introduction to financial statements this module provides an introduction to the three primary...

Introduction to Financial Statements

This module provides an introduction to the three primary financial statements: income statement, balance sheet, and cash flow statement.

Author: Stu James

© 2015 Stu James and Management by the Numbers, Inc.

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This tutorial will provide a brief introduction to the three most important financial statements:

• Balance Sheet• Income Statement• Cash Flow Statement

The purpose of this tutorial is only to introduce the format and purpose of the three financial statements, as well as acquaint you with the various account categories within each statement.

FINANCIAL STATEMENTS

Financial Statements

MBTN | Management by the Numbers

There is a follow-up module for each statement that provides more information on how the statements are generated, though only at a superficial level.

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There are two primary reasons that companies generate financial statements:

• To provide insights for managers and shareholders about the financial health of the company.

• To fulfill the quarterly reporting requirement for publicly traded companies.

Now, let’s look at each statement individually, starting with the Balance Sheet.

FINANCIAL STATEMENTS

Financial Statements


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• The Balance Sheet is one of the essential financial statements (reports) for a company and is a required filing for all public companies.

• The Balance Sheet provides important information about the financial health of a company at a particular point in time – a “snapshot”. This information includes:

• Assets (what the company owns)• Liabilities (what the company owes)• Shareholder’s Equity (what is left for shareholders)

INTRODUCTIO

N TO THE BALANCE SHEET

Introduction to the Balance Sheet


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SAMPLE BALANCE SHEET

Sample Balance Sheet


Apple, Inc.As of Sept 27, 2014

$Millions

Assets 231,839

Liabilities 120,292

Shareholder Equity 111,547

Here is a (very) simplified balance sheet for Apple, Inc. as of Sept 27, 2014. Apple’s balance sheet consists of three major categories. What else can we say?

First, note that Assets = Liabilities + Shareholder Equity

($231B = $120B + $111B)This must always be true!

Second, note that the figures are as of Sept 30, 2013, a particular moment in time.

We can also say that Apple’s assets (what it owns) far outweighs its liabilities (what it owes).

Now let’s look at these three parts of the balance sheet in more detail.

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ASSETSAssets


Apple, Inc. Assets $Millions

Cash and Cash Equivalents 13,844

Short-Term Investments 11,233

Receivables 31,537

Inventory 2,111

Other Current Assets 9,806

Total Current Assets 68,531

Long Term Investments 130,162

Plant, Property and Equipment 20,624

Intangible Assets 8,758

Other Assets 3,764

Total Assets 231,839

Let’s look at Apple’s assets in more detail.

First, note that assets are divided into current assets and non-current assets. Examples of current assets include cash, CDs, marketable securities (stocks and bonds), accounts receivable (payments owed to a company by customers), inventory, and pre-paid expenses (when a company pays a bill in advance).

Definition: Current Assets are those assets which can reasonably be

expected to be converted into cash within one year.

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ASSETSAssets


Apple, Inc. Assets $Millions

Cash and Cash Equivalents 13,844

Short-Term Investments 11,233

Receivables 31,537

Inventory 2,111

Other Current Assets 9,806

Total Current Assets 68,531

Long Term Investments 130,162

Plant, Property and Equipment 20,624

Intangible Assets 8,758

Other Assets 3,764

Total Assets 231,839

Now let’s consider non-current assets. Examples of non-current assets include buildings, vehicles, operating plants, equipment, office furniture, and intangible assets. Intangible assets would include intellectual property and goodwill. Most long-term assets are depreciated or amortized over time. Depreciation and amortization represent how a long-term asset gets used up over time.

Definition: Non-Current Assets are longer-term assets that are not

expected to be liquidated. These are depreciated or amortized over

time.

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LIABILITIESLiabilities


Apple, Inc. Liabilities $Millions Accounts Payable 48,649 Short-Term Debt 6,308 Other Current Liabilities 8,491Total Current Liabilities 63,448 Long Term Debt 28,987 Other Liabilities 27,857Total Liabilities 120,292

Let’s look at Apple’s liabilities in more detail:

Just like current assets, current liabilities are those debts that are expected to be paid during the coming year. Examples of current liabilities include accounts payable (what a company owes vendors for products or services purchased), taxes payable, debt of less than one year or debt coming due within a year (bonds that mature in the coming year).

Definition: Current Liabilities are those debts which are expected to

be paid within the coming year.

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Apple, Inc. Liabilities $Millions Accounts Payable 48,649 Short-Term Debt 6,308 Other Current Liabilities 8,491Total Current Liabilities 63,448 Long Term Debt 28,987 Other Liabilities 27,857Total Liabilities 120,292

LIABILITIESLiabilities


Now let’s consider Apple’s long-term liabilities:

Long-term liabilities include items such as long-term bonds with a maturity date over a year, real estate loans, and other long-term bank loans.

Definition: Long-Term Liabilities are those debts which are expected

to be repaid more than a year in the future.

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SHAREHOLDER EQ

UITYShareholder Equity


Apple Shareholder Equity $Millions Retained Earnings 87,152 Capital Surplus 23,313 Other Shareholder Equity 1,082Total Shareholder Equity 111,547

Now let’s look at Apple’s Shareholder Equity:

Shareholder equity includes retained earnings (from the Income Statement), Capital Surplus (any initial or subsequent investment in the company by shareholders beyond the par value of the stock). In addition, the par value of any preferred or common stock would be listed here separately.

Definition: Shareholder Equity accounts are the residual accounts –

what would be left for the shareholders after all liabilities are paid.

InsightEquity accounts represent the (residual) value of the company (or, assets minus liabilities)

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• The income statement is one of the essential financial statements (reports) for a company and is a required filing for all public companies.

• The income statement provides important information about the financial health of a company over a certain period of time (usually a year or a quarter). This information includes:

• Revenues (sales of product/services)• Expenses (costs of doing business)

INTRODUCTIO

N TO THE INCO

ME STATEM

ENTIntroduction to the Income Statement


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SAMPLE INCO

ME STATEM

ENTSample Income Statement


Apple, Inc.Year ending Sept 27, 2014

$millions

Revenues 182,795

Expenses 143,285

Net Income 39,510

Here is a (very) simplified income statement for Apple, Inc. for the year ending Sept 27, 2014. What can we say about this income statement?

First, note that Revenues – Expenses

= Net Income(182,795 – 143,285 = 39,510)

Second, note that the reporting period is for 12 months (Sept

28 2013 - Sept 27, 2014)

We can also say that Apple is a profitable company during this period, because revenues exceed total expenses, leaving net income of $39,510 million. Now let’s look at these areas in more detail.

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TOTAL REVENUE

Total Revenue


Apple, Inc. Inc. Statement $MillionsTotal Revenue 182,795 Cost of Revenue 112,258Gross Profit 70,537 Research and Development 6,041 Selling, General and Admin. 11,993Operating Income or Loss 52,503 Interest Expense 0 Net Non-Recurring Events 980 Income Taxes 13,973Net Income 39,510

Total Revenue is the combined total for all sales in a period.

Total revenue is all sales from products and services for the company (aka the “top line” of the business – as opposed to the “bottom line” or net income.). Publicly, only a single line will be shown for revenue, but internally to the company, revenue will be reported in a very detailed fashion – broken out by product line, geographic region, etc.

Definition: Total Revenue = Net sales of all products and services.

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GRO

SS PROFIT

Gross Profit


Subtracting the Cost of Revenue leaves Gross Profit.

Gross Profit is what is left after subtracting cost of revenue. Cost of Revenue (or Cost of Sales) includes any direct expenses (cost of goods / services sold) associated with revenues. Gross profit (as a percent) varies widely by business type. Both gross profit and cost of revenue are often expressed as % of total revenue for comparisons.

Definition: Gross Profit = Total Revenue – Cost of Revenue

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OPERATING

INCOM

EOperating Income


Now let’s look at the next section of the Income Statement.

Operating Income (or EBIT – Earnings before Interest and Taxes) represents a company's earnings from its normal operations (not including interest expense, taxes and one-time costs). It is calculated by subtracting other on-going operating expenses from Gross Profit. Operating income is often used by analysts rather than net income as a measure of profitability.

Definition: Operating Income = Gross Profit – (SGA + R&D)

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NET INCOM

ENet Income


Net Income is the “bottom line” of the Income Statement

Definition:

Net Income = Oper. Income - Interest - Taxes - Non Recurring Items

To calculate Net Income, or the “bottom line” of a business, we subtract remaining expenses from operating income. For various reasons, analysts separate out interest expense (financing costs), net non-recurring events (special situations) and income taxes from the normal operating costs of a business.

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• The cash flow statement is the third essential financial statement for a company and is a required filing for all public companies.

• The cash flow statement provides important information about the sources and uses of cash:

• From operating activities• From investing activities• From financing activities

INTRODUCTIO

N TO THE CASH FLO

W STATEM

ENTIntroduction to the Cash Flow Statement


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SAMPLE CASH FLO

W STATEM

ENTSample Cash Flow Statement


Apple Computer, Inc.Year ending Sept 27, 2014

$millions

Net Cash Flow-Operating $59,713

Net Cash Flow-Investing ($22,579)

Net Cash Flow-Financing ($37,549)

Net Cash Flow ($415)

Here is a (very) simplified cash flow statement for Apple, Inc. for the year ending Sept 27, 2014. What can we say about this cash flow statement?

First, note that there are 3 general areas of cash flow: operations, investing, and financing, and, at least at

Apple, all of their positive cash flow came from operations. A

positive cash flow from operations is generally a sign

of a healthy company.

Now let’s look at these three areas of cash flow in more detail.

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CASH FLOW

FROM

OPERATING

ACTIVITIESCash Flow from Operating Activities


Apple, Inc. Cash Flow Statement (Operating Activities) $Millions

Net Income 39,510 Depreciation 7,946 Adjustments to Net Income 5,210 + Decrease in Accts Receivable (6,452) + Increase in Liabilities 13,408 + Decrease in Inventories (76) Other Changes in Operating Act. 167Total Cash Flow from Operating Activities 59,713

Let’s start with cash flow from operating activities (CFO).

This category of cash flow starts with net income and then makes any adjustments necessary to get a more complete picture of how much cash was generated (or lost) from operating activities. This would include adding back depreciation and other non-cash expense, and adjusting for any changes in accounts receivable, liabilities, and inventories.

InsightIn this example, inventories increased by $76M, a use of cash.

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CASH FLOW

FROM

INVESTING ACTIVITIES

Cash Flow from Investing Activities


Apple, Inc. Cash Flow Statement(Investing Activities) $Millions

Capital Expenditures (9,571) Investments (9,017) Other Cash Flows from Investing (3,991)Total Cash Flow from Investing Activities (22,579)

Next is cash flow from investing activities (CFI).

This category of cash flow addresses more long-term asset or liability decisions, which would include purchase or sale of long-term assets (land, building, equipment, securities, etc.), long-term borrowing arrangements with suppliers or customers, and transactions relating to mergers and acquisitions.

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CASH FLOW

FROM

INVESTING ACTIVITIES

Cash Flow from Financing Activities


Apple, Inc. Cash Flow Statement(Financing Activities) $Millions

Dividends Paid (11,126) Sale / Purchase of Stock (44,270) Net Borrowings 18,266 Other Cash Flows from Financing (1,158)

Total Cash Flow from Financing Activities (37,549)

Next is cash flow from financing activities (CFF).

This category of cash flow captures the company’s own financial choices such as selling or repurchasing their own stock and/or bonds, paying dividends (and associated taxes), and repayment of debt principal, including capital leases.

InsightThis section of Apple’s Cash Flow Statement is rather unique. Why would they be borrowing funds and repurchasing stock at the same time, especially when operations are generating so much cash? See if you can search articles online to find out why.

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MBTN Balance Sheet, Income Statement and Cash Flow Statement Modules which review the basic information provided here, but adds examples of how various accounting transactions impact each statement and introduce debits and credits.

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introduction to financial statements this module provides an introduction to the three primary...

Documents

assets mbtn management

apples balance sheet

apples assets

important financial

primary financial statements

simplified balance sheet

essential financial

noncurrent assets