MBA ASAP Understanding Financial Statements

Financial Statements are what accounting produces.  Double entry bookkeeping and accounting helped usher in the modern world.

History of Accounting and Commerce

Introduction

Being able to read and understand financial statements is a fundamental skill to understanding how businesses function. Since financial statements are the end product of accounting, understanding them provides the context for understanding accounting. Mastering this skill will help you become a better manager.

Being able to read financial statements will also help you make better investment decisions in the stock market because you will be able to get meaningful information out of an Annual Report or a 10K.

If you are an entrepreneur planning a start up then understanding financial statements is critical for your credibility as you meet with angel investors, bankers, and VCs.

I hope you find this e book helpful as an introduction, refresher, or reference.

Financial Statements

Accounting information is prepared, organized, and conveyed is in Financial Statements. Financial statements are reports in which accounting information is organized so users of financial information have a consistent, quick, and thorough means of reading and understanding what is going on in the business. 

There are two basic financial statements: the Balance Sheet and the Income Statement. 

Interested parties need to understand the financial and accounting activities of a business.  The Balance Sheet and Income Statement are a formal record of the financial activities of a business. They are presented in a structured manner and in a form that is consistent and easy to understand once you understand the format.

Financial Statements provide a high level view of accounting and a summary of how a business is performing. They provide a quick picture that can be easily compared across businesses and industries. Understanding how to read and analyze a Balance Sheet and Income Statement is a great place to start understanding accounting and finance.  

Financial statements are the end product of bookkeeping.  Think of financial statements as the destination or goal of bookkeeping and accounting. When you know where you are going and who the audience is, it is easier to make good bookkeeping decisions.  When you understand the liquidity, solvency and capital structure of a company you can make good financing and investment decisions.

Financial Statements contain information required to quickly analyze and assess the relative health of a business.  A basic understanding of financial statements also provides the high level perspective on the goals of the bookkeeping work and accounting entries.  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 let you follow the money.

Why take this course?  Finally understand the numbers side of Business.  Financial Literacy matters to your career and success   Senior executives routinely share and discuss financial data with marketing directors, operations chiefs, and other direct reports. But how much do those managers really understand about finance and the numbers? A recent investigation into this question concluded most managers understand not enough to be useful.  Asked to take a basic financial-literacy exam—a test that any CEO or junior finance person should easily ace—a representative sample of U.S. managers from C-level executives to supervisors scored an average of only 38%.   Lack of financial literacy matters and impacts an organizations ability to optimally perform. Those who can’t speak the language of business can’t contribute much to a discussion of performance and are unlikely to advance in the hierarchy or reach their full potential.   Does a lack of financial literacy matter? From a managers’ point of view, it surely does. Those who can’t speak the language of business can’t contribute much to a discussion of performance and are unlikely to advance in the hierarchy. They may get caught off guard by financial shenanigans, as many employees at Enron were.

They also are unable to gauge the health of a prospective or current employer.  The CFO of a small manufacturing company often asks candidates for engineering positions whether they would like to review the past two years of the company’s financials. None yet have taken him up on the offer—knowing, perhaps, that they could make neither head nor tail of the statements.  People don’t tell their bosses that they don’t speak finance. It’s the usual human reluctance to admit ignorance. In a survey managers were asked what happens in meetings when people don’t understand financial data. The majority chose answers reflecting that reluctance, such as “Most people don’t ask because they don’t want to appear uninformed in front of their boss or peers.”  Don’t let this be you. Take this course and understand Financial Statements.

Download the book here.  It will take your through the three financial statements and how they interconnect and flow. 

Bookkeeping and Accounting produce Financial Statements. which are the cornerstone of Corporate Finance.  Understanding how business transactions aggregate up to produce financial statements is critical to a foundational understanding of how to read and understand financial statements and corporate finance. 

Setting Up the Books

When we talk of the “books” what we refer to is the group of all the accounts of the transactions of an enterprise. This list, or group, makes up the general ledger.

The general ledger is the collection of all asset, liability, equity, revenue and expense accounts. Transactions are grouped together in some related way as accounts, and accounts are grouped and categorized into the General Ledger (“GL”). Transactions are usually related by vendor, customer or type of transaction. For example, all of your office rent payments would be grouped in an account called “Landlord” or “Office Rent” or something similar. Your sales income might be grouped by customer, or simply in a general “sales revenue” account; all of your electric bills and payments would be recorded in an account set up for the utility company.

This list of accounts and vendors is the basic organizing principle of your accounting system. When you initially start an accounting system for a company you create a chart of accounts that classifies different groupings of business transactions. The chart of accounts is a listing of all accounts used in the general ledger of an organization. The chart of accounts is simply a laundry list of all the accounts.

Usually when you begin working for an existing company the chart of accounts already exists and as new vendors occur, a new account is added. The vendor list shows information about the people or companies from whom you buy goods and services, including banks and tax agencies.

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.

Bank Reconciliation - Manual vs Automated

Automation wasn't even in sight when I started preparing bank reconciliations as a general ledger accountant.

Yes, there was a time when you had to manually reconcile GL transactions and bank statements line by line.

Print them both and knock off reconciled items one by one.

You couldn't even download bank statements as CSV files.

The statements used to be paper-based and received in snail mail.

That also meant difficulty in reconciling bank accounts before the month-end close.

These days, life is much easier!

• Bank portal integration with the accounting software/ERP.

• Downloadable bank statements in the format you need.

• Automated reconciliation software.

You name it, you have it.

When entering transactions in the ERP system, one crucial consideration is that you must accurately tag each transaction so that the reconciliation software can read and compare it with the bank statement.

And tags should be aligned with the data provided by the bank.

Otherwise, reconciliation software is not very useful.

Remember, the review and approval process remains integral to bank reconciliation even after automation.

Here is a comparison of how accounting processes have evolved by leveraging technology.

1- Gathering Data

2- Match Transactions

3- Identify Differences

4- Adjustments

5- Ending Balances

6- Reconciliation

7- Review and Approval

8- Resolve Discrepancies

9- Final Reconciliation

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

The General Ledger Closing Checklist

As I write this, I am helping a client streamline their month-end closing and reporting process, including developing and implementing best practices to close each function within the finance department.

Once complete, part of the project is to develop a management and board reporting pack to ensure a seamless record-to-report process.

The accuracy of the General Ledger is critical to achieving accurate and reliable reporting.

Accounting teams cannot avoid the task of closing the books at the end of the month.

It always seems like the next month-end closing is upon us before we close the previous month.

The cycle keeps repeating itself over and over again, like Groundhog Day.

For those days, checklists become handy to ensure we have completed each task necessary to close the month.

I'm a big fan of checklists. Atul Gawande's The Checklist Manifesto is a great book.

One such checklist is the general ledger closing checklist.

Here's something I've created for my client. I am sharing it with the broader audience.

It is helpful to take this and create one based on your processes and dates.

Here's what I have covered in the graphic:

1. Preparation and Planning

2. Review Subsidiary Ledgers

3. Adjusting Entries

4. Revenue Recognition

5. Expense Recognition

6. Depreciation and Amortization

7. Bank Reconciliation

8. Accruals

9. Financial Statement Preparation

10. Review and Approval

11. Documentation & Audit Trail

12. Adjusting Entries

13. Aging Reports

14. Post-Closing Adjustments

15. Final Review

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.

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:

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Establish clear budget procedures and approval processes and monitor performance.

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

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

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

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

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

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Implement controls to protect sensitive financial information.

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

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

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

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✅ Alignment with Strategy

✅ Collaboration & Communication

✅ Driver-Based Planning

✅ Use of Technology

12 Steps Approach to Process Improvement

Improve any process within your organization by following these steps.

With years of corporate experience and a current focus on helping establish and improve processes, I've witnessed the transformative power of streamlining processes.

From enhancing efficiency to boosting productivity, the results speak for themselves.

Here are some of the benefits:

- Enhances quality and consistency.

- Increases efficiency and reduces waste.

- Supports compliance and risk management.

- Facilitates better communication and collaboration.

- Promotes continuous improvement and innovation.

Leveraging my experience, I am helping SMEs document and improve accounting and finance processes and supporting them in doing the same in other departments across the organization.

Here are some examples of processes across the organization:

- Accounting & Finance: Customer Invoicing

- Human Resources: Employee onboarding process

- Operations: Manufacturing workflow optimization

- Customer Service: Customer support ticket resolution

- Information Technology: Software deployment and update process

- Supply Chain Management: Inventory management and replenishment

Here's how you can follow the systematic approach to improve any process within your organization:

1- Understand the Current Process

2- Define the Current Process

3- Identify Pain Points and Bottlenecks

4- Set Objectives

5- Engage Stakeholders

6- Research Best Practices

7- Design the Future State

8- Document the Improved Process

9- Implement Changes Incrementally

10- Provide Training

11- Monitor and Measure

12- Iterate and Refine

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

Attached is a sample income statement that you can download and review so you can become familiar with its structure, organization, and presentation.

Revenue = profit per unit sold X number of units sold

Pricing power. Charge more.

Silicon Valley legend Marc Andreessen was asked what he would put on a billboard. Marc said two words: "Raise Prices.

The number one thing – just the theme, and we see it everywhere – the number one theme that our companies have when they get really struggling is they are not charging enough for their product. It has become absolutely conventional wisdom in Silicon Valley that the way to succeed is to price your product as low as possible under the theory that if it's low-priced everybody can buy it and that's how you get the volume. And we just see over and over and over again people failing with that because they get in the problem we call too hungry to eat. They don't charge enough for their product to be able to afford the sales and marketing required to actually get anybody to buy it. And so, they can't afford to hire the sales rep to go sell the product. They can't afford to buy the TV commercial, whatever it is. They cannot afford to go acquire the customers."

The Income Statement

The basic structure and components of the Income Statement are reviewed in this section. 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. 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 it will appreciate in value so you can sell it in the future for more than you paid.

It's also the rule for stocks: buy low, sell high.

The same logic applies to having a sustainable business model in the long run. You can't sell things for less than they cost to make and stay in business for long. So if you own and 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 than we make. Instead, 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.

We may invest some of what we set aside with an eye toward future benefits. We may invest in stocks, bonds, mutual funds, or education to expand our future earnings 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 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 marketing, sales, staffing, products, expenses, and strategy decisions.

P & L responsibility is one of the most critical responsibilities of any executive position. It 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 many examples of formats and presentations. Again, 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

This lecture analyzes the top line of the Income Statement: Revenue.  Revenue is calculated as Price X Quantity Sold.  I go into detail as to how prices are determined through supply and demand. 

Expenses

Salaries are usually a company's most significant Expense.

Opex vs. Capex.

Opex is short for Operating Expense, and Capex is short for Capital Expense. For example, salaries are an operating expense, and automation or robotics is a capital expense that offsets salaries by reducing the number of employees necessary to run a business.

Capital expenses appear as an asset on the balance sheet and are depreciated in the Income Statement.

COGS cost of goods sold.

Cost of goods sold (COGS) is the direct cost of making a company's products. It is an important line on your income statement that can tell you a lot about your financial performance, efficiency, and profitability.

SG&A

SG&A is an initialism used in accounting to refer to Selling, General, and Administrative Expenses, which is a significant non-production cost presented in an income statement.

Fixed costs

A fixed cost is an expense that a firm incurs that remains the same regardless of how many goods and services are produced or sold. Fixed costs are frequently associated with ongoing expenditures like rent, interest payments, and insurance that are not directly tied to production.

Variable costs

A variable cost is an expense for the firm that varies according to how much is produced or sold. Depending on a company's production or sales volume, variable costs grow or fall. They climb as output rises and reduce as production declines.

A manufacturing company's raw material and packaging costs, credit card transaction fees, or shipping charges, which increase or decrease with sales, are examples of variable costs.

Fixed costs and variable costs can be compared and analyzed.

Break even with revenue.

When determining when you will break even financially, a break-even analysis compares the expenses of a new business, service, or product against the unit sale price. In other words, it indicates when you will have generated enough revenue to pay for all your expenses, both fixed and variable.

Non-cash expenses: AP, depreciation, and amortization

The second most significant Expense in business is usually Taxes.

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

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.

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.

Financial Projections Lecture

How to construct Pro Forma Financial Projections

In this lecture I go over:

· Income Statement format of pro formas

· Cost Structure

· Fixed and Variable Costs

· Risk Management and Fixed Costs

· Revenues

· Price and Quantity

· Cost of Goods Sold COGS

· Cost Accounting

· Contribution Margin

· Breakeven Analysis

· Profit

To get a valuation for your project or enterprise: take the stream of profits from your projections and pull them back to Present Value using Discounted Cash Flow technique. That present value calculation is your best estimate of the value of your venture!

See the attached slide deck and Excel workbook template that accompany this video lecture to get a better understanding of how to structure financial projections and calculate a valuation using DCF and NPV.

Budgeting Made Easy: 5 Methods You Should Know

Feeling a bit overwhelmed in the world of budgeting? No need to fret; I've got your back! Today, we're simplifying the five most popular budgeting methods to help you find the perfect fit for your business.

Swipe through to learn about:

????-????? ?????????: Great for cost control and focusing on priorities, but be prepared to invest some time!

Incremental Budgeting is simple and fast, but it may not be the best method for adapting to change.

????????-????? ?????? (???): Gain a clear picture of how your money drives revenue, but be prepared to put in the groundwork.

????? ??????????? ??????: Ensure resources are directed towards high-impact initiatives, but prioritize clear communication across departments.

???????? ??????: Adapt to changing market conditions quickly, but don't lose sight of long-term goals.

????????, ??? ???? ????????? ?????? ?? ??? ??? ???? ????? ??? ???

Understanding these approaches can help you make an informed decision and put your business on the path to financial success.

20 Rates you should know

>> Interest Rate: The cost of borrowing money or the return on invested funds. Includes prime rates, SOFR, and treasury rates.

>> Exchange Rate: The value of one currency in terms of another, vital for international business operations.

>> Inflation Rate: Measures the rate at which the general level of prices for goods and services is rising.

>> Discount Rate: The rate used in discounted cash flow analysis

>> Capitalization Rate (Cap Rate): This is a common term in real estate, representing the rate of return on a property investment.

>> Internal Rate of Return (IRR): The rate at which a project or investment breaks even, used in capital budgeting.

>> Annual Percentage Rate (APR): Reflects the annual cost of borrowing money, including fees and interest.

>> Effective Annual Rate (EAR): The actual annual return on an investment or cost of a loan, considering compounding.

>> Dividend Yield: A financial ratio showing how much a company pays out in dividends relative to its stock price.

>> Risk-Free Rate: Theoretical return on investment with no risk, often represented by government bonds.

>> Hurdle Rate: The minimum rate of return required on an investment for it to be considered acceptable.

>> Tax Rate: The percentage of Net Income paid out to the government through Income Tax.

>> Return on Investment (ROI): Measures the gain or loss generated on an investment relative to the money invested.

>> Return on Equity/Assets ROE/ROA: Indicates a company's profitability in generating profits from its shareholders' equity or from its total assets.

>> Depreciation Rate: The percentage rate at which an asset's value decreases over time, reflecting its wear and tear,

usage, or obsolescence.

>> WACC (Weighted Average Cost of Capital): Represents a firm's blended cost of capital across all sources, including debt

and equity.

>> Growth Rate: Used to measure the increase in a company's revenue or earnings, critical for future projections and

valuations.

>> Lease Rate: In equipment finance or real estate, this rate determines the periodic payment amount for the use of an

asset.

>> Coupon Rate: The interest rate bond issuers pay on the bond's face value.

>> Yield to Maturity (YTM): The total return anticipated on a bond if held until it matures.

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.

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.

The Balance Sheet

Assets = Liabilities + Equity

What Is an Asset?

The real bet of a new business is that a founder can use the capital from investors to purchase a variety of assets, uniquely combine those assets, and create more value than those assets could produce on their own.

Return on Invested Capital (ROIC) measures the success of this effort and strategy.

Let's say I wanted to raise money for a crypto company: I don't know how it will work, but I think considerations will involve stuff like ownership, community, and software. I first need to raise capital from investors. My investors hope I will use this capital to build the business, and I will use the money to buy assets of some sort.

If you asked a startup founder what excited them about their new venture, none would say "responsible stewardship of assets." It's all about building products! Building teams! Few people get into entrepreneurship to carefully manage spreadsheets.

However, understanding how to communicate in assets allows technology leaders to relate with their management team; it means founders no longer glaze over when their accountant speaks; it means understanding investors' incentives.

Knowing finance is power.

The most fundamental atomic unit of business is the asset. Understanding what an asset is, why it matters, and what excites investors is critical to career success. This is the way I wish I was taught finance!

What is An Asset and Why Do They Matter

Assets are a concept where the outline is clear, but the details are blurry. If you say "asset" in a meeting, everyone will nod their head in vigorous agreement while simultaneously thinking of entirely different definitions. The only realistic way for a savvy builder to navigate this dilemma is to understand what asset means in context.

On the outline level, an asset is any resource with an economic value. That's it! However, there is a big difference between your boss calling you an asset and your accounting team deciding what number to put next to "assets" on the balance sheet.

In a company, assets produce income. They are called income-producing assets. An asset can increase sales and revenue or help reduce costs. Both ways add to improving the bottom line (net income).

Let's take a step back and ask why we need to keep track of this stuff. The point of GAAP (generally accepted accounting practices) is to enforce a standard quantifiable version of a story that a business tells about itself. This standard is critical so that investors can look at the company's information and have reasonable trust that it corresponds to something specific in the real world.

So, if standard transparent information for owners (or potential owners) is generally the reason for accounting classifications, what is the need for the idea of an "asset" specifically? It's to give you some idea of the value of a company.

In business, assets break down into four broad categories. They are:

Current Assets

Current Assets are easy to liquidate; Cash and one step removed from cash assets. These are what a company uses when it needs Cash quickly. When things get tight, you want current assets readily available. Interestingly, there is no universal rule on what level of disclosure is required, so you'll often see different companies emphasize different things depending on their type of business.

The second thing an asset can be is:

Fixed Assets

Assets lasting longer than a year are called fixed assets. These are also called Tangible Assets. You will typically hear it called "PP&E" in corporate meetings: property, plants, and equipment. Financial judgments are made in calculating and depreciating the asset for an expense. Depending on which country a company is headquartered in and what accounting standard they adhere to, depreciation can occur over the "useful life" of the asset or on a more accelerated timeline.

Treating your assets and claiming depreciation expenses can result in huge swings in valuations.

Financial investments

Say you are a successful company like Apple. One of the best parts about being a great company is making lots of Cash. A company can, and probably should, return it to shareholders, but sometimes they choose to keep it. But when inflation strikes, you don't want all of that sitting in a bank account. You want it out in the market, hopefully making a return or keeping up with inflation. Cash management is where you'll see some companies deploy their excess Cash in various ways.

Microstrategy put their excess Cash in Bitcoin. It worked incredibly well until it didn't. Tesla also took a position with its Cash in Bitcoin, but then Elon thought better of it and decided to sell that position and be safer. Most companies put their Cash in marketable securities. Marketable Securities is the Asset line on the Balance sheet just below Cash for most companies.

Intangible assets

The last type of thing an asset can be is intangible. Intangible assets are the best example to highlight the difference between accounting and finance. Finance is about long-term power: it deals with the strategic use and investment of capital. Accounting is tracking the day-to-day flows of value and is concerned with painting a hyper-accurate current picture of reality.

For intangible assets, there is often strong disagreement between the two functions. For example, when trying to value a brand or a patent, accountants have to use the principle of conservatism.

This point is significant because most technology companies' competitive advantages are arguably intangible assets. Ask yourself this: what value would you ascribe to the network effects of LinkedIn? How valuable is the data housed therein? When Microsoft bought them for $26.2B in 2016, the company had a book value of assets worth roughly $7B. The $19.2B difference comprised future expectations of cash flows AND the other assets that hadn't been valued up to the point of acquisition.

The difference between finance and accounting is minute compared to the difference between executives and accounting. Perhaps the most crucial assets of all, a talented workforce and productive culture aren't considered assets by accountants. They're an expense. There is a vast difference between how financial statements portray the world and reality.

How To Think About Technology Companies in the Pursuit of Assets

Many of the most successful companies have as few assets as possible. They can wring more economic value out of the minimal amount of assets. The more assets required to make your economic engine work, the more capital you must raise, and the lower the return on invested capital. Asset-light companies have a better return on assets.

There are notable exceptions, with some of the most highly valued companies today (Walmart and Tesla) taking an asset-heavy approach, but they are the exception. Vertical integration is a risky strategy. Hard tech, like building factories and producing complicated things like computer chips or batteries, can act as moats and barriers to entry—this approach limits threats of competition.

It's simple. The more a company can offload its unprofitable assets onto suppliers, the better return it can generate.

An investment round into a project is about purchasing returns-driving assets. Sometimes asset means the accountant definition, sometimes the CEO one. The game of finance is knowing when and how you should appeal to the right audience.

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.

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?

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.

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. 

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.

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

Free Cash Flow

Download the PDF; it teaches you everything you need to know.

1️⃣ What is free cash flow?

A company's free cash flow is equal to all the cash that enters it minus all the cash that leaves it over a certain period.

You can calculate it as follows:

Free cash flow = operating cash flow - CAPEX

The operating cash flow measures the cash generated by a company's regular business operations.

Capital expenditures (CAPEX) show how much money a company has used to maintain or buy physical assets.

2️⃣ What can a company do with its FCF?

The company can do different things with its free cash flow:

▪️ Reinvest for organic growth

▪️ Pay down debt

▪️ Acquisitions and takeovers (M&A)

▪️ Paying out dividends

▪️ Buying back shares

3️⃣ FCF Margin

This metric indicates how much cash a company generates per dollar in sales.

FCF margin = (free cash flow/sales)

Visa, for example, has a free cash flow margin of 60.2%.

For every $100 in sales, Visa generates $60.2 in pure cash.

4️⃣ FCF > Net Income

Earnings are an opinion; cash is a fact.

While earnings are an accounting metric, free cash flow looks at the money that actually entered and left the firm over a certain period.

5️⃣ FCF Conversion

The more earnings are translated into. FCF, the better.

FCF Conversion = (free cash flow / net earnings)

Seek companies with an FCF conversion of at least 85%.

6️⃣ Free cash flow yield

The free cash flow yield (FCF Yield) of a company is a great way to assess its valuation.

Free cash flow yield = (Free cash flow per share/ stock price)

The higher this ratio, the cheaper the stock.

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.

Here is an excellent textbook to use as a reference guide for corporate finance.

Welcome to "Cash Flow Forecasting," your go-to guide for mastering one of the most crucial aspects of financial management. Edited by Andrew Fight, this book is part of the Essential Capital Markets series, designed to make the complex world of finance more approachable and understandable.

Whether diving into finance for the first time or looking to deepen your understanding, this book has got you covered. It's packed with practical insights and easy-to-follow explanations to help you grasp the essentials of cash flow forecasting. So, let's break down what you can expect to find in this treasure trove of financial wisdom.

First up, we have an Overview of Cash Flow Forecasting. This chapter is like your crash course on the basics – what cash flow forecasting is all about and why it's so important. Imagine having a roadmap for your financial health – that's what this chapter is all about.

Next, we dive into the Summary of Financial Statements. Think of this as your financial toolkit. You'll learn about the key components of financial statements and how they all fit together. It's like understanding the DNA of a company's finances.

In Factors Impacting Financial Performance, we explore what makes or breaks a company's financial health. This chapter covers the external and internal factors that influence financial performance, from strategic analysis to management practices.

The heart of the book is Cash Flow Forecasting of Financial Statements. Here, you'll get hands-on with projecting financial statements and analyzing historical performance. It's where theory meets practice, helping you build accurate and reliable forecasts.

The Cash Flow Forecasting of Project Finance chapter is a must-read for those interested in large-scale projects. It focuses on how to apply forecasting techniques to ensure they're financially viable and well-structured.

Finally, we have Pro Forma Forecasts Using Amadeus Electronic Databases. This chapter is all about leveraging technology to enhance your forecasting skills. Learn how to use electronic databases to generate detailed and accurate financial forecasts.

To top it all off, the book includes appendices, suggested readings, and a glossary. These extras are like the bonus features on a DVD – they provide additional context and tools to help you get even more out of your learning experience.

"Cash Flow Forecasting" isn't just a textbook; it's a practical guide designed to equip you with the skills you need to succeed in the financial world. Whether you aim to ace your exams, impress your professors, or prepare for a career in finance, this book is your trusty sidekick.

So, grab a cup of coffee, settle in, and get ready to dive into the world of cash flow forecasting. With Andrew Fight as your guide, you're in for an engaging and enlightening journey through the fundamentals of financial management. Let's get started!

The Big Picture of Financial Statements     

The three Financial Statements: Balance Sheet, Income Statement, and Cash Flow Statement, are interconnected and the accounting numbers flow through them.   They are the measure of a company’s performance and health.    

The basic interconnection starts with a Balance Sheet showing the financial position at the beginning of the period (usually a year); next you have the Income Statement that shows the operations during the year period, and then a balance Sheet at the end of the year.     

The Cash Flow is necessary to reconcile the cash position starting from the Net Income number at the bottom of the Income Statement. The cash number calculated from the Cash Flow Statement is added to the cash reported on the beginning Balance Sheet. This number needs to match the actual cash in the bank at the end of the period and is used as the Cash account balance at the top right (Asset column) of the end of year (EOY) Balance Sheet.     

The Net Income number from the Income Statement is then added to the Retained Earnings number in the Equity section (lower left hand side) of the end of year (EOY) Balance Sheet.    

Changes in non-cash accounts like Accounts Receivable and Accounts Payable and Depreciation and Amortization will make up the difference between the Cash Flow number added on the right side of the Balance Sheet and the Net Income number added on the left hand side.    

When this is done correctly, all the numbers should reconcile and the Assets will be equal to the Liabilities and Equity (remember the Accounting Equation A = L + E) of the EOY Balance Sheet.    

Financial Statement Interconnections and Flow   

Think of it as a system of two Balance Sheets acting as bookends for the Income Statement.  And the Cash Flow Statement used to reconcile the Net Income (or Loss) at the bottom of the Income Statement with the amount of cash actually in the bank.  This process accounts for every penny that has come in, gone through, and gone out of a company during the period.    

Understanding these three financial statements and how they knit together will allow you to assess the financial health, viability and prospects of any company, and help you make rational fact-based investment decisions. This is how Warren Buffett does it.    

This post ties together the functionality of the financial statements. I hope this might be an “aha” moment for you. It was for me when I finally realized how this all fit and worked together. This is the basis of Financial Literacy and Capitalism. Understanding this conceptual big picture of accounting will provide a context to keep you from ever getting lost in the details.

Here is a quiz to test your new knowledge of financial statements and how they interconnect and flow together.  Download the spreadsheet and fill in the yellow squares numbered 1-22.  The only number you need to know is at the top where it says that Accounts Receivable AR increased by $75.  The AR increase is a random number I picked to illustrate that with just one given, we can calculate all the other numbers. 

Try to work it out and then watch the next video and download the answer sheet. 

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.

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.

Download the attached answer sheet and follow along.  If you struggled to understand what the task was, after seeing the first few answers maybe stop and go back and try again.  The answers and the process will make more sense if you first try on your own.  If you got it, congratulations!!

Here is another look and review of the Financial Statement Flow Quiz.  This one is from a classroom and the video isn't as clear as the one above, but hearing another take on the analysis will help the concepts sink in. You can Download the attached PDF with the answers to the quiz, if you haven't already, and follow along with the video lecture.