Understanding Financial Statements

Online SeminarDay 5

Nov. 13, 2009

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An Online Seminar Presented By

The Donald W. Reynolds National Center

For Business Journalism

At Arizona State University

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Presented By

James K. Gentry, Ph.D. Clyde M. Reed Teaching Professor School of Journalism and Mass Communication University of Kansas jgentry@ku.edu

Schedule for Week Day 1: Introduction to financial

statements Day 2: Income statement Day 3: Balance sheet Day 4: Cash flows Day 5: Beyond the basics

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Beyond the Basics

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Income Statement Sales or revenues Cost of goods sold Gross profit Sales, general and administrative Operating profit Other income/expenses Interest Income taxes Net income or profit

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Other Income/Expenses Discontinued items Unusual/extraordinary items Changes in accounting principle Impairment charge Sale of investment Minority interest

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Thinking Inside the Box Revenues Minus cost of goods sold Equals gross profit Minus operating expenses Equals operating profit Minus or plus other expenses/income Minus or plus interest expenses/income Minus ncome taxes Net income

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Earnings Per Share Basic earnings per share

(Bloomberg) Diluted earnings per share (Wall

Street Journal, fully diluted)

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Balance Sheet It balances Assets = Liabilities + Shareholders’

Equity

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Assets Current assets

Cash and cash equivalents Accounts receivable Inventories Prepaids

Investments and other assets

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Assets Property, plant and equipment, net

Land and improvement Buildings and improvements Equipment Less accumulated depreciation

Goodwill and other intangibles

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Goodwill Difference between what a firm pays to buy

another company and the book value (total assets minus total liabilities) of that company.

Has been written off over time, typically 40 years

No longer amortize Other intangible assets will continue to be

amortized over useful lives

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Impairment Instead of writing off over time, now use

“impairment testing” The impairment is expensed on the

income statement

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Liabilities Current liabilities

Accounts payable Accrued liabilities Income taxes Current maturity of long-term debt

Noncurrent liabilities Long-term debt Deferred income taxes

Commitments and contingencies

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Shareholders’ Equity Capital stock

Preferred stock Common stock

Additional paid-in capital Retained earnings Treasury stock

Total shareholders’ equity Total L + OE

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Cash Flows From operations From investing From financing

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Free Cash Flow Several ways to calculate it Companies create their own models Gross way to do it:

Cash from operating activities Minus capital expenditures Equals free cash flow

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American Standard Model

Cash from operating activities Minus capital expenditures Plus proceeds from disposal of property Plus proceeds from sale and

leasebacks Equals free cash flow

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A Basic Look at the Numbers Look at changes in amounts year to year, especially

revenues and expenses Look at numbers that are significantly larger or

smaller than the previous period Look at the trend line for sales/revenues, operating

income and net income. Calculate percentage change for each.

Look at the trend for cash flow Look at the trend for free cash flow Tie the numbers to the footnotes

The Next Step Calculate percentage change year-to-

year or over several years … Especially for large numbers that are

significantly larger or smaller than the previous period …

Especially for sales/revenues, operating income, net income, cash and free cash.

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Identify trends Identify what causes changes in totals on

financial statements Easier to compare percentages than raw

numbers Easier to compare companies Easier to compare companies with industry

averages

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Common Size

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Common Size Analysis For Income Statement, divide all entries

by revenue For Cash Flows, divide all entries by the

total increase or decrease of cash inflows for the year (add cash from operating, investing and financing)

Comparable Statements Often have to restructure Income

Statement to the in-the-box format we discussed

Typical problems come from items we would consider Other Income/Expenses

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Trends in Margins How have Cost of Goods Sold and

Sales, General and Administrative changed?

What does that mean for Gross Margins and Operating Margins?

Value of using Basis Points

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Ratio Analysis Takes your analysis to yet another level Finance types especially fond of ratios

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Common Size, Ratios These techniques let you drill below the

surface and start developing a more complete picture of the company’s performance Strengths Weaknesses Strategic effectiveness

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