Accounting: Income Statement and Statement of cash flows

By Cameron Fen

Income Statement

• Income Statement includes Revenues, Expenses and Profit

• We also like to talk about margins which is usually a percentage of revenue– Ex net profit margins = net profit/revenue

• As an investor we don’t just look at this years earnings, look at the long term earnings trend as well as average earnings

Revenue and Cost of Goods Sold

• Revenue is the total amount of sales the company has made

• What is Cost of Goods Sold mean?• What does Gross Profit Margin mean?

Revenue and Cost of Goods Sold

• Revenue is the total amount of sales the company has made

• Cost of Goods Sold is the total direct cost of sales– Ex how much it costs to buy the materials and

manufacture a phone• Gross Profit is Revenue – COGS• Gross Margin is Gross Profit/Revenue

Operating Expenses

• Operating Expenses are expenses necessary for the operations of the business

• What are different types of operating expenses?

Operating Expenses

• Operating Expenses are expenses necessary for the operations of the business

• Different types of expenses include SG&A, R&D, D&A and other

SG&A and R&D

• Selling General and Administrative includes marketing expenses as well as administration expenses (obviously!)

• Research and Development is something companies can cut to boost earnings in the short term but doesn’t bode well in the long term.– R&D often times gives a company it’s moat and

benefits from economies of scale

Operating profit and interest expenses

• What is operating profit comprised of?• How do you get from operating profit to profit

before taxes?

Operating profit and interest expenses

• Operating profit is gross profit minus operating expenses

• Next you take away interest expenses and add in interest income to get Profit before taxes– Here S&P adds affiliate income and other income

too (take accounting if you are interested in learning more)

Taxes and profit

• After you take out taxes you get net profit• Sometimes you will have to takeout minority

owners interest as well as preferred interest before you get earning attributable to common shareholders

• Net profit margin = net profit/revenue

Some other terms

• EBIT = Earnings Before Interest and Taxes– When trying to calculate enterprise value ratios (more on

that later) you will use EBIT in place of earnings• EBITDA = Earnings Before Interest Taxes

Depreciation and Amortization– D&A is a real cost the business has to pay but often times

a bond holders will use this to measure how safe it is– Sometimes equity holders will use this metric too to

evaluate the company if say the company is not making any money yet

EBIT

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EBITDA

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What is the Statement of Cash Flow?

Cash Flow

• The statement of cash flow measures the change in cash from one period to the next

• Statement of Cash Flow split into 3 parts– Cash from Operations, Cash from Investments and

Cash from Financing• Since the balance sheet has to balance, the

change in cash is equal to the opposite change in everything else on the balance sheet

What do you think is included in Cash from Operations?

Cash for Operations

• Cash from Operations include net income plus all non cash expenses on the income statement (Ex Depreciation and Amortization) as well as includes all the changes in current assets and current liabilities

What will be included in Cash from Investing?

Cash from Investments

• Cash from Investments primarily includes Capital expenditures, acquisitions, and purchases of investments

What about Cash from Financing?

Cash from Financing

• Includes paying and repaying debt, dividends and buyback payments

Net Change in Cash is = Change in Cash on the Balance Sheet

Free Cash Flow (FCF)

• This is another measure of earning power• Free Cash Flow is Cash from Operations minus

Capital Expenditures– This is the amount of money available to common

shareholders– Usually a more accurate measure of the earning

power of a company than net earnings if averaged over the long term

– If the company is growing a lot need to adjust capital expenditures for growth capex

Stock Jargon

Does anyone know any ratios or words we use when looking at

valuation?

Stock Statistics

• Market Capitalization: The total value of the company usually the total value of all the stock

• Enterprise Value (EV): Total Debt + Market Capitalization – Cash– This is how much debt and equity holders value

the operating business

Stock Ratios

• P/E ratio: The total market capitalization divided by the net income– The inverse of the P/E gives you the earning yield

and can help approximate the rate of return you should expect from the stock if there is no growth and mediocre but not poor capital allocation and no capital appreciation

– Can think of the earnings yield as the interest rate on the equity

EV ratios

• EV/EBIT: gives the ratio of earnings that goes to the Enterprise owners (keep in mind interest is the “earnings” that go to debt holders)

• EV/EBITDA: It is used for debt and equity analysis but shouldn’t be– It is just another ratio to value how cheap a

company

Return on equity/investments

• Return on Equity = net profit/total equity in the company– Measures how effectively the equity generates

income• Return on Investment = net profit/(equity +

debt)– Measures how effectively a dollar in enterprise

value generates income