its Liabilities), and    

• What is the amount left after satisfying the liabilities (its Equity)   

Balance sheet data is based on what is known as the 

Accounting Equation: Assets = Liabilities + Owners' Equity.   

Think of a Balance Sheet in terms related to everyday life.  Home ownership, when you have a mortgage, is represented as a Balance sheet. Your home ownership basically has the three components of Asset, Liability and Equity. The Asset is the value of the house. This is determined by an appraisal. An appraisal takes into account recent sales of homes in the area and compensates for differences like the number of bath or bedrooms, the size of the lot, etc.    

The Liability is the mortgage. This is how much you owe against the house. The Equity is the difference between the value of the Asset and the amount of the Liability. If your home is worth $200,000 and you have a remaining mortgage balance of $150,000, then you have $50,000 in Equity. We sometimes call this homeowner’s equity.    

If your mortgage balance is more than the value of the home, then you are considered “upside down” or “under water”. The same principle applies to a business: if the value of its Liabilities is more than the value of the Assets then the enterprise is insolvent and probably headed for bankruptcy.     

    A Balance Sheet is organized under subheadings such as current assets, fixed assets, current liabilities, Long-term Liabilities, and Equity With income statement and cash flow statement, it comprises the financial statements; a set of documents indispensable in running a business.     

What does the Balance Sheet balance?   

The balance sheet is structured to show the amount and type of assets an enterprise owns and how those assets are funded.  One side of the balance sheet shows what you have (assets) and the other side shows how you paid for it (debt and equity).    

Assets can be purchased and paid for in two ways: with debt or with equity (or a combination of the two).  What a company owes, the debts or loans, are called Liabilities; what a company owns is the Equity or Stock.    

The Liabilities and Equity are equal to the Assets.  They are two sides of the same coin and they must balance; hence the term Balance Sheet. This is a fundamental principal of Accounting called the Accounting Equation.  Assets = Liabilities + Equity.     

Balance Sheet Format   

A Balance Sheet is typically organized in two columns with the Assets on the left and the Liabilities and Equity on the right. It is divided into subcategories with the most current types on top and the more long-term varieties towards the bottom.     

Current Assets are ones like cash that can be used on short notice and Long term Assets are things like factories that would take longer to convert to cash.  Current means short term; stuff that needs to be addressed within one year. Long-term means stuff longer than the next year.    

Bills that need to be paid within the month are considered Current Liabilities and loans that are paid back over years are considered Long term Liabilities.    

Equity is what the owners actually own.  Equity is basically Assets less the Liabilities and is shown as accounts below the Liabilities on the left hand side.  Equity is shown below the Liabilities because debt has senior claims on the assets. In the event of liquidation like a bankruptcy, the debt holders get paid from the sale of assets first and then anything left over goes to the equity holders.    

Here is an example Balance Sheet to get and idea of the format; notice that the Total Assets equals the Total Liabilities plus Equity.

Company Specific Financial Information

Public companies are corporations that are traded on the stock market. Most large companies you are familiar with are publicly traded. Their stock price is listed in the paper and on Yahoo! Finance and other websites. The Securities and Exchange Commission (SEC) regulates these companies and the stock markets.

One of the requirements for these companies is to submit audited financial statements, including the Balance Sheet, along with descriptive information about their operations to the SEC. These annual reports, called 10Ks, are available online for public review.

Look on the SEC.gov website for 10Ks of public companies. Go to the EDGAR section of the website. You can search for the company of interest by name or trading symbol.

Besides their annual financial statements, public companies must also disclose information about their operations and strategy such as:

· Who they believe their competitors are,

· How they plan to grow the business,

· What the general economy looks like and

· How they predict it will affect their business segments.

This represents a wealth of expert opinion on your specific business domain and makes for great and profitable reading

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This used to confuse me.

There's an easy way to distinguish them.

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Here are some other noteworthy differences:

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- Tangible assets are depreciated over their useful life.

- Intangible assets are amortized over their useful life.

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- Valuation of tangible assets is generally based on cost or market value.

- Intangible assets valuation often relies on the income approach or market comparables.

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- Tangible assets typically have a finite lifespan.

- Intangible assets can have an indefinite lifespan, depending on the asset type.

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- Tangible assets are more risky due to physical deterioration or technological advancements.

- Intangible assets face lower physical obsolescence risks but can be affected by changes in law, market demand, or technology.

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- Tangible assets are often used as collateral for loans due to their physical value.

- Intangible assets are less commonly used as collateral due to difficulty in valuation.

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- Tangible assets are acquired or constructed physically.

- Intangible assets are created through legal or intellectual effort.

I'll teach you How to Read a Balance Sheet in 7 minutes.

I've spent 30+ years studying Finance, with 15 as a public company CFO.

This post is a "cheat sheet" ebook on how to read a Balance Sheet in 7 minutes:

• What does the balance sheet tell you?

• What is the structure of the balance sheet?

• What are Assets?

• What are Liabilities?

• What is Equity?

• How do you analyze a balance sheet?

Here is a quick analysis of the balance sheet:

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Calculate the working capital (current assets - current liabilities) to assess the company's liquidity.

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calculate cash to short-term liabilities to review any potential liquidity issues in the very short term.

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Calculate dso to see how quickly the company collects cash.

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Calculate dio to see how the company is efficient in converting inventories into cash

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Check the efficiency with fixed asset turnover evaluation.

Evaluate fair value, especially for intangibles.

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Calculate the current ratio and quick ratio to assess liquidity.

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Calculate Days Payable Outstanding (DPO) to track how quickly a company pays a bill and tends to prolong terms.

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The top priority in payment. Make sure the company is able to meet its immediate financial obligations.

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Evaluate debt-to-asset ratio to determine solvency.

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Calculate the equity ratio (equity / total assets) to understand stability

ROE (net income/equity) to understand the profitability

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1. understand the meaning of the ratio

2. result interpretation

3. compare with last period, budget and industry peers

4. action plan

Here's how you can be a financial expert by analyzing balance sheets:

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==============

Grasp the fundamental concepts of assets, liabilities, and equity. Familiarize yourself with the balance sheet equation: Assets = Liabilities + Equity.

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==========================

Assess the company's ability to convert its assets into cash within a year. Evaluate the value of long-term assets like property, plant, and equipment.

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============

Evaluate the company's short-term and long-term obligations. Understand how these obligations impact the company's financial flexibility.

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==================

Analyze the company's common stock and retained earnings. Assess the ownership structure and the company's ability to generate profits over time.

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============

Utilize ratios like the current ratio, debt-to-equity ratio, and debt-to-asset ratio to gain insights into the company's financial strength and efficiency.

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=================

Be vigilant about red flags like increasing accounts receivable, rising inventory, and high debt levels. These signals could indicate potential financial risks.

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================

Benchmark the company's balance sheet ratios against industry peers to assess its relative financial position.

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====================

Financial analysis is not an exact science. To enhance your expertise, stay informed about financial trends, accounting standards, and industry developments.

What is Working Capital?

Here's a simple way to understand this confusing finance term.

Working capital -- aka Net Working Capital -- is the difference between a company's current assets (expected to be used/consumed/converted into cash <1 year) and current liabilities (debts that are expected to be paid off in <1 year).

Why is working capital important?

Working Capital is a quick way to assess a company's liquidity, which is its ability to meet its short-term obligations.

It serves as an indicator of a company's financial health.

If working capital is positive, it indicates that a company has sufficient resources to cover its short-term financial needs.

If working capital is negative, it indicates that a company may face financial difficulties.

There are three ways to calculate working capital:

THE SIMPLE METHOD

Current Assets - Current Liabilities

This is the most common method and easiest to calculate.

THE NARROW METHOD

(Current Assets - Cash) - (Current Liabilities - Debt)

This method excludes cash & debt, which can help compare companies with different capital structures.

THE SPECIFIC METHOD:

Accounts Receivable + Inventory - Accounts Payable:

This method focuses on the cash conversion cycle of a business, which is the time it takes to convert inventory into cash.

DEPRECIATION

DEPRECIATION is an accounting method used to allocate the cost of tangible assets (such as buildings, machinery, and vehicles) over their useful lives. It represents the systematic reduction in an asset's value due to wear and tear, obsolescence, or other factors.

Depreciation happens to TANGIBLE Assets (you CAN touch them)

Examples:

• Car

• Equipment

• Buildings

3 DEPRECIATION METHODS

STRAIGHT - LINE

The most common and easiest method to calculate depreciation. To use this depreciation method, you need to divide the cost of an asset by the useful life of an asset (in years).

FORMULA: Cost / Useful Life

DECLINING BALANCE

Used to calculate large depreciation expenses or assets that quickly lose value. Multiply the opening book value by the depreciation rate.

FORMULA: Opening book value x (100% / Useful Life of asset)

SUM OF THE YEARS DIGITS

An accelerated depreciation method increases the expense in the early years and lowers it in the latter years. Multiply the cost of an asset by its useful life over the sum of the years digits.

FORMULA: Cost x ( Useful life / Sum of the Years digits)

See the infographic for examples!

14 Types of Costs You Should Know

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- Relevant/Incremental Costs: Future costs that are relevant to decision-making

- Irrelevant/Sunk Costs: Past costs that are irrelevant to decision-making

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- Product Costs: Inventoried costs associated with the production of products or services

- Period Costs: Costs not related to production and expensed in the period

- Manufacturing Costs: total costs associated with the production of goods, including direct materials, direct labor, and manufacturing overhead

- Operating Costs: total costs associated with day-to-day operations

- Conversion Costs: costs incurred when converting raw materials into finished products

- Overhead Costs: indirect costs not tied to a specific product or service, often including items like rent, utilities, and administration costs (can be manufacturing or non-manufacturing)

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- Direct Costs: Costs that can be traced directly to a specific cost object

- Indirect Costs: Costs that cannot be traced directly to a specific cost object

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- Fixed Costs: Costs that remain constant regardless of the level of production or services

- Variable Costs: Costs that vary in direct proportion to the level of production

- Semi-variable Costs/Mixed Costs: Costs that contain both fixed and variable components

- Step Costs: Costs that remain fixed only for a certain volume or range of activity

Economic Costs: the total cost of producing your goods or services, including explicit costs (such as wages and materials) and implicit costs (such as opportunity costs).

Allocated Costs: indirect costs that you cannot directly trace to a specific product or service and which you instead distribute to products based on a pre-determined method ideally driven by a cause-effect relationship

Learn Income Statements like a pro! With our guide, discover the basics of financial reporting and boost your financial knowledge!

1️⃣ What is an Income Statement?

An income statement, also known as a profit and loss statement (P&L), is a financial report that shows a company's revenues, expenses, and profits (or losses) over a specific period, typically a fiscal quarter or year.

2️⃣ Components of an Income Statement

Revenue (Sales): The total income from selling goods or providing services.

Cost of Goods Sold (COGS): The direct costs of producing the goods or services.

Gross Profit: Revenue minus COGS, representing the initial profit before operating expenses.

Operating Expenses: Costs related to the day-to-day operations of the business (e.g., salaries, rent, utilities).

Operating Income: Gross profit minus operating expenses, indicating the profit from core operations.

Non-Operating Income (Expenses): Additional income or expenses not directly related to core operations.

Net Income (Profit or Loss): The final result indicates the overall profit or loss after all income and expenses.

3️⃣ Analysis of an Income Statement

To evaluate a company's Income Statement, various margins and ratios are used:

Profit Margin

(Net Income / Revenue) x 100

Gross Margin

(Gross Profit / Revenue) x 100

Operating Margin

(Operating Income / Revenue) x 100

EBITDA Margin:

(EBITDA / Revenue) x 100

Revenue Growth Rate:

((Current Period Revenue – Previous Period Revenue) / Previous Period Revenue) x 100

Return on Equity (ROE):

(Net Income / Shareholders' Equity) x 100

Return on Assets (ROA):

(Net Income / Total Assets) x 100

4️⃣ Interpreting an Income Statement

Positive Net Income: The company is profitable, and the amount represents its earnings for the period.

Negative Net Income: The company incurred losses for the period.

Trends: Analyze trends over multiple periods to assess the company's financial health.

Comparisons: Compare the income statement with those of competitors or industry standards for benchmarking.

5️⃣ Importance of the Income Statement

• Investor Insight

• Management Tool

• Creditworthiness

• Strategic Planning

• Legal Compliance

• Transparency and Trust

• Benchmarking

Income Statements don't have a universal look or layout.

That's because management teams have complete control over the terms & layout of their financial statements.

Here are the other words that management teams can use when creating their Income Statement:

INCOME STATEMENT SYNONYMS:

→Revenue Statement

→Earnings Statement

→Operating Statement

→Statement of Earnings

→Statement of Operations

→Profit and Loss Statement (P&L)

REVENUE SYNONYMS:

→Sales

→Income

→Top Line

→Receipts

→Turnover

→Gross Sales

→Gross Income

COST OF GOODS SOLD SYNONYMS:

→Goods Cost

→Direct Costs

→Cost of Sales

→Cost of Revenue

→Cost of Products Sold

GROSS PROFIT SYNONYMS:

→Sales Profit

→Gross Margin

→Gross Income

→Gross Earnings

OPERATING EXPENSES SYNONYMS:

→Overhead

→Operating Costs

→Operating Outgo

→Sales & Marketing

→Business Expenses

→Operational Expenses

→General & Administrative

→Research & Development

→Selling, General, and Administrative Expenses (SG&A)

OPERATING INCOME SYNONYMS:

→Operating Profit

→Business Income

→Operating Margin

→Operating Earnings

→Operating Cash Flow

→Earnings Before Interest and Taxes (EBIT)

PRE-TAX PROFIT SYNONYMS:

→ Pretax Profit

→ Pretax Earnings

→Income Before Tax

→Profit Before Tax (PBT)

→Earnings Before Tax (EBT)

→Operating Profit Before Tax

→Earnings Before Income Taxes (EBIT)

INCOME TAX SYNONYMS:

→Direct Tax

→Revenue Tax

→Earnings Tax

→Tax on Income

→Corporate Income Tax

→Fiscal Charge on Income

EARNINGS SYNONYMS:

→Profits

→Income

→Earnings

→Net Profit

→Bottom Line

→Net Earnings

→Profit After Tax (PAT)

→Net Income After Taxes

→Earnings After Tax (EAT)

→Net Income Before Extraordinary Items

SHARES OUTSTANDING SYNONYMS:

→Issued Shares

→Outstanding Stock

→Outstanding Equity

→Basic Shares Outsanding

→Diluted Shares Outstanding

→Outstanding Shares of Stock

→Fully Diluted Shares Outstanding

EARNINGS PER SHARE SYNONYMS:

→EPS

→Profit Per Share

→Net Income Per Share

3 Easy Steps to Analyze Business Profitability.

Most business problems fall into one of 3 main areas:

Profitability: How effectively your business generates profit in relation to its expenses.

Cash Flow: The management of the inflow and outflow of cash, ensuring that your business can meet its financial obligations.

Growth: The ability of your business to expand sustainably and profitably.

Financial analysis is a key tool in identifying and addressing these three critical business issues.

Here's how to solve profitability issues:

1️⃣ Gross Profit Margin: (Gross Profit / Revenue) x 100

>> This tells you how efficiently you use raw materials and labor.

>> Drops could be due to increased costs or ineffective pricing.

>> If this margin is dropping, look to renegotiate contracts, trim waste in production, or tweak prices

2️⃣ Operating Profit Margin: (Operating Income / Revenue) x 100

>> This shows how much of each dollar of revenues is left after considering COGS and OPEX (operating expenses).

>> If this margin is dropping, your indirect costs may need to be reviewed because you lack operating flexibility.

3️⃣ Net Profit Margin: (Net Income / Revenue) x 100.

>> Net Profit is what's left of revenues after all expenses and taxes are paid.

>> If this margin is dropping but your other margins are fine, consider tax and debt cost optimization.

>> If this margin drops alongside your other margins, your business model and capital structure may need an overhaul.

EBITDA Explained

What is EBITDA, and what is your take on this metric?

EBITDA stands for:

• Earnings

• Before:

• Interest

• Taxes

• Depreciation

• Amortization

It's a financial metric that shows how much money a company makes before accounting for non-operational expenses like interest and taxes and non-cash expenses like Depreciation and Amortization.

Why is EBITDA important for Businesses?

EBITDA is important because it gives businesses an idea of how much money they generate from their operations.

This is useful for investors and lenders who want to know how profitable a company is.

It's like a scorecard to know how much money a company is making.

How is EBITDA calculated?

To calculate EBITDA, start with a company's revenue and subtract its cost of goods sold.

Then, you subtract its operating expenses (like salaries and rent).

Another way to calculate it:

Net Income

+ Interest Expense

+ Taxes

+ Depreciation

+ Amortization

EBITDA vs. Net Income

EBITDA:

In EBITDA, you don't consider these expenses: Depreciation, Taxes, and Interest.

Net Income:

However, net income is what remains as actual profit after Depreciation, interest, and taxes are taken into account.

The P&L Statement, Visualized

If you're in business, you MUST understand how a Profit & Loss Statement works.

P&L has many different names, including:

• Income Statement

• Revenue Statement

• Earnings Statement

• Operating Statement

• Statement of Earnings

• Statement of Operations

The P&L shows a company's profitability at multiple levels over a period of time using accrual accounting.

Its purpose is to track a company's revenue, expenses, and profits.

Main sections:

? REVENUE: Total Sales

➖ COST OF GOODS SOLD: The cost to deliver the product or service

? GROSS PROFIT: Revenue - Cost of Goods Sold

➖ R&D EXPENSES: All expenses related to developing products & services

➖ SG&A EXPENSES: All other overhead expenses

? OPERATING INCOME: Gross Profit - Operating Expenses

➖ INTEREST EXPENSE: Interest paid to bondholders & banks

? PRE-TAX INCOME: Operating Income - Interest Expense

➖ INCOME TAX: Taxes paid to Governments

? NET INCOME: Pre-Tax Income - Income Tax

To analyze a P&L quickly, focus on changes in margins.

GROSS MARGIN

Gross margin is a profitability metric that indicates the percentage of revenue after subtracting the cost of goods sold (COGS).

Calculation

Gross Margin = Gross Profit / Revenue

Gross Profit = Revenue - COGS

OPERATING MARGIN

Operating margin, or operating profit margin, measures the percentage of operating income (profit after operating expenses) relative to total revenue.

Calculation

Operating Margin = Operating Income / Revenue

NET MARGIN

Net margin, also referred to as net profit margin or simply profit margin, represents the percentage of net income (profit after all expenses, including interest and taxes) relative to total revenue.

Calculation

Net Margin = Net Income / Revenue

The Income Statement

The basic structure and components of the Income Statement are reviewed in this lecture.  The Income Statement is sometimes called the Profit and Loss Statement or P&L for short. 

The components of the Income Statement are:

• Revenue

• Expenses

• Net Income

• Profit

• Earnings

  
  

The Income Statement    

The daily operations of a business are measured in the money that comes in as revenues, the money that goes out as expenses, the money that is retained as profit, the money that is invested in operational assets, and the money that is owed.  It’s all about the money. Financial statements follow the money.    

The report that measures these daily operations, of money in and money out over a period of time, is the Income Statement.    

Revenues minus Expenses equals Net Income   

The Income Statement can be summarized as: Revenues less Expenses equals Net Income.  The term Net Income simply means Income (Revenues) net (less) of Expenses.  Net Income is also called Profit or Earnings.  The terms "profits," "earnings" and "net income" all mean the same thing and are used interchangeably. They are synonyms for the bottom line number on the Income Statement. Revenues are often called Sales and are represented on the top line.    

You understand the dynamics of this concept intuitively.  We always strive to sell things for more than they cost us to make or buy. When you buy a house you hope that it will appreciate in value so you can sell it in the future for more than you paid for it. It’s also the rule for stocks: buy low, sell high. In order to have a sustainable business model in the long run, the same logic applies.  You can’t sell things for less than they cost to make and stay in business for long. If you own run a sandwich shop you had better make sure that you are selling the sandwiches for more than they cost you to make.    

Think of the Income Statement in relation to your monthly personal finances.  You have your monthly revenues: in most cases the salary from your job.  You apply that monthly income to your monthly expenses: rent or mortgage, car loan, food, gas, utilities, clothes, phone, entertainment, etc.    Our goal is to have our expenses be less than our income.     

There is an old adage: “If you outflow is more than your income, your upkeep is your downfall.”   

Over time, and with experience, we become better managers of our personal finances and begin to realize that we shouldn’t spend more that we make.  We strive to have some money left over at the end of the month that we can set aside and save.  In business, what is set aside and saved is called Retained Earnings.      

Some of what we set aside we may invest with an eye toward future benefits.  We may invest in stocks and bonds or mutual funds, or we may invest in education to expand our future earning and career prospects.  This is the same type of money management discipline that is applied in business.  It’s just a matter of scale. In business we buy assets that help the enterprise expand or perform more efficiently. There are a few additional zeros after the numbers on a large company’s Income Statement but the idea is the same.    

This concept applies to all businesses.   Revenues are usually from Sales of products or services.  Expenses are what you spend to support those sales in terms of the operations: Salaries, raw materials, manufacturing processes and equipment, offices and factories, consultants, lawyers, advertising, shipping, utilities etc.   What is left over is the Net Income or Profit.   Again: Revenues – Expenses = Net Income.    

Net income is either saved in order to smooth out future operations and deal with unforeseen events (save for a rainy day); or invested in new facilities, equipment, and technology. Or part of the profits can be paid out to the company owners, called shareholders or stockholders, as a dividend.     

The Income Statement is also known as the "profit and loss statement". Business people sometimes use the shorthand term "P&L," which stands for profit and loss statement.  A manager is said to have “P&L responsibilities” if they run an autonomous division where they make the decisions about marketing, sales, staffing, products, expenses, and strategy. P & L responsibility is one of the most important responsibilities of any executive position and involves monitoring the net income after expenses for a department or entire organization, with direct influence on how company resources are allocated and responsibility for performance.     

Google the term “income statement” and you will see lots of examples of formats and presentations. You will see there is variety depending on the industry and nature of the business but they all follow these basic principles.    

Remember:  Income (revenue or sales) – Expenses = Net Income or profit   

How do we analyze companies?

Start with the income statement.

It can show us the revenues, expenses, and profits over a specific period.

The income statement can give us insights into whether the company is growing or shrinking.

Here is the breakdown of an income statement in its most common form:

???????: This includes all income from sales, services, or other primary business activities.

???? ?? ????? ???? (????): Direct costs attributable to the production of goods sold by a company.

????? ??????: Calculated as Revenue minus Cost of Goods Sold. It represents a company's profit after deducting the costs associated with making and selling its products.

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???????, ???????, ??? ?????????????? ???????? (??&?): Expenses related to selling products and managing the business.

???????? ??? ??????????? (?&?): Costs of developing new products or services.

????????? ?????? is Earnings Before Interest and Taxes (EBIT), which is calculated by subtracting operating expenses from gross profit.

???????? ???????: The cost incurred by an entity for borrowed funds.

????? ??????/????????: Non-operational revenue or costs, such as gains or losses from investments or foreign exchange.

???-??? ??????: Income before income taxes are deducted.

Income Tax Expense: The amount of tax owed based on pre-tax income.

??? ??????: The final bottom line of the income statement, calculated as Pre-tax Income minus Income Taxes. This figure represents the total earnings attributable to shareholders after deducting all expenses.

Also crucial to analyzing an income statement is margins:

• Gross margin = Gross profit/revenues

• Operating margin = Operating profit/revenues

• Net Income margin = Net Income profit/revenues

Ideally, we want stable or growing margins.

The bottom line is that we want a growing, profitable company that can lead to further digging.

4 Types of Income Statement Analysis

1. Vertical Analysis:

Vertical analysis dissects the income statement vertically, showcasing each line item as a percentage of total revenue.

This method offers a snapshot of the proportion of expenses, making it easier to identify trends and assess cost structures.

2. Horizontal Analysis:

By comparing income statements across multiple periods, horizontal analysis unveils the evolution of financial performance over time.

Understanding year-over-year changes aids in identifying growth patterns, potential areas of concern, and overall business stability.

3. Ratio Analysis:

Ratios derived from income statement figures provide a deeper understanding of a company's financial health.

Key ratios like the profit margin, return on assets, and earnings per share offer valuable insights into profitability, efficiency, and overall operational effectiveness.

4. Common Size Analysis:

This analysis involves expressing each line item as a percentage of total revenue.

It provides a standardized view of the income statement, facilitating comparisons across different companies or industries.

Common size analysis helps investors and analysts evaluate the relative importance of each expense category.

Embracing these diverse analytical approaches empowers financial professionals to make informed decisions, assess risk, and strategize for sustained business success.

In this lecture I review the Balance Sheet and Income Statement and how they are connected and the flow of money through them.  This is a summary and preparation for discussing the Cash Flow Statement. 

I've spent 35 years studying Finance, with 15 as a CFO, and

I'll teach you everything you need to know about the Statement of Cash Flows (SCF) in the next 7 minutes:

• What does the SCF tell you?

• What are the different types of cash flows?

• What are operating activities?

• What are investing activities?

• What are financing activities?

• How do you analyze the SCF?

How to Analyze a Cash Flow Statement

Earnings are an opinion; cash flow is a fact.

The Cash Flow Statement is by far the most important Financial Statement.

I'll teach you everything here.

1️⃣What is a Cash Flow Statement?

- A cash flow statement shows you how much cash goes in and out of a company over a certain period

- The purpose of this statement is to track how much cash is moving through a business

- You want to invest in companies that generate cash and manage their cash position well

2️⃣Structure of a Cash Flow Statement

Every cash flow statement consists of 3 parts:

• Cash Flow from Operating Activities

• Cash Flow from Investing Activities

• Cash Flow from Financing Activities

3️⃣Cash Flow from Operations

- This section shows all cash the company generated from its normal business activities

- It shows you all the cash a company earned from selling its normal products and services

- The cash flow from operating activities is comparable to net income, but it filters out a few income and expense posts that didn't cause actual cash to enter or exit the company

- Cash Flow from operating activities = net income + non-cash charges +/- changes in working capital

4️⃣Cash Flow from Investing Activities

The Cash Flow from Investing Activities gives you an overview of the company's investment-related income and expenditures.

- The Cash Flow from Investing Activities consists of 3 major parts:

o Capital expenditures (CAPEX)

o Mergers & Acquisitions

o Marketable securities

- Cash flow from investing activities = Sale of marketable securities + divestments - CAPEX - Mergers & Acquisitions - purchase of marketable securities

5️⃣Cash Flow from Financing Activities

- Measures the cash movements between a company and its owners (shareholders) and its debtors (bondholders)

- This section gives you an insight into how the company is financing its business activities

- Cash Flow from Financing Activities = Debt issuance + issuance of new stocks - dividends - debt repayments - share buybacks

6️⃣Changes in cash balance

- Finally, you can calculate the total changes in the cash balance

- Cash at the end of the year = Cash at the beginning of the year + CF from operating activities + CF from investing activities + CF from financing activities

Cash Flow is King

What is free cash flow yield, and why is it important?

In running a business, nothing beats real cash on hand.

In the investment world, cash flow, especially free cash flow, is essential to understand a company's stability and capital strength.

The Power of Free Cash Flow

Free cash flow is the money left after a company pays its expenses, taxes, interests, and capital expenditures. In addition, dividends, debt payments, stock buyback, and growth investments come from free cash flow.

When a company earns a positive free cash flow, it generates more cash than it needs to operate its business and can invest in growth.

Free cash flow (FCF) = Operating cash flow minus capital expenditure.

A company's cash flow statement is where operating cash flow and capital expenditure items are found.

Free cash flow is not net income because net income does not measure a company's actual cash position. For example, if a company increases revenue in the form of accounts receivable to be collected next year, the company has not received the cash yet. So, an increase in accounts receivables will reduce cash flow even though the revenue is reported in the net income number.

Therefore, free cash flow (FCF) is a better number than net income to measure a company's performance and how much cash is available to distribute to shareholders and invest for future growth.

Companies can manipulate their Net Income number but cannot mess around with free cash flow.

What is Free Cash Flow Yield?

Free Cash Flow Yield is calculated by comparing a company's free cash flow per share to its stock price per share.

Free cash flow yield (FCFY) = Free Cash Flow per Share/Price per Share

The higher the free cash flow yield, the more valuable the company is because of its stronger ability to pay off debt, distribute cash to shareholders, and invest for its benefit and growth.

Warren Buffett likes to look at cash flow rather than earnings multiples to determine if an investment is a value or not.

“I wouldn't look for a single metric like relative P/Es to determine what — how — to invest money. You really want to look for things you understand, and where you think you can see out for a good many years, in a general way, as to the cash that can be generated from the business. And then, if you can buy it at a cheap enough price compared to that cash, it doesn't make any difference what the name attached to the cash is. “

Warren Buffett

What to Look For When Screening Investments

You have probably heard of "value" and "growth" stocks and wondered how to tell them apart and the benefits of one versus the other. Unfortunately, the two terms are arbitrary to a degree.

We want a screening tool that is less vague and subjective and more quantitative and objective.

Rather than looking for a value or growth stock, a better way to screen investments is to look at the free cash flow yield to understand the company's business strength compared to its market value.

In a risk-off environment, investors care for quality and cash flow.

A persistent negative free cash flow may signify a company is becoming illiquid and cannot sustain its operations.

A negative free cash flow yield is not always bad. If the company is investing for the future and is expecting a higher investment return than the cash paid, like in a high-growth company, the temporary negative free cash flow yield needs to be investigated against the company's business needs and potential.

When measuring investment options, cash is King.

Cash Flow Statements do not have a universal look or layout.

That's because management teams control the terms and categories of their financial statements.

Here are the other words that management teams can use when creating their Cash Flow Statement:

CASH FLOW STATEMENT SYNONYMS:

→Cash Statement

→Statement of Cash Flow

→Financial Flow Statement

→Statement of Financial Flows

→Statement of Cash Operations

NET INCOME SYNONYMS:

→Profits

→Income

→Earnings

→Profit After Tax

→Earnings After Tax

NON-CASH CHARGES

→Depreciation

→Amortization

→Write-downs

→Deferred Taxes

→Impairment Charges

→Stock-based Compensation

→Unrealized Gains and Losses

CHANGES IN WORKING CAPITAL

→Credits

→Accruals

→Payables

→Provisions

→Inventories

→Receivables

→Prepayments

OPERATING CASH FLOW

→Cash Profit

→Cash Income

→Operating Cash

→Cash from Operations

→Cash Generated from Operations

→Net Cash from Operating Activities

CAPITAL EXPENDITURES:

→Capex

→PPE Spend

→Plant Outlay

→Property Spend

→Facilities Spend

→Equipment Spend

→Infrastructure Spend

→Property, Plant, and Equipment

ACQUISITIONS:

→Merger

→Takeover

→Asset Buy

→Consolidation

→Company Purchase

→Corporate Acquisition

PROCEEDS FROM SALE OF INVESTMENTS

→Sale Gain

→Disposal

→Asset Sale

→Divestiture

→Liquidation

→Sale Proceeds

→Disposal of Investments

→Proceeds from Sales of Assets

→Proceeds from Disposition of Investments

NET CASH FROM INVESTING ACTIVITIES

→Investing Cash

→Investment Flow

→Investment Outlay

→Cash from Investing

→Investing Cash Flows

→Cash Used in Investing

→Cash Flow from Investments

→Net Cash Used in Investing Activities

BORROW / REPAY DEBT:

→Debt Raised

→Loan Issuance

→Bond Issuance

→Debt Refinance

→Issuance of Bonds

→Borrowing Activities

→Repayment of Loans

→Debt Financing Activities

→Payments on Borrowings

→Debt Issuance/Repayment

→Proceeds from Issuance of Debt

ISSUE / REPURCHASE STOCK:

→Stock Sale

→Equity Issue

→Issuing Shares

→Equity Buyback

→Share Buyback

→Stock Issuance

→Equity Offering

→Stock Redemption

→Equity Repurchase

→Repayment of Share Capital

→Issuance of Equity Interests

→Repurchase of Equity Interests

PAY DIVIDENDS:

→Payouts

→Dividend Outlay

→Profit Distribution

→Dividend Allocation

→Distribute Earnings

→Dividend Remittance

→Dividend Distribution

→Dividend Disbursement

→Shareholder Dividends

→Cash Dividend Payment

NET CASH FROM FINANCING ACTIVITIES:

→Finance Cash

→Funding Cash

→Financing Flow

→Fund Injections

→Funding Activities

→Cash from Financing

→Cash from Financial Activities

→Net Cash Provided by Financing Activities

Cash is King!

And the CFO is the king-maker.

Here are 19 ways you can improve your cash flow:

1. VOLUME - More volume from existing customers

2. VOLUME - Bring in new customers

3. VOLUME - Get referrals from existing customers

4. VOLUME - Run marketing campaigns for new leads

5. VOLUME - Launch new products and categories

6. PRICE - Launch higher-priced new items

7. PRICE - Raise prices on existing items

8. COGS - Get better deals with your suppliers

9. COGS - Automate processes and production

10. COGS - Manager better and learn from returns

11. SG&A - Cut the marketing budget

12. SG&A - Optimize the payroll

13. SG&A - Cut other spending like travel and consultants

14. SG&A - Find new ways to run your logistics

15. PP&E - Increase return on assets

16. PP&E - Develop proprietary technology

17. INVENTORY - Increase inventory turns

18. INVENTORY - Better inventory management

19. INVENTORY - Increase your buying efficiency

This is a partial list.

There are so many ways you can optimize cash flow.

You must identify through an analysis where the most considerable potential is.

Then, bring the right people around the table to discuss actions to take.

Decide what to do and follow up if you get the desired results.

If yes, push for more.

If not, find out why and execute better or do something different.

That's the WHAT and HOW of increasing cash flow.

Invested Capital vs Working Capital

Invested capital includes the assets Microsoft uses to grow.

Working capital is the lifeblood Microsoft uses to function daily.

Invested Capital

1. ??????????: Total capital invested in a company's operations.

2. ??? ??????????: Includes equity, debt, and retained earnings.

3. ???????: Used to fund a company's growth and operations.

4. ???????????: Sum of debt and equity minus non-operating assets.

5. ?????: Measures the company's use of funds for generating returns.

Working Capital

1. ??????????: Difference between current assets and current liabilities.

2. ??? ??????????: Includes cash, receivables, and inventories minus payables.

3. ???????: Manages day-to-day operational expenses.

4. ???????????: Current assets minus current liabilities.

5. ?????: Indicates short-term financial health and liquidity.

??? ???????????

1. Invested capital represents total funds used for growth; working capital focuses on daily operational liquidity.

2. Invested capital includes long-term debt and equity; working capital covers short-term assets minus liabilities.

3. Invested capital is for overall company investment; working capital ensures smooth day-to-day operations.

Understanding invested and working capital is crucial for evaluating a company's long-term investments and short-term financial health.

The Cash Conversion Cycle - Visualized

What is it? Why is it important?

The Cash Conversion Cycle (CCC) is not just a theoretical concept but a practical tool that measures how efficiently a company manages its working capital. Understanding CCC can help you identify areas for improvement in your business operations.

It is the time period between when a company purchases inventory from its suppliers and when it collects the cash from customers.

A shorter CCC is a sign of efficient business operations. This means the company can quickly convert its investments into cash, available for other business needs. This improves the company's liquidity and allows it to respond more effectively to market changes and opportunities.

The CCC is measured in days.

The formula for CCC is straightforward: it's the sum of the Days Inventory Outstanding (DIO), the Days Sales Outstanding (DSO), minus the Days Payable Outstanding (DPO).

DIO = Days Inventory Outstanding = (Average Inventory/COGS) × 365

DSO = Days Sales Outstanding = (Average AR/ Credit Sales) x 365

DPO = Days Payable Outstanding = (Average AP/ COGS) x 365

AR = Accounts Receivable

AP = Accounts Payable

COGS = Cost of Goods Sold

A bad CCC is 90+ days.

An average CCC is between 30 and 90 days.

A good CCC is <30 days.

A GREAT CCC is <0, which means the company collects cash from customers before it pays its suppliers.

Cash Flow Ratios

The Cash Flow Statement shows a company's profitability at multiple levels over a period of time using cash accounting.

3 Main sections:

OPERATING ACTIVITIES

Shows cash inflows & outflows from normal operations

INVESTING ACTIVITIES

Shows cash outflows from capital expansion & long-term investments

FINANCING ACTIVITIES

Shows cash changes to the company's capital structure

6 Cash Flow Ratios to watch

LIQUIDITY RATIOS

Cash Ratio = Cash Balance ➗ Current Liabilities

Current Ratio = Current Assets ➗ Current Liabilities

COVERAGE RATIOS

Cash Coverage Ratio = Cash Balance ➗ Interest Expense

Debt To OCF = Total Debt➗ Operating Cash Flow

VALUATION RATIOS

Price to CFFO = Share Price ➗ Cash Flow From Operations Per Share

Price to FCF = Share Price ➗ Free Cash Flow Per Share

In this lecture I tie together the financial statement interconnection and flow and then review the Balance Sheet and Income Statement.

How Financial Statements Interconnect and Link

Understanding how the three financial statements connect is critical to gaining financial fluency.

INCOME STATEMENT

Shows a company's revenue, expenses, and net income over a period of time (month, quarter, year) using accrual accounting.

BALANCE SHEET

Shows a snapshot of a company's assets, liabilities, and equity at a point in time using accrual accounting.

CASH FLOW STATEMENT

Shows a company's cash movements over a period of time (month, quarter, year) using cash accounting.

Many connections between financial statements bridge the gap between cash accounting & accrual accounting.

Note: This visual doesn't show all the connections, just the major ones.

Understanding the Interconnectivity of Financial Statements

Financial statements are interwoven documents that tell the entire fiscal story of a business. The interplay among the Balance Sheet, Income Statement, and Cash Flow Statement is essential for a comprehensive understanding of a company's financial standing.

The Balance Sheet, a snapshot of the company's financial status at a specific point in time, reflects information derived from the Income Statement.

In turn, the Income Statement, which details the company's revenues and expenses over a period, draws upon data concerning the company's assets, liabilities, and equity as depicted in the Balance Sheet.

Meanwhile, the Cash Flow Statement serves as the connecting thread, demonstrating how the business's operations generate and use cash, thus linking the operational results with the company's financial position.

To construct a dynamic financial model, one begins by channeling Net Income from the Income Statement to the Balance Sheet, contributing to Retained Earnings, and then to the Cash Flow Statement as a part of Operating Cash Flow.

The adjustments made in Current Assets and Current Liabilities on the Balance Sheet are totaled to reflect the Changes in Operating Assets and Liabilities within the Cash Flow Statement.

Adding back the Depreciation Expense, a non-cash charge, into the Cash Flow Statement under Operating Cash Flow is a crucial step. This amount is then reconciled in the Investing Cash Flow section by adjusting the beginning Fixed Assets balance and any acquisitions or disposals to arrive at the net cash used or provided by investing activities.

The reconciliation of Long-Term Debt involves subtracting the opening balance from the ending balance, which determines the cash flows related to financing activities. Similarly, Equity adjustments are made by adding the period's Net Income to the opening balance and subtracting the ending balance to finalize the Financing Cash Flows.

The sum of the previous period's ending cash balance and the current period's flows from operations, investing, and financing activities cumulatively determine the new closing cash balance on the Balance Sheet.

It's crucial to remember that crafting a Cash Flow Statement requires just two Balance Sheets—one from the start and one from the end of the period—and an Income Statement that covers the interim. This setup is instrumental in tracking the cash's journey through the business, providing key insights into the company's vitality and risk exposure.

However, avoiding jumping to conclusions based on cash flow figures is essential. Positive cash flows may not always signal financial health, just as negative cash flows don't inherently spell trouble. The context in which these cash flows occur is vital for accurate interpretation and analysis.

Revenue and Income are NOT the same things!

Costs and Expenses are NOT the same things!

Net Income and Free Cash Flow are NOT the same things.

Confused? Let me break it down for you:

Sales and revenue mean the same things.

Both are the money that comes in from customer payments.

They both refer to the "top line" of the income statement.

Orders and sales are NOT the same things.

Orders are when a customer places a request for the future delivery of a product or service.

Orders become sales when the product is actually shipped or the service is performed.

Costs are different from expenses.

Costs are money spent on making a product or delivering a service (hence "cost of goods sold")

Expenses are money spent on developing, selling, accounting for, and managing the product or service.

Costs and expenses both become expenditures when money is actually sent to the vendors to pay the bills.

Profits, earnings, and net income all mean the same thing.

They are the "bottom line" of the income statement.

They all represent what is left over after all of the costs & expenses are subtracted from the revenue.

Net income and free cash flow are NOT the same things!

Net income measures profitability on the income statement using accrual accounting.

Free cash flow measures cash flow available to shareholders on the cash flow statement using cash accounting.

Accrual accounting and cash accounting are not the same things.

Accrual accounting: revenue or expenses are recorded when they occur, not when payment is received or made

Cash accounting: transactions are recorded only when money goes in or out of an account.

Audited Financial Statements

• Transparency

• Interpretation

• Conflict of Interest

• Accounting Firms and Consulting business

• SOX Sarbannes Oxley

• Regulation, how much is just enough

• Materiality

WHO DOES WHAT TOWARD FINANCIAL STATEMENTS

✅ CFO

? Pivotal role in the FS creation  and interpretation

? Ensures that FS complies with standards

? Uses FS as a tool for strategic planning

? Presenting key results to the stakeholders

? FS and budget approvals

✅ Accountant

? Involved in the nitty-gritty details

? Ensures that FS are aligned with GAAP

? Provides data on cost structures

✅ Controller

? Supervision of the overall accounting process

? Internal controls setup to ensure the quality of FS

? Ensures that financial reports are accurate

✅ Tax Specialist

? Analyses whether costs are deductible

? Calculates deferred tax assets and liabilities

? Reconciliation of tax account to ensure FS quality

? Tax provision calculation

? Involved in FS projection as a part of tax planning

✅ Auditor

? Testing internal controls that ensure FS quality

? Assess general and specific audit risks

? Make testing of presented figures

? Issue the opinion of conducted audit toward FS

✅ Acquirer

? Due Diligence of FS

? Quality of earning based on FS

? Net debt and Net working capital analysis

? EBITDA adjustments

✅ FP&A specialist

? Reads and interprets FS to gauge the financial health

? FS long-term projections

? Cash flow planning

? KPI and management reporting

? Budget variance analysis

? Ratio and Scenario analysis

✅ Investment Analyst

? Compare FS with other companies in the industry

? Identifies financial trends

? CAPEX analysis

? ROCE analysis

? ROIC analysis

? Gross and net margin analysis

? Use projected FS to make a valuation

? Various risk assessments

✅ Banker

? Uses FS to assess the creditworthiness

? Solvency, liquidity, and profitability analysis

? Recommends suitable loan amounts and structure

Financial statements aren't just for accountants or finance teams.

They are a guidebook for various stakeholders, from investors to competitors.

Each user has a unique perspective and focuses on different aspects of these statements.

Grasping the diverse uses of financial statements can provide a significant competitive edge, empowering you as a business or finance professional in strategic decision-making and relationship-building.

Most Confusing Finance Terms Explained

FIXED COSTS VS. VARIABLE COSTS

• Fixed Costs: Costs that do not change with production or sales volume (e.g., rent).

• Variable Costs: Costs that vary with production or sales volume (e.g., materials, direct labor).

EBITDA VS. NET INCOME

• EBITDA: Earnings before interest, taxes, depreciation, and amortization.

• Net Income: Total profit after all expenses, including interest, taxes, depreciation, and amortization.

PROFIT VS. REVENUE

• Profit: Net earnings after deducting all expenses.

• Revenue: Total Income generated from sales or services before deducting expenses.

CAPEX VS. OPEX

• CapEx: Funds used by a company to acquire, upgrade, and maintain physical assets (PPE, buildings, or intangibles)

• OpEx: Day-to-day business expenses (e.g., rent, utilities).

ACCRUAL VS. CASH ACCOUNTING

• Accrual Accounting: Recording revenues and expenses when they are incurred, regardless of when cash is exchanged.

• Cash Accounting: Recording revenues and expenses only when cash is exchanged.

MARKET CAP VS. ENTERPRISE VALUE

• Market Cap: Total value of a company's outstanding shares.

• Enterprise Value: Total value of a company, including debt and excluding cash

Financial Ratio Analysis

A complete guide

Here's what you will learn:

- Introduction to Financial Analysis

- Different types of Financial Ratios

- Using Financial Ratios for Analysis

- Limitations of Financial Ratios

- Advanced Financial Analysis

- Pitfalls of Financial Ratios

And much more!

Margin shows how much of a product's sales price or revenue you got to keep.

Markup shows how much over cost you've sold your product(s) for.

Let's dig deeper into each of these.

Margin (or Gross Profit Margin in this case) is the proportion of a product’s Sales Price that exceeds the Product Cost.

Margin = (Product Sales Price - Product Cost)/ Product Sales Price

Margin = Gross Profit per Product / Product Sales Price x 100

Note that the Margin is calculated as a percentage.

Meanwhile, Gross Profit is calculated as an amount.

Markup is the proportion by which you increase the Product Cost to arrive at the Sales Price.

Markup = (Product Sales Price - Product Cost)/ Product Cost

Markup = Gross Profit per Product / Product Cost x 100

Markup can be calculated based on a product's variable cost or based on its total (absorption) cost.

Marking up the variable cost could result in under-costing and underpricing the product, which may increase revenues at the expense of reduced profitability and cash flows.

Use Cost-Volume-Profit analysis to determine the number of units you need to sell to break even.

Marking up the absorption cost could result in over-costing and overpricing, which in turn could reduce revenues also at the expense of reduced profitability and cash flows.

Be careful with the fixed manufacturing depreciation expense which gets included in the full/absorption cost of a product.

To calculate your margin if you know your markup: Margin = Markup /(1+Markup)

To calculate your markup if you know your margin: Markup = Margin / (1-Margin)

How to use Margin and Markup:

Both Margin and Markup calculate the difference between price and cost.

Margin relates that difference to Price or Revenue.

Markup relates that difference to Cost.

If you know the Product Cost, use Markup to determine an appropriate selling Price.

If you know the Product Gross Profit, use it to determine the Gross Profit Margin and track profitability over time.

Learn the basics of Working Capital (WC) and Invested Capital (IC).

?? - ??????????? ??????????? / ????? ????

WC is the difference between a company's current assets (short-term resources) and current liabilities (short-term obligations).

Working Capital is like a financial safety net, measuring a company's liquidity and its ability to handle day-to-day operations. It's your company's financial superhero, providing a buffer against unexpected cash flow disruptions.

Working Capital management involves optimizing current assets and liabilities to improve liquidity.

?? - ????????? ??????????? / ???? ????

IC is the total amount of money invested in a company or project.

IC can include equity from shareholders, debt from lenders, and retained earnings. It represents the total Capital employed to generate returns.

It provides a buffer against unexpected cash flow disruptions. It is used in metrics like return on invested Capital (ROIC) to evaluate profitability and efficiency.

I have explained how the cost of equity is calculated in simple language.

Read till the end. You will get the following insights.

1. what is the cost of equity?

2. How do your expectations influence the cost of equity?

Cost KPIs

Key Performance Indicators

???? ?? ????? ???? (????)

COGS = Direct Materials + Direct Labor + Manufacturing Overhead

COGS = Opening Inventory + Purchases - Ending Inventory

Your direct costs associated with producing a product or delivering a service expressed in absolute terms or as a percentage of revenue.

????????? ??????? ?????: Operating Expenses / Net Sales x 100

Evaluates how much of the total sales is consumed by operating expenses.

???????? ???? ?????: Variable Costs / Sales x 100

Assesses the proportion of sales that is consumed by variable costs.

????? ???? ?????: Fixed Costs / Sales x 100

Evaluates the proportion of sales that is consumed by fixed costs.

?????? ????? ???? %: Direct Labor Costs / Sales x 100

Measures the percentage of sales that goes towards compensating the labor directly involved in producing a product.

????? & ????????? ?????: Sales & Marketing Expenses / Sales x 100

Indicates the percentage of sales spent on sales and marketing activities.

???????? & ??????????? (?&?) ?????: R&D Expenses / Sales x 100

Measures the percentage of sales invested in research and development activities.

??????? & ?????????????? (?&?) ?????: G&A Expenses / Sales x 100

Evaluates the percentage of sales consumed by general and administrative expenses.

????????? ????????: Cost of Goods Sold / Average Inventory

Indicates how many times a company's inventory is sold and replaced over a period.

???? ?? ?????????: 365 / Inventory Turnover

Measures the average number of days items stay in inventory before being sold.

How to analyze a business, FAST:

Study these 12 accounting ratios.

PROFITABILITY RATIOS

→ Gross Profit Margin = Gross Profit ➗ Sales

→ Operating Margin = Operating Profit ➗ Sales

→ EBITDA Margin = EBITDA ➗ Sales

→ Net Profit Margin = Net Income ➗ Sales

RETURN ON CAPITAL RATIOS

→ Return on Equity = Net Income ➗ Total Equity

→ Return on Assets = Net Income ➗ Total Assets

→ Return on Capital Employed = EBIT ➗ (Total Assets - Current Liabilities)

→ Return on Invested Capital = NOPAT ➗ Invested Capital

LIQUIDITY RATIOS

→ Current Ratio = Current Assets ➗ Current Liabilities

→ Cash Ratio = Cash & Cash Equivalents ➗ Current Liabilities

FINANCIAL LEVERAGE RATIOS

→ Debt Ratio = Total Debt ➗ Total Assets

→ Debt To Equity Ratio = Total Liabilities ➗ Total Equity

DIVIDEND POLICY RATIOS

→ Payout Ratio = Dividend Per Share ➗ Earnings Per Share

→ Dividend Yield = Dividend Per Share ➗ Share Price

Notes:

EBT = Earnings Before Tax

EBIT = Earnings Before Interest & Taxes

EBITDA = Earnings Before Interest, Taxes, Depreciation & Amortization

NOPAT = Net Operating Profit After Tax

What ratios do you look at the most?

The Most Important Financial Ratios

Including:

1️⃣ Liquidity Ratios

2️⃣ Profitability Ratios

3️⃣ Efficiency Ratios

4️⃣ Solvency Ratios

5️⃣ Valuation Ratios

6️⃣ Return Ratios

7️⃣ Coverage Ratios

8️⃣ Growth Ratios

9️⃣ Market Ratios

? Payout Ratios

20 Financial Feasibility Terms

When conducting a financial feasibility study, you need to keep specific terminologies in mind.

And what they mean and how do you use them in your feasibility.

Here are 20 terms to know: (Check out the downloadable PDF below)

1- CAPEX (Initial Investment)

2- OPEX

3- Revenue

4- Gross Profit

5- Net Income

6- Cash Flow

7- Payback Period

8- Internal Rate of Return (IRR)

9- Net Present Value (NPV)

10- Return on Investment

11- Profitability Index (PI)

12- Return on Equity (ROE)

13- Return on Capital Employed (ROCE)

14- Debt Service Coverage Ratio (DSCR)

15- Break-Even Point

16- Sensitivity Analysis

17- Discount Rate

18- Weighted Average Cost of Capital (WACC)

19- Working Capital

20- Terminal Value

Warren Buffett's Financial Statement Rules of Thumb:

INCOME STATEMENT:

1: Gross Margin

Equation: Gross Profit / Revenue

Rule: 40% or higher

Buffett's Logic: Signals the company isn't competing on price.

2: SG&A Margin

Equation: SG&A Expense / Gross Profit

Rule: 30% or lower. Buffett's Logic states that wide-moat companies can spend less on overhead to operate.

3: R&D Margin

Equation: R&D Expense / Gross Profit

Rule: 30% or lower

Buffett's Logic: R&D expenses don't always create value for shareholders.

4: Depreciation Margin

Equation: Depreciation / Gross Profit

Rule: 10% or lower

Buffett's Logic: Buffett doesn't like businesses that need to invest in depreciating assets to maintain their competitive advantage.

5: Interest Expense Margin

Equation: Interest Expense / Operating Income

Rule: 15% or lower

Buffett's Logic: Great businesses don't need debt to finance themselves.

6: Income Tax Expenses

Equation: Taxes Paid / Pre-Tax Income

Rule: Current Corporate Tax Rate

Buffett's Logic: Great businesses are so profitable that they are forced to pay their full tax load.

7: Net Margin (Profit Margin)

Equation: Net Income / Sales

Rule: 20% or higher

Buffett's Logic: Great companies convert 20% or more of their revenue into net income.

8: Earnings Per Share Growth

Equation: Year 2 EPS / Year 1 EPS

Rule: Positive & Growing

Buffett's Logic: Great companies increase profits every year.

⚖ BALANCE SHEET:

9: Cash & Debt

Equation: Cash > Debt

Rule: More cash than debt

Buffett's Logic: Great companies don't need debt to fund themselves.

10: Adjusted Debt to Equity

Equation: Total Liabilities / Shareholder Equity + Treasury Stock

Rule : < 0.80

Buffett's Logic: Great companies finance themselves with equity.

11: Preferred Stock

Rule: None

Buffett's Logic: Great companies don't need to fund themselves with preferred stock.

12: Retained Earnings

Equation: Year 1 / Year 2

Rule: Consistent growth

Buffett's Logic: Great companies grow retained earnings each year.

13: Treasury Stock

Rule: Exists

Buffett's Logic: Great companies repurchase their stock.

? CASH FLOW STATEMENT:

14: Capex Margin

Equation: Capex / Net Income

Rule: <25%

Buffett's Logic: Great companies don't need much equipment to generate profits.

Caveats:

There are plenty of exceptions to these rules.

CONSISTENCY IS KEY!

The Altman Z-Score is a formula developed by Edward Altman in the 1960s. It is used to predict the likelihood of a company going bankrupt within two years.

The Z-Score uses five different financial ratios to develop a single number that measures the company's financial health.

Altman Z-Score breaks down into five major components:

• ??????? ??????? ?? ????? ?????? - A measure of ?????????

• ???????? ???????? ?? ????? ?????? - A measure of ?????????????

• ???????? ?????? ???????? ??? ????? ?? ????? ?????? - A measure of ????????? ??????????

• ?????? ????? ?? ?????? ?? ????? ??????????? - A measure of ????????

• ????? ?? ????? ?????? - A measure of ????? ????????

With these components, you can understand if a company's risk of bankruptcy is due to issues with liquidity, profitability, operating efficiency, solvency, or asset utilization.

????'? ? ????????? ?? ??? ???????:

(1.2 × Working Capital/Total Assets)

+

(1.4 × Retained Earnings/Total Assets)

-

(3.3 × EBIT/Total Assets)

+

(0.6 × Market Value Equity/Total Liabilities)

-

(1.0 x Sales/Total Assets)

=

Altman Z-Score

Altman Z-Score RESULTS:

0.0 - 1.8 = Distress Zone

1.8 - 3.0 = Grey Zone

3.0 - 4.0+ = Safe Zone

Example:

Working Capital = $2,000

Total Assets = $10,000

??????? ??????? ?? ????? ?????? = ??%

Retained Earnings = $3,000

???????? ???????? ?? ????? ?????? = ??%

EBIT = $2,500

???? ?? ????? ?????? = ??%

Market Value of Equity = $12,000

Total Liabilities = $5,000

?????? ????? ?????? ?? ????? ??????????? = ?.?

Sales = $20,000

????? ?? ????? ?????? = ???%

?????? ?-????? = (1.2 × 20%) + (1.4 × 30%) + (3.3 × 25%) + (0.6 × 2.4) + (200%) = 4.925

4.925 = SAFE ZONE

Here are the 15 areas covered in ??? ????????? ???????? ?corecard:

1. Define Objectives: Set key goals for your financial analysis.

2. Data Collection: Gather relevant financial and operational data.

3. Environmental Scanning: Analyze main factors impacting strategic context.

4. Competitive Benchmarking: Compare company metrics against industry peers.

5. Quality of Earnings: Assess the reasonable and sustainable reported profits.

6. Ratio Analysis: Assess financial health using financial ratios.

7. Financial Statement Analysis: Deep dive into your company's financial reports.

8. Cash Flow Analysis: Evaluate the movement of cash within the business.

9. Budget vs. Actual Analysis: Compare projected figures to real outcomes.

10. Debt and Equity Structure: Analyze your company's capital composition.

11. Valuation Models: Assess your company's market worth.

12. Risk Assessment: Evaluate potential financial threats.

13. Sensitivity and Scenario Analysis: Identify and estimate your financial outcomes.

14. Summary of Key Findings: Round up your main insights from financial analysis.

15. Actionable Recommendations: Complete your analysis with strategic advice.

Envision a voyage into the intricate realm of financial statements, armed with a compass that hones your analytical prowess. Welcome to the 'Financial Statement Analysis Workbook' by Martin Fridson and Fernando Alvarez, a game-changing resource meticulously crafted to demystify the often perplexing domain of corporate finance.

This workbook presents a systematic, progressive method to master financial statement analysis. Through a series of thoughtfully designed exercises and tests, this guide reinforces theoretical understanding and immerses you in practical applications, rendering the intricate world of financial statements accessible and compelling.

Why is this workbook a must-read for students? Here are a few compelling reasons:

1. Practical Application: This workbook offers real-world scenarios and exercises beyond theoretical learning. This practical approach empowers you to understand the principles of financial statement analysis and confidently apply them in real-life situations.

2. Critical Thinking: The questions and exercises are designed to challenge your analytical skills, encouraging you to think critically and develop a skeptical eye toward financial reports. This is crucial in an era where financial misreporting and accounting gimmicks can mislead even the most experienced analysts.

3. Expert Insights: Authored by Martin Fridson and Fernando Alvarez, renowned experts in the field, the workbook distills decades of experience into practical advice and insightful commentary. Their expertise provides a solid foundation for understanding the nuances of financial analysis.

4. Comprehensive Coverage: The workbook spans a wide range of topics, from basic financial concepts to advanced analytical techniques. Whether you're a beginner or an advanced student, the content is designed to support your learning at every stage.

5. Interactive Learning: The format of the workbook promotes interactive learning. By actively engaging with the material, you retain information more effectively and develop a deeper understanding of the subject matter.

In today's dynamic financial landscape, accurately interpreting financial statements is a vital skill. This workbook equips you with the tools to navigate this landscape, enhancing your decision-making capabilities. Stay ahead of the curve with the Financial Statement Analysis Workbook.

Embark on this educational journey with the "Financial Statement Analysis Workbook" and transform your understanding of financial statements from a daunting challenge into a rewarding skill. This workbook is not just a study guide; it is your gateway to becoming a savvy financial analyst, ready to tackle the complexities of the financial world with confidence and precision. Dive in and discover the power of financial statement analysis today!

What is behind the 3 Statements Forecast? Here are some of the puzzle pieces.

✅ ??????? ????????:

Historical data

Trend analysis

Time series

Expert analysis

✅ ???? & ????? ??????

Gross margin

Pricing trends

Supply chain

Scrap, shortages

✅ ????????

Headcount forecast

Annual increase

Bonus scheme

ESOP

✅ ???? ????????

Existing loan schedules

New loans plan

Short vs long-term

✅ ??? ??????? ???????

AR & DSO

Inventories & DIO

AP & DPO

? Red Flags in Financial Statements ?

• Declining profit margins

• Creative accounting practices

• Excessive debt levels

• Inconsistent Cash Flow

• Frequent changes in auditors

• Overstated revenue or assets

• Integrity concerns

• Unusual inventory levels

• Declining market share

• Unexplained changes in accounting policies

In today's data-rich business landscape, it's easy to get overwhelmed by the sheer volume of information. But what if you could harness the power of data to drive growth, improve efficiency, and make informed decisions that propel your business forward?

The answer lies in data analysis. You can uncover hidden insights, identify trends, and make data-driven decisions that drive results by leveraging the right analytical tools and techniques.

Here are eight essential ways to analyze data for business decision-making:

Ratio Analysis: Assess your company's liquidity, operational efficiency, and profitability.

Trend Analysis: Identify patterns and trends to forecast future performance.

Cash Flow Analysis: Understand your company's ability to generate cash and cover debts.

Break-Even Analysis: Determine the point where revenue equals expenses.

DuPont Analysis: Decompose Return on Equity (ROE) into three components: profit margin, asset turnover, and financial leverage.

Monte Carlo Simulation: Assess the impact of risk and uncertainty in predictions and forecasts.

Scenario Analysis: Evaluate the impact of different predefined scenarios on a decision's outcome.

Sensitivity Analysis: Understand how a single input affects the output of a model.

FP&A Internal Controls and Best Practices

Management and the board rely on your analyses and insights, making decisions based on your TIMELY reports.

A single error can question the accuracy and reliability of the entire report.

How do you achieve accuracy, reliability, and timeliness?

Always remember two things:

1- Accuracy and reliability through internal controls

2- Efficiency and timeliness through process improvement & technology

Here's something to help you achieve just that:

???????? ????????

✅ ?????? ????????

Establish clear budget procedures and approval processes and monitor performance.

✅ ???????? ???????? ??????????

Implement controls to monitor actual outcomes versus projections and conduct variance analysis.

✅ ???? ????????? ??? ??????????

Financial data accuracy, completeness, and reliability in FP&A require data validation checks and reviews of data sources and inputs.

✅ ?????? ??? ???????? ?????????

Implement controls to ensure financial analyses, reports, and recommendations are subject to appropriate review and approval.

✅ ??????????? ?? ??????

Establish segregation of duties within the FP&A function to prevent conflicts of interest and reduce the risk of errors.

✅ ?????? ??????????

Implement controls to manage changes in processes, models, or methodologies.

✅ ???? ???????? ??? ???????????????

Implement controls to protect sensitive financial information.

✅ ????????????? ??? ????? ?????

Maintain proper documentation of FP&A activities, including assumptions, models, and calculations.

✅ ?????????? ??????????

Establish controls to ensure compliance with relevant financial regulations, accounting standards, and internal policies.

✅ ??????????? ??????????? ??? ??????????

Implement controls to monitor the performance and effectiveness of the FP&A function.

???? ?????????

✅ Alignment with Strategy

✅ Collaboration & Communication

✅ Driver-Based Planning

✅ Use of Technology

The 10 Key Types of Equity Everyone Should Understand.

Master them to refine your capital structure,

To drive optimal financing strategies,

To seize growth opportunities,

To increase profitability.

1️⃣ Angel Investors

• Gain funding from wealthy individuals looking to invest in promising startups.

• Offer equity in exchange for capital in early-stage companies

• It also provides mentorship and industry connections

2️⃣ Venture Capital

• Secure funding from venture capital firms focusing on high-growth potential businesses

• Involves significant equity given away, often in multiple funding rounds

• Provides extensive resources and guidance, but requires sharing control

3️⃣ Seed Funding

• Obtain initial capital to start or expand the business, often from family, friends, or early investors.

• Typically, smaller amounts that help prove a concept before seeking more significant investments

• Often structured as convertible notes or equity stakes

4️⃣ Crowdfunding

• Raise small amounts of money from many people

• Can offer rewards, equity, or debt based on the type of crowdfunding

• Enables validation of business concepts through market interest

5️⃣ Private Equity

• Access capital from private equity firms

• Involves significant investment in exchange for substantial equity stakes

• Firms actively engage in managing and growing the business

6️⃣ Initial Public Offering (IPO)

• Offer shares to the public in a new stock issuance, providing capital for expansion

• Increases scrutiny as public companies must adhere to strict regulatory standards

7️⃣ Corporate Venture Capital

• Receive investment from a corporation looking to fund startups with strategic alignment

8️⃣ Convertible Debt

• Borrow money under the condition that the debt will convert into equity

• Protects investors with the security of debt instruments

• Useful for startups in early stages when valuation is challenging

9️⃣ Equity Crowdfunding

• Raise capital by selling small amounts of equity to a large number of investors via crowdfunding platforms

• Allows investors from various backgrounds to invest in startups they believe in

• Provides startups with a broad investor base and potential brand advocates

? Employee Stock Ownership Plans (ESOPs)

• Provide company shares to employees as part of compensation

• It helps align employee interests with those of shareholders

What would you add?

Debt vs Equity

Debt vs Equity: does Debt to Equity tell the whole picture?

We must measure how well a company invests to grow.

Companies have two options beyond internal (free cash flow).

Debt or Equity.

Understanding these options can significantly influence a company's financial structure and growth trajectory.

???? involves borrowing money that must be repaid over time, with interest.

It includes instruments like bank loans, bonds, debenture, and credit lines.

Debt financing is advantageous because interest payments are tax-deductible, and it doesn't dilute ownership.

However, it requires regular repayments that can strain cash flow, and excessive debt can lead to an increased risk of bankruptcy.

?????? represents ownership in a company acquired through instruments like stocks.

Equity financing allows companies to raise capital without incurring debt.

The main advantages include no obligation for repayment and no interest expenses, which is beneficial during cash flow downturns.

However, issuing Equity can dilute current shareholders' stakes and might lead to conflicting interests among investors.

????? ?? ????:

1. ??????? ????: Backed by collateral, offering lower risk and interest rates. Think bonds or bank loans

2. ????????? ????: Based on creditworthiness, typically carrying higher interest rates. Think lines of credit or commercial paper.

????? ?? ??????:

1. ?????? ??????: Provides voting rights and dividends, subject to business performance.

2. ????????? ??????: Often carries no voting rights but provides fixed dividends.

????????? ????:

1. ????-??-?????? ?????: Indicates the proportion of debt to shareholder equity, look for ratios < 1.0

2. ???????? ???????? ?????: Shows how easily a company can pay interest on its outstanding. Ideal > 3x

????????? ??????:

1. ?????? ?? ?????? (???): Measures how well a company leverages its Equity to grow profits. Look for > 15%.

2. ?????-??-???????? ????? (?/?): Helps evaluate if a stock price accurately reflects the company's earnings prospects. The higher, the better.

So, to summarize:

Don't let some ratio decide whether a company has too much debt.

Reason from first principles.

What's the ???? created by all this debt? Is this risk comfortably manageable given the company's cash-generating power? Or is Equity a better option for the company?

I am excited to share a guide on Debt Financing. I address the essential aspects of the topic to provide insight into how strategic borrowing can rocket a business to new heights. Jump in and enhance your financial strategy today.

What This Guide Will Cover

1️⃣ Overview of Debt Financing.

2️⃣ Purpose, Importance & Key players involved.

3️⃣ Types of Debt Financing.

3️⃣ Debt Term Length & Security.

4️⃣ Impact on Financial Statements.

5️⃣ Key Considerations Before Borrowing.

6️⃣ Leading Debt Financing Options Globally and their reason.

7️⃣ Pros and Cons of Debt Financing.

8️⃣ Summary.

There are essentially two basic techniques that are used in Corporate Finance. One is the ratio analysis of financial statements and the other is calculating the present value of future cash flows.  Bankers, investors, financiers, CFOs and entrepreneurs use these tools and techniques to value assets and make decisions.   

In these next lectures we will look at using financial ratios as an investment decision tool. There are lots of different accounting ratios that get used inside of a firm.    

By ratio analysis I mean taking two numbers from financial statements and dividing one by the other. What we are doing is taking two pieces of accounting data, put one over the other, and this forms a ratio. We are taking two pieces of data and forming a performance metric. Ratios are usually presented as a percentage or a number depending on whether the usual case is bigger or less than one.    

Besides being a capital budgeting tool, ratios allow us to compare different companies or a company over time. Ratios are great tools to do this comparison because they allow us to “normalize” the numbers. A ratio eliminates any size differences and allows for pure comparison so you can compare apples to apples. 

Check out the eBook attached below.   

You also may want to go through the video lectures on Ratios, then reread the books from the last section, and then go back through the videos.  That way you will know this information and have a solid skill set. 

Welcome to "How to Analyze Financial Statements Fast," a concise guide to help you quickly understand and interpret a company's key financial documents. This resource is for those who need to grasp the essentials of financial statements without diving into overwhelming detail.

Every company produces three primary financial statements, each serving a distinct purpose:

• Balance Sheet: Provides a snapshot of a company's net worth at a specific point in time.

• Income Statement: Reveals whether the company is profitable over a particular period.

• Cash Flow Statement: Shows the movement of cash in and out of the business over time.

In this guide, we break down each statement into its core components and highlight the critical elements to focus on for a rapid assessment:

1. Balance Sheet

   • Cash & Equivalents: Assess liquidity.

   • Debt: Compare against cash holdings.

   • Goodwill: Check for significant amounts.

   • Retained Earnings: Ensure they are positive and growing.

   • Receivables & Inventory: Monitor their levels.

2. Income Statement

   • Revenue: Track trends.

   • Gross Profit: Observe changes.

   • Earnings Per Share: Check profitability.

   • Shares Outstanding: Note any fluctuations.

   • Operating Expenses: Evaluate stability.

3. Cash Flow Statement

   • Operating Cash Flow (OCF): Determine positivity and growth.

   • Capital Expenditures (CapEx): Compare with OCF.

   • Non-Cash Charges (NCC): Look for stock-based compensation.

   • Stock Transactions: Identify buybacks or issuances.

   • Debt Management: Check borrowing and repayment activities.

With less than five minutes of analysis per statement, this guide will help you swiftly identify a company's strengths and weaknesses, providing a solid foundation for more in-depth financial decision-making.

Download the MBA ASAP Financial Ratios Handbook for the Most Important Financial Ratios with their Formulas. Here is what you will find:

Liquidity Ratios:

- Current Ratio: Current Assets / Current Liabilities

- Quick Ratio: (Current Assets - Inventory) / Current Liabilities

- Cash Ratio: Cash and Cash Equivalents / Current Liabilities

Profitability Ratios:

-Net Profit Margin: Net Profit / Revenue

-Gross Profit Margin: (Revenue - Cost of Goods Sold) / Revenue

-Return on Assets (ROA): Net Income / Average Total Assets

Efficiency Ratios:

-Inventory Turnover: Cost of Goods Sold / Average Inventory

-Receivables Turnover: Revenue / Average Accounts Receivable

-Asset Turnover: Revenue / Average Total Assets

Solvency Ratios:

-Debt to Equity Ratio: Total Debt / Shareholders' Equity

-Interest Coverage Ratio: Earnings Before Interest and Taxes (EBIT) / Interest Expense

-Debt Ratio: Total Debt / Total Assets

Valuation Ratios:

-Price-to-Earnings (P/E) Ratio: Market Price per Share / Earnings per Share (EPS)

-Price-to-Book (P/B) Ratio: Market Price per Share / Book Value per Share

-Dividend Yield: Dividends per Share / Market Price per Share

Return Ratios:

-Return on Equity (ROE): Net Income / Average Shareholders' Equity

-Return on Investment (ROI): Net Profit / Investment Cost

-Return on Capital Employed (ROCE): Earnings Before Interest and Taxes (EBIT) / Capital Employed

Coverage Ratios:

-Fixed Charge Coverage Ratio: (EBIT + Lease Payments) / (Interest + Lease Payments)

-Debt Service Coverage Ratio: Net Operating Income / Debt Service

Growth Ratios:

-Earnings Growth Rate: (Current Year EPS - Last Year EPS) / Last Year EPS

-Sales Growth Rate: (Current Year Sales - Last Year Sales) / Last Year Sales

-Dividend Growth Rate: (Current Year Dividends - Last Year Dividends) / Last Year Dividends

Market Ratios:

-Market Capitalization: Number of Shares Outstanding * Market Price per Share

-Earnings per Share (EPS): Net Income / Weighted Average Shares Outstanding

-Dividends per Share: Total Dividends Paid / Number of Shares Outstanding

Payout Ratios:

-Dividend Payout Ratio: Dividends per Share / Earnings per Share

-Retention Ratio: (Net Income - Dividends) / Net Income

Learning and understanding these ratios can empower financial professionals like you to make informed decisions and optimize business performance.

Vertical and Horizontal Analysis

Vertical and horizontal analysis are techniques used in financial statement analysis to assess

• a company's performance,

• financial health, and

• to compare it with other companies or

• its historical performance.

Here's a detailed breakdown of their professional differences:

Definition:

???????? ????????

It involves expressing each item on a particular financial statement as a percentage of a base figure.

For example, each line item (like Cost of Goods Sold or Operating Expenses) can be presented as a percentage of total revenue on an income statement.

?????????? ????????

Evaluates changes in financial statement numbers across multiple periods.

It looks at the amount and percentage change from one period to the next.

???????:

???????? ????????

Provides insights into the structure of assets, liabilities, and equity OR the composition of revenues and expenses.

It helps in understanding the relative proportion of each component.

?????????? ????????

It helps to identify trends over time.

Aids in determining if certain financial metrics are improving or deteriorating over time.

???? ??? ??????????:

???????? ????????

Each item is compared to a single item within the same period. For instance, on a balance sheet, all accounts might be represented as a percentage of total assets.

?????????? ????????

Items are compared to the same item from a previous period.

Intro to Financial Ratios and Analysis

• Financial performance metrics

Financial Statement Analysis and Ratios

Accounting and Finance overlap in this area.  The launching place for Corporate Finance is the ability to read and understand Financial Statements. The analysis of financial statements and subsequent assumptions and projections based on that analysis is the next step.  Financial Statement Analysis is the process of analyzing a company's financial statements and comparing the analysis across companies and industries in order to make better operating and investing decisions. This analysis method involves specific techniques for evaluating and quantifying risk, performance, financial health, and the future prospects of an enterprise.  We can look at the performance of a particular company over time such as year to year results.  This is called Horizontal Analysis.  And we can look at various performance characteristics within a single time period. This is called Vertical Analysis.  We can create metrics across an industry segment as an average value to compare our company against.  This is called Benchmarking.  We can also aggregate up different industry groups and see how they perform relative to each other.  This type of analysis can be helpful in gauging where to allocate investment dollars in a portfolio.  It can also be used to see how a management team is performing relative to its competition. 

Financial Ratios Handbook

This compilation includes:

Profitability Ratio

A. Return

Return on Equity

Return on Assets

Return on Capital Employed

B. Margin

Gross Margin Ratio

Operating Profit Margin

Net Profit Margin

Leverage Ratio

Debt-to-Equity Ratio

Equity Ratio

Debt Ratio

Efficiency Ratio

Accounts Receivable Turnover Ratio

Accounts Receivable Days

Asset Turnover Ratio

Inventory Turnover Ratio

Inventory Turnover Days

Liquidity Ratio

A. Asset

Current Ratio

Quick Ratio

Cash Ratio

Defensive Interval Ratio

B. Earnings

Times Interest Earned Ratio

C. Cash Flow

Times Interest Earned (Cash Basis) Ratio

CAPEX to Operating Cash Ratio

Operating Cash Flow Ratio

Valuation Ratio

A. Price

Price-to-Earnings Ratio

B. Enterprise Value

EV/EBITDA Ratio

EV/EBIT Ratio

EV/Revenue Ratio

In this lecture I show you a spreadsheet with Financial Statements and we calculate and discuss financial ratios.   Download the spreadsheet in order to get better insight into the calculations and how financial statements interconnect and flow.    

Horizontal and Vertical Analysis   

Horizontal analysis compares financial information over time, typically from past financial statements such as the income statement. When comparing this past information we look for variations of particular line items such as higher or lower earnings, sales revenues, or particular expenses. Horizontal analysis is used to look for trends that can be extrapolated in order to predict future performance.    

Vertical analysis is a proportional analysis performed on financial statements. It is ratio analysis. Line items of interest on the financial statement are listed as a percentage of another line item. For example, on an income statement each line item will be listed as a percentage of Sales.     

Financial Ratios   

Financial ratios are powerful tools used to assess company upside, downside, and risk. There are four main categories of ratios: liquidity ratios, profitability ratios, activity ratios and leverage ratios. These are typically analyzed over time and across competitors in an industry. Using ratios “normalizes” the numbers so you can compare companies in apples-to-apples terms.    

Liquidity and Solvency   

Solvency and liquidity are both refer to a company’s financial health and viability. Solvency refers to an enterprise's capacity to meet its long-term financial commitments. Liquidity refers to an enterprise’s ability to pay short-term obligations. Liquidity is also a measure of how quickly assets can be sold to raise cash.    

A solvent company is one that owns more than it owes. It has a positive net worth and is carrying a manageable debt load. A company with adequate liquidity may have enough cash available to pay its bills, but may still be heading for financial disaster down the road. In this case a company meets liquidity standards but is not solvent. Healthy companies are both solvent and possess adequate liquidity.    

Liquidity ratios are used to determine whether a company has enough current asset capacity to pay its bills and meet its obligations in the foreseeable future (current liabilities).  Solvency ratios are a measure of how quickly a company can turn its assets into cash if it experiences financial difficulties or is threatened with bankruptcy. Both measure different aspects of if, and how long, a company can pay its bills and remain in business.    

The current ratio and the quick ratio are two common liquidity ratios. The current ratio is current assets/current liabilities and measures how much liquidity (cash) is available to address current liabilities (bills and other obligations).  The quick ratio is (current assets – inventories) / current liabilities.  The quick ratio measures a company’s ability to meet its short-term obligations based on its most liquid assets, and therefore excludes inventories from its current assets. It is also known as the “acid-test ratio.”   

The solvency ratio is used to examine the ability of a business to meet its long-term obligations. Lenders and bankers most commonly use the solvency ratio because they are most concerned about their ability to get paid back any money they lend. The ratio compares cash flows to liabilities. The solvency ratio calculation involves the following steps:   

All non-cash expenses are added back to after-tax net income. This approximates the amount of cash flow generated by the business. You can find the numbers to add back in the Operations section of the Cash Flow Statement.    

Add together all short-term and long-term obligations.  This is the Total Liabilities number on the Balance Sheet. Then divide the estimated cash flow figure by the liabilities total.   

The formula for the ratio is:   

(Net after-tax income + Non-cash expenses)/(Short-term liabilities + Long-term liabilities)   

A higher percentage indicates an increased ability to support the liabilities of a business over the long-term. Acceptable solvency ratios vary from industry to industry, but as a general rule of thumb, a solvency ratio of greater than 20% is considered financially healthy.    

Remember that estimations made over a long term are inherently inaccurate. There are many variables that can impact the ability to pay over the long term. Using any ratio to estimate solvency needs to be taken with a grain of salt.

Return on Invested Capital  ROIC

Return on invested capital (ROIC) measures a firm's profit over the typical cost of the debt and equity capital it uses.

The value of other businesses can be determined using the return on invested capital as a benchmark.

The efficiency with which a company directs the funds under its control toward successful investments or projects is measured by its return on invested capital (ROIC). The ROIC ratio demonstrates how effectively a business generates returns from its capital (equity and debt). Investors determine the effectiveness of a company's use of invested capital by contrasting its return on invested capital with its weighted average cost of capital (WACC).

Calculate ROIC as EBIT/(debt + equity)

ROCE Explained Simply

ROCE = Return on Capital Employed

It's a ratio that measures how efficiently a company uses its equity and debt to generate profits.

ROCE Formula:

EBIT / Capital Employed

Capital Employed = Average Total Assets - Average Current Liabilities

This represents the long-term funds used in the business by both creditors and owners.

When to Use ROCE?

Utilize ROCE when evaluating the efficiency of companies within the same industry.

It's particularly useful in capital-intensive sectors like manufacturing or utilities.

Pros of ROCE:

• A broader measure of capital efficiency.

• Simple to calculate and understand.

• Useful for capital-intensive industries.

Cons of ROCE:

• Can be skewed by high debt levels.

• Neglects timing of cash flow.

• Not reliable when comparing companies in different industries.

Things to Be Aware Of:

• Inconsistencies in definition

• Sensitivity to short-term fluctuations

• High debt levels distorting results

If you invest, you MUST understand ratio analysis.

Here are the top 6 ratios every investor should know:

Gross Margin

▶ Formula: Gross Profit / Sales

▶ Shows How Good the Company is at Turning Sales into Gross Profit

Price to Earnings

▶ Formula: Share Price / Earnings Per Share

▶ Shows the Company's Current Valuation

Debt to Equity

▶ Formula: Total Liabilities / Shareholder Equity

▶ Shows How the Company has Financed Itself

Return on Equity

▶ Formula: Net Income / Shareholder Equity

▶ Shows How Good the Company is at Generating Profits For Shareholders

Net Profit Margin

▶ Formula: Net Income / Sales

▶ Shows How Good the Company is at Turning Sales into Profits

Return on Invested Capital

▶ Formula: NOPAT / Invested Capital

▶ Shows the Capital Efficiency of the Business

What is Dupont Analysis?

Here's everything you need to know:

Dupont analysis is a framework for understanding the drivers of Return on Equity (ROE).

It was created by DuPont in the early 20th century and is still used as a tool for performance assessment and financial management today.

Dupont Analysis breaks down ROE into three major components:

A measure of Operational Efficiency

A measure of Asset Use Efficiency

A measure of Financial Leverage

This method helps to understand how efficiently a company is using its equity to generate profits.

Return on Equity (ROE)

=

Net Profit Margin

×

Asset Turnover

×

Equity Multiplier

With the components broken out, you can now see if the driver of ROE is profit margins, efficient use of assets, or significant use of debt.

Example:

Net Income = $1,000

Revenue = $10,000

Revenue = $10,000

Assets = $5,000

Assets = $5,000

Equity = $2,000

Return on Equity (ROE) is a fundamental performance measure to analyze the return for owners or investors.

The DuPont Formula breaks down ROE into its individual components, providing context on business efficiency and financing.

This formula originated at the DuPont Chemical Company in the 1900s.

?????? ??????? ?????????

- ?????? ?? ?????? is Net Profit divided by Equity. However, this alone lacks context. For a meaningful analysis, it's crucial to understand the underlying drivers.

- ??? ?? ?????: Both Net Profit and the Equity Balance are broken down into multiple drivers, offering detailed insights. Notably, all components except Net Income and Equity cancel out in the formula. For example, Operating Income appears in both the Operating Margin (top) and Interest Burden Ratio (bottom), thus canceling out. The result? Only Net Income and Total Equity remain.

??? ????? ???????

1. ????????? ??????????: Highlighted by the net profit margin (Net Income / Revenue).

2. ????? ??????????: Measured by the asset turnover ratio (Revenue / Total Assets).

3. ????????? ????????: Measured by the equity multiplier formula (Total Assets / Total Equity).

?????????

- ????????????: All accounting metrics can be manipulated or adjusted to appear better.

- ??? ????: A higher ROE does not mean more cash is available to pay bills.

- ????? ???????: Ratios are the result, but they don't explain the "why."

The DuPont Analysis is a comprehensive framework that breaks down the various factors contributing to a company's Return on Equity (ROE). By dissecting ROE into its fundamental components, investors and analysts can gain deeper insights into a company's financial performance and pinpoint specific areas of strength and weakness. This detailed approach thoroughly examines profitability, asset utilization, and financial leverage, providing a clearer picture of what drives a company's financial success.

The model was developed by F. Donaldson Brown, an employee of the DuPont Corporation, in 1914. 

The attached graphic visually simplifies the DuPont analysis to highlight its key elements. The analysis begins with revenues, adjusted for costs and expenses to determine net profit. When divided by revenues, this net profit yields the profit rate, a crucial indicator of profitability. Additionally, the analysis considers current and fixed assets to calculate asset turnover, another vital component that measures how effectively a company utilizes its assets to generate sales.

The culmination of these factors—profit rate and asset turnover—combined with the equity multiplier, leads to the calculation of Return on Equity. By using this structured approach, the DuPont Analysis equips investors and analysts with the tools to delve into the underlying reasons behind the variations in ROE, whether it is due to the company's profitability, asset efficiency, or leverage. This powerful tool provides a nuanced understanding that goes beyond the surface-level financial metrics, enabling better investment decisions and strategic financial planning.

Here is a comparison of profitability metrics:

????

Measures the profitability from both its equity and debt capital.

Suitable in capital-intensive sectors like manufacturing and utilities

Used by investors and analysts

???

Measures the profitability from its shareholders' equity.

It is best used for companies where equity financing is dominant.

Preferred by shareholders and equity analysts to see how well their investments are performing.

???

Measures the profitability from its total assets.

It indicates how effectively a company utilizes its assets to generate earnings.

Suitable for real estate companies.

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It gives insight into how effectively a company is using the money invested in it to generate profits.

Can indicate the quality of a management and their ability to generate a return on the total capital

Suitable for evaluating companies that rely heavily on a combination of debt and equity for their operations

Favored by portfolio managers and strategic planners

EBITDA vs. Free Cash Flow vs. FCFF vs FCFE

Ultimate grudge match of cash flows. Which one is the best?

EBITDA

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1. ?????????? ???????? ???????? - EBITDA removes non-operating costs like taxes and interest expenses, as well as non-cash charges depreciation and amortization.

2. ?????????? ??????????????: Investors often use EBITDA to assess a company's potential profitability and cash flow capabilities.

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1. ?????????? ????????? ??????: EBITDA can overstate a company's performance by ignoring expenses like capital expenditures and changes in working capital.

2. ????? ???????????????: GAAP does not define EBITDA, which can lead to wild adjustments.

FCF (Free Cash Flow)

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1. ???? ???? ??????????: FCF measures the actual cash a company generates after accounting for cash outflows to support operations and maintain capital assets.

2. ??????????? ??? ????????????: High FCF provides more flexibility for the company to invest in growth opportunities, pay dividends, and reduce debt.

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1. ????????: FCF can be highly volatile and influenced by irregular capital expenditures and changes in working capital.

2. ?????’? ??????? ??? ?????? ???????????: FCF can be negative in growth periods where heavy investments are made.

FCFF (Free Cash Flow to Firm)

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1. ????????? ????????: FCFF is used in DCF model to value a company.

2. ?????? ??? ??? ?????????: Focuses on all the cash flows available to shareholders (debt, equity).

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1. ??????? ?? ?????????: FCFF calculation involves adjusting net income for non-cash items and changes in working capital.

2. ??????? ??????? ???? ?????????: While FCFF gives a total view of cash flow, it does not account for the financial structure effects (debt vs. equity).

FCFE (Free Cash Flow to Equity)

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1. ?????? ??????????? ?????: FCFE calculates shareholders' distributable cash post-expenses, reinvestments, and debt.

2. ????????? ?? ???????? ?????????: High FCFE suggests that a company has the potential to maintain or increase dividends.

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1. ????????? ?? ???? ?????????: Changes in debt levels can significantly affect FCFE.

2. ???????? ??????? ????????????: FCFE may overlook required capital, potentially exaggerating payout capabilities.

How To Evaluate Financial Statements Like Warren Buffett

Value investing tends to be simplified to identifying numbers on a financial statement, comparing them with other companies, and evaluating how much one should pay for an investment.

A better explanation of value investing is understanding the movement of cash in a company and understanding if managers are deploying capital effectively enough that the company makes a profit but also maintains a competitive advantage.

Let's look at one of the ways Warren Buffett reads financial statements and footnotes to find winners. We'll do this with the help of a flow chart.

Understanding Profit

Operating Profit is revenue minus operating expenses, where revenue is how the company makes money, and operating expense is what a company has spent in the reporting year. Profit, or Net Income, takes place before calculating and paying tax.

Dig into the footnotes accompanying the financial statements to find out about the operating segments, how revenue is made, and a breakdown of expenses.

Be wary of companies that don't provide meaningful segments (e.g., Lacking geographical segments) or do not even give a breakdown of expenses that satisfies your curiosity.

These are signs of companies that are obscuring their costs of doing business.

You can also calculate a company's operating profit margin by dividing operating Profit by revenue. This calculation is one of Warren Buffet's preferred financial ratios.

Operating Profit Margin = Operating Profit/Revenue.

Using the operating profit margin, you can compare a company's performance to others in the same industry.

What management does with retained earnings matters.

Retained earnings are the net Profit retained by a business after dividends are paid out.

The importance of retained earnings is how a company uses them. Some common ones include buyback of shares, investments, payments for property, plant, and equipment, or repaying debt.

Make sure retained earnings are going to good use.

Buffett's rule of thumb is to calculate ten years' worth of retained earnings and compare it to a company's growth in market value for the same time range. So he's expecting that more than one dollar in market value is created for every dollar retained.

Pay attention to property, plant, and equipment.

Property, plant, and equipment (PPE) are the income-producing and cost-saving assets that keep a company running. The importance of these items is how a company has allocated its capital to create value.

Assets lose their Balance Sheet value over time through depreciation and amortization.

Because of depreciation and amortization, Warren Buffett looks for companies that roughly match their 5-year average capital expenditures (CAPEX) to their yearly depreciation and amortization.

Depreciation expense is in the Income Statement. Capital expenditures (CAPEX) show up in the investment section of the Cash Flow Statement as payments for property, plant, and equipment.

Compare depreciation and amortization to payments for property, plant, and equipment and make sure they are pretty close.

Conclusion

Understand how the three financial statements are interconnected and how cash flows within a company, and you'll not only be an expert investor, you'll be a profitable businessperson.

Key Financial Ratios

Here's everything you need to know:

Balance Sheet Ratios

You want to invest in companies that are in good financial shape.

• Interest Coverage

• Net Debt/Free Cash Flow

• Goodwill/Assets

Capital intensity

The lower the capital intensity, the better

• CAPEX/Sales

• CAPEX/Cash from Operations

Capital Allocation

Capital allocation skills are the most critical task of management.

• Return On Equity (ROE)

• Return On Invested Capital (ROIC)

• Return On Capital Employed

Profitability

The higher the profitability, the better

• Gross Margin

• EBIT Margin

• Free Cash Flow Margin

Dividend

You want a company's dividend to be gradually increasing and robust.

• Dividend yield

• Payout ratio

Valuation

The cheaper you can buy a company, the higher your margin of safety

• Price-to-earnings ratio

• Free Cash Flow Yield

Ratios every investor should know:

Liquidity and efficiency

▪️Quick: immediate short-term debt-paying ability

▪️Current ratio: short-term debt-paying ability

▪️Accounts receivable turnover: Efficiency of collection

▪️Inventory turnover: Efficiency of inventory management

▪️Days' sales uncollected: Liquidity of receivables

▪️Days' sales in Inventory: Liquidity of inventory

▪️Total asset turnover: Efficiency of assets in producing sales

Solvency

▪️Debt ratio: Creditor financing and leverage

▪️Equity ratio: Owner Financing

▪️Debt-to-equity ratio: Debt versus equity financing

▪️Times interest earned: Protection in meeting interest payments

Profitability

▪️Gross margin: Gross margin in each sales dollar

▪️Profit margin: Net income in each sales dollar

▪️Return on Assets: Overall profitability of assets

▪️Return on Equity: Profitability of owner investments

▪️Book value per common share: Liquidation at reported amounts

▪️Earnings per share: Net income per common share

Market Prospects

▪️ Price-earnings ratio: Market value relative to earnings

▪️ Dividend yield: Cash returns per common share

Will investment analysts soon be out of a job?

We investigate whether an LLM can successfully perform financial statement analysis in a way similar to a professional human analyst. We provide GPT4 with standardized and anonymous financial statements and instruct the model to analyze them to determine the direction of future earnings. Even without any narrative or industry-specific information, the LLM outperforms financial analysts in its ability to predict earnings changes.

The LLM demonstrates a relative advantage over human analysts in certain situations where the latter may struggle. However, it's important to note that the LLM's prediction accuracy is comparable to a narrowly trained state-of-the-art ML model. This suggests that LLMs could serve as a valuable tool in the financial industry, complementing the expertise of human analysts rather than replacing them.

LLM prediction does not stem from its training memory. Instead, the LLM generates useful narrative insights about a company's future performance. Lastly, our trading strategies based on GPT's predictions yield a higher Sharpe ratio and alphas than strategies based on other models. Our results suggest that LLMs may take a central role in decision-making.

Check out the paper below.

This e-book, "Financial Distress: The Leading Cause of Corporate Turnaround," explores the critical financial challenges that often necessitate a turnaround.

Here are a couple of highlights from the e-book:

Declining Revenue

Persistent declines in sales or revenue can signal deeper issues within a company, from market competition to product obsolescence. Addressing the root cause is crucial to reversing the trend and stabilizing the business.

Increasing Debt

High debt levels can become unsustainable, especially if revenue is insufficient to cover interest and principal payments. A comprehensive financial review and restructuring may be necessary to manage debt levels and regain financial health.

Understanding and addressing financial distress is crucial for any business leader aiming to steer their company back to stability and growth.