Basics in Business Finance & Accounting #2020Beyond

Goals Read & Understand Financial Statements Concepts & Practices in Managing Assets & Cash Flow Finance & Accounting Best Practices #2020Beyond

Financial Statements Balance Sheets Income Statement Snapshot of Assets, Liabilities and Stockholders Equity at Particular Time (ex. 12/31/2015) Income Statement Earnings during a defined Period of Time (ex. Fiscal Year Ending 12/31/2015) Statement of Cash Flows Net Cash Inflows and Outflows during A Period of Time (ex. Fiscal Year Ending 12/31/2015) #2020Beyond

Balance Sheet #2020Beyond

Balance Sheet Assets = Liabilities + Equity Example: Need to Buy $100k of Equipment a) Borrow Money to Purchase Equipment b) Pay Cash to Purchase Equipment Assets = Liabilities + Equity Assets = Liabilities + Equity c) Sell stock to Purchase Equipment Assets = Liabilities + Equity #2020Beyond

Balance Sheet How Would You Purchase the Equipment (Borrow, Pay Cash, Issue Stock)? Highly Levered: Financing Assets Through A Lot of Debt Why Do Companies Apply Leverage (vs. pay more in cash or issue stock)? Risks of Leverage? #2020Beyond

Balance Sheet Assets = Liabilities + Equity Common Balance Sheet Ratios Formula Meaning Examples Current Ratio Current Assets / Current Liabilities Leverage and Liquidity. Quick Measure of Risk for Debt and Equity holders. Ex. Apple: 109% Debt to Equity Total Debt / Equity Leverage. How are you financing growth? Sensitivity to a “hiccup”. Ex. Sears: $14B of Debt. Equity: (-906M) Ex. Apple: $147B of Debt. Equity: $126B of Equity Quick Quick Assets /Current Liabilities Liquidity. Assets: Cash; A/R and marketable securities (stocks, bonds, etc..). Ex. Apple: 69%. $45B Quick Assets, including $15B++ Cash and $19B++ Marketable Securities #2020Beyond

Income Statement Sales Less: COGS (primarily Direct Materials + Direct Labor) Gross Profit Less: SG&A (Selling, General and Administrative) Operating Income Other Income/Expenses Pre-Tax Income Less: Taxes Net Income After Taxes #2020Beyond

What is “EBITDA”? Common acronym used to quantify a company’s performance, but Why? (First, what is depreciation and amortization?) Ex. The Machine We Purchased EBITDA: Net Income After Taxes + Interest Expense + Tax Expense + Depreciation Expense + Amortization Why add back interest, tax, depreciation and amortization expenses?? Proxy for Operating Cash Flow – Remove implications of Financing (Debt vs Equity). Investors make decisions based on the anticipated return on investment Warren Buffett: “People who use EBITDA are either trying to con you or they’re conning themselves. Telecoms, for example, spend every dime that’s coming in. Interest and taxes are real costs.” Charlie Munger: EBITDA = BS Earnings #2020Beyond

Income Statements: Ratios Return on Sales Return on Assets Return on Equity Gross Margin Operating Margin Price Per Earning Ratio #2020Beyond

Statement of Cash Flow Why Do You Need a Statement of Cash Flows If You Have a Financial Statement? Who is interested in the Cash Flow Statement, and particularly Operating Cash Flow? Cash vs. Accrual: When to Recognize Income? When product ships or when you received customer’s payment? Statement of Cash Flow Starts with the Net Income and Makes Adjustments to Reflect Actual Cash Inflows and Outflows: Change Explanation + Depreciation and Amortization Financial Benefit to Buying Equipment but unless there are repairs, this is not an actual cost + Decrease in A/R OR – Increase in A/R A/R is an asset but it’s not received cash. Which would you rather have? (Ex. If you are holding A/R, you are financing your customers) + Increase in A/P OR - Decrease in A/P A/P is a liability, but if you don’t pay it, you still have the cash. (Ex. Vendors financing your business) + Increase in Inventory If you purchase more inventory, this is a cash outflow. #2020Beyond

Cash Flow Analysis Free Cash Flow Cash Return on Sales Current Cash Debt Coverage Ratio Cash Flow Coverage Ratio #2020Beyond

Relationship of Financial Statements Assets   Current Cash $ 150,000.00 A/R - Net $ 250,000.00 Inventory Property ,Plant and Equipment $ 1,000,000.00 Less: Accumulated Depreciation $ (100,000.00) Intangible $ 15,000.00 Goodwill $ 10,000.00 Total Assets $ 1,475,000.00 Sales $ 2,000,000.00 COGS $ (1,000,000.00) Gross Profit $ 1,000,000.00 Operating Expenses - Selling, General and Admin Expenses $ (650,000.00) Operating Income $ 350,000.00 Non-Operating Income/Exp   Interest Income $ 20,000.00 Gain on Sale $ 15,000.00 Interest Expenses $ (30,000.00) Net Income $ 355,000.00 Liabilities   Current N/P $ 150,000.00 A/P $ 100,000.00 W/P Total Current $ 350,000.00 Long-Term $ 320,000.00 Total Long Term Total $ 670,000.00 Stock Holders Equity Common Stock $ 400,000.00 Retained Earnings $ 355,000.00 Beg RE $ 50,000.00 End Retaining Earnings $ 405,000.00 Total SE $ 805,000.00 Total Lia. + SE $ 1,475,000.00 Cash Flow from Operations   Net Earnings $ 355,000.00 Depreciation $ 50,000.00 Decrease in A/R $ 25,000.00 Increase in A/P $ 30,000.00 Increase in Inventory $ (50,000.00) Net Cash From Operations $ 410,000.00 Cash Flow from Investing Equipment $ (70,000.00) Cash Flow from Financing N/P Cash Flow $ 365,000.00 #2020Beyond

Cash Flow Optimization: The Case Examples in Reality Dell (1997) Compaq (1997) Days Sale of Inventory (DSI) 13 39 Days to Collect A/R (DSO) 37 59 Days Payable Outstanding (DPO) 54 58 Cash Conversion Cycle (CCC) -4 40 Dell: Founded in 1984 to be a direct seller of PCs. In 1999, Overtakes Compaq to become largest PC seller in US Negative Cash Conversion Cycle Can operate with little / no margin Compaq Founded in 1987 to sell and support computers Acquired in 2002 and the name has been discontinued Cash tied up in depreciating inventory Requires significant margin to fund operations Dell gets paid by their customers before they have to pay their suppliers for the goods! Dell would have needed roughly $430M of additional inventory if same # of inventory days as Compaq. This is roughly 80% of Dell’s 1996 Net Income #2020Beyond

The Cases: #1 and #2 Time: Inventory Is Received 30 Pay for Inventory 60 Ship Inventory to Customer 105 Receive $ from Customer #1: High Growth: Seems Great! Growth, Solid Gross Margin. Problems: As sales grow, inventory grows proportionally and the company’s cash is tied up in Inventory. Inventory can become obsolete or can decrease in value (because of customer preferences, commodity markets, etc..) and may have lower margins. Leverage Increases to Finance Inventory #2: Low Growth: Seems Okay. Slow Growth, Solid Gross Margin. Problems: Same issues as high growth scenario but less exaggerated #2020Beyond

The Cases: #3 and #4 Time: Inventory Is Received 30 Pay for Inventory 60 Ship Inventory to Customer 105 Receive $ from Customer #3: Negative Growth: Seems Terrible! Losing sales and expenses are higher % of sales so lower Income Margin Benefits: Relative to the positive growth examples, more operating cash flow because fewer dollars tied up in inventory #4: Moderate Growth and Lower Expenses: Seems Great! Sales still growing and improved Income margin. Problems: Even with improved Income margin (make more net income per dollar of sales), too many dollars are consumed to support the sales growth. #2020Beyond