Accounting Fundamentals--Summer Income Statement Classification Operating income Other income and expense Income from continuing operations Income, gains & losses from discontinued operations Extraordinary gains and losses Changes in accounting principles

Accounting Fundamentals--Summer Statement of Cash Flows FASB Components Operating cash: Operations and working capital Investing cash: Non-current assets and investments Financing cash: L/T debt, equity and dividends

Accounting Fundamentals--Summer Roots = Financing Activities Trunk & Branches = Investing Activities Fruit = Operating Activities Businesses are like Fruit Trees

Accounting Fundamentals--Summer Net Income vs. Cash Flow Indirect Method Net Income +/- Non-cash Items +/- Changes in Operating Working Capital = Cash Flow from Operations

Accounting Fundamentals--Summer Indirect vs. Direct Method FASB prefers the direct method FASB requires net income to cash from operations reconciliation Components: Cash from customers Cash from dividends Cash from interest income Other operating cash receipts Cash paid to suppliers Cash paid to employees Cash paid for taxes Cash paid for interest Other operating cash payments

Accounting Fundamentals--Summer Economic Value Added Income from Capital - Cost of Capital = E V A 

Accounting Fundamentals--Summer Sources of Capital Debt (interest %) Equity (interest % + 6%)

Accounting Fundamentals--Summer Capital Working capital Net tangible non-current assets Capitalized R & D Capitalized Employee Devel. Costs

Accounting Fundamentals--Summer Adj. Operating Income Operating income Plus: R & D Emp. Devel. Costs Minus: R & D Amort. Emp. Devel. Cost Amort

Accounting Fundamentals--Summer Keys to Success Make it a way of life K I S S CEO / Management buy-in Gradual introduction Thorough training

Accounting Fundamentals--Summer Today’s Session Financial Statement Analysis The Goal

Accounting Fundamentals--Summer Target Your Efforts Solvency assurance Wealth enhancement Performance improvement

Accounting Fundamentals--Summer Start with the 3 P’s Planning Processing Presenting

Accounting Fundamentals--Summer Include the Trifecta: Q-S-T Q: Quantitative analysis S: Strategic assessment T: Tactical feasibility

Accounting Fundamentals--Summer Tools for Financial Statement Analysis Ratio analysis Trend analysis Common-size analysis Base period analysis Comparative analysis Horizontal and vertical analyses

Accounting Fundamentals--Summer A Financial Statement Approach Look for key relationships Focus on spending drivers Don’t overlook the Statement of Cash Flows Remember to measure trends Tell a story

Accounting Fundamentals--Summer Guidelines for a Presentation Clarity Accuracy Simplicity Visually friendly Limit page content

Accounting Fundamentals--Summer Cash Flow Red-Flags Receivable and inventory growth rate exceeds sales growth rate Payables growth rate exceeds inventory growth rate Current liabilities grow faster than sales Sustained operating losses (negative net income)

Accounting Fundamentals--Summer Cash Flow Red-Flags (cont’d) Negative operating cash flow Capital expenditures exceed operating cash flow Sustained capital expenditures reductions Sustained sales of marketable securities in excess of purchases Substantial shift from long to short term borrowing Dividend reduction or elimination

Accounting Fundamentals--Summer Cash Sufficiency Ratio Cash Flow From Operations + Interest + Taxes PPE + Debt Servicing + Taxes + Dividends Should be greater than 1 Can easily disaggregate Different footprints for different development stages

Accounting Fundamentals--Summer Cash Conversion Cycle Cash conversion cycle Days in payables ≥ DSO + Days in inventory

Accounting Fundamentals--Summer Typical Common Ratios Solvency & liquidity Earnings Performance

Accounting Fundamentals--Summer Ratio Analysis General guidelines: Be consistent Ascertain contents of numerator and denominator Apply common sense…

Accounting Fundamentals--Summer Trend Analysis Static analysis is virtually useless Trend direction is key Combine with other approaches

Accounting Fundamentals--Summer Common-size Analysis Helpful for size discrepancies Keyed to sales or total assets Helpful for industry comparisons

Accounting Fundamentals--Summer Base Period Analysis Combines trending and percentage analysis Select representative base year and set the index at 100 Measure subsequent periods in terms of the base year Helpful for industry comparisons Eliminates size bias

Accounting Fundamentals--Summer Comparative Analysis Cautions Timing variances GAAP variances Conservative vs. Aggressive GAAP Management attitude…”win at all cost!” Size Geographic venues

Accounting Fundamentals--Summer Horizontal and Vertical Analysis The most basic…and most powerful analytical tool Key element in fraud detection Keeps the organization under control

Accounting Fundamentals--Summer Horizontal Analysis Period versus period changes Value changes Percentage changes Look for irregularities

Accounting Fundamentals--Summer Horizontal Analysis - Example

Accounting Fundamentals--Summer Vertical Analysis Relationships within the same period: Numerical relationships Percentage relationships Look for irregularities

Accounting Fundamentals--Summer Vertical Analysis - Example

Accounting Fundamentals--Summer Theory of Constraints The Concept The Process The Measures

Accounting Fundamentals--Summer The Concept Presented in Eliyahu Goldratt’s The Goal The goal of a business is to make money…consistent with customer satisfaction Continuous flow Avoid the “herbies” Eliminate the bottlenecks first

Accounting Fundamentals--Summer The Process Identify the constraints Exploit the constraints (reduce the bottlenecks) Subordinate everything else Elevate the constraints (remove the bottlenecks) Reiterate the process

Accounting Fundamentals--Summer The Measures Throughput-Net income Inventory-ROI Ops. Expenses-Cash Flow