© 2008 TAB Boards International, Inc Understanding Financial Statements

© 2008 TAB Boards International, Inc Company Financial Information  You need to understand your company financial information in order to professionally manage your business.  Money sources look for accurate and current information.  You need to understand your current financials.

© 2008 TAB Boards International, Inc GAAP (Generally Accepted Accounting Principles) The sets of standards that govern how most businesses manage their accounting.

© 2008 TAB Boards International, Inc The Three Equations The Accounting Equation 1.Assets = Liabilities + Owner Equity The Profit Equation 2.Profit = Income – Expenses The Tax Equation 3.Taxable Income = Revenue – Deductions

© 2008 TAB Boards International, Inc The Accounting Cycle  Journal Entries record businesses transactions entered into the “book” of the company from source documents.  Adjusting Entries record activities of the company not triggered by source documents.  Closing Entries bring all operating statements to a zero balance at the end of a accounting period the net P&L are transferred to balance sheet via the retained earnings account.

© 2008 TAB Boards International, Inc It’s All About the “T” Accounts 3 Common Rules for “T” Accounts 1.There are 5 major categories of accounts 2.Debits on the left, credits on the right 3.Every debit entry must have a credit entry and vice versa

© 2008 TAB Boards International, Inc The 5 Major Categories Asset Accts Debit | Credit Liability Accts Debit | Credit Equity Accts Debit | Credit Income Accts Debit | Credit Expense Accts Debit | Credit

© 2008 TAB Boards International, Inc Table of Debit & Credit Entries Type of account If the transaction will Increase the account, Enter it as a.... If the transaction will Decrease the account, Enter it as a.... Asset Balance Liability Sheet Equity Statements Income Operating Expense Statements Debit Credit Debit Credit Debit Credit

© 2008 TAB Boards International, Inc Cash or Accrual Cash  Revenue is only recognized when received  Expense is only recognized when paid Accrual  Revenue is recognized when sale is made or when goods are shipped  Expense is recognized when goods received or services are rendered

© 2008 TAB Boards International, Inc Cost Tracking  A direct expense or cost is directly traceable to production i.e. labor, material  An indirect expense or cost is not directly traceable to production i.e. general and administrative expenses  A fixed expense or cost remains the same over a relatively broad range of service or sales volume, or production level - rent, insurance salaries

© 2008 TAB Boards International, Inc Cost Tracking  A variable expense or cost increases and decreases in proportion to changes in service or sales volume, or production level – commissions, labor, materials  A semi-variable expense or cost has both fixed and variable characteristics – utilities, cell phones

© 2008 TAB Boards International, Inc Capital Expenditures Three Minimum Criteria 1.Tangible asset 2.Minimum useful life of one year 3.Meet the minimum monetary cutoff in accordance with company policy Six Elements Included in a Capital Budget 1. Net purchase price4. Installation 2. Shipping5. Insurance during shipping 3. Sales tax6. Costs that extend useful life

© 2008 TAB Boards International, Inc Lease Expenditures Capital Lease  Recorded as a capital expenditure  Capitalized costs allocated over future periods  Title may revert to lessee depending upon covenants  Cost of execution usually absorbed by lessee Operating Lease  Recorded as rental expense and included in operating expenses  Title remains with lessor throughout lease period  Cost of execution usually absorbed by lessor

© 2008 TAB Boards International, Inc Two Methods of Depreciation  Straight-line depreciation is the method of choice for most organizations. It allocates costs uniformly over the assets useful life.  Accelerated depreciation methods might be chosen to more accurately reflect the market value of an asset. This method results in a shift of depreciation toward the beginning of the asset’s useful life, applying relatively large amounts of depreciation expense in the first years and small amounts in the later years.

© 2008 TAB Boards International, Inc Four Common Financial Statements 1.Operating Statement (Income Statement or P & L) 2. Balance Sheet 3.Retained Earnings Statement 4.Statement of Cash Flow

© 2008 TAB Boards International, Inc Operating Statement (EBIT) Sales:  Service 402,000  Machines 923,000 TOTAL SALES1,325,000 Cost of sales:  Purchases (COG) 330,000  Direct Labor 352,000 TOTAL COST OF GOODS 582,000 GROSS PROFIT 743,000

© 2008 TAB Boards International, Inc Operating Statement (EBIT) Operating expenses:  Advertising109,000  Commissions 55,000  depreciation 34,000  Insurance 38,000  Repairs & maintenance192,000  Salaries 145,000  FICA tax 29,000  Unemployment tax 12,000  Legal & accounting 26,000  Miscellaneous 7,000 TOTAL OPERATING EXPENSE 647,000 OPERATING PROFIT 96,000

© 2008 TAB Boards International, Inc Operating Statement (EBIT) Other income: (Not from operations)  Interest8,000 TOTAL OTHER INCOME8,000 NET PROFIT104,000 Common shares outstanding 100,000 Earnings per share 1.04

© 2008 TAB Boards International, Inc Balance Sheet Assets Current assets  Cash in bank 40,000  Notes receivable 40,000  Accounts receivable 330,000  Inventory 360,000  Prepaid expenses 9,000 TOTAL CURRENT ASSETS 779,000

© 2008 TAB Boards International, Inc Balance Sheet Assets Fixed assets  Land (no depreciation) 50,000  Buildings 315,000  Fixture & equipment 310,000  Capitalized equipment lease 20,000  Accumulated depreciation(197,000) TOTAL FIXED ASSETS 498,000

© 2008 TAB Boards International, Inc Balance Sheet Assets Intangible assets  Franchisee fee 10,000  Goodwill 0 TOTAL INTANGIABLE ASSETS 10,000 TOTAL ASSETS1,287,000

© 2008 TAB Boards International, Inc Balance Sheet Liabilities Current liabilities  Notes payable 10,000  Accounts payable207,000  Accrued salaries and expenses113,000  Current portion under capital lease 2,000 TOTAL CURRENT LIABLITIES332,000

© 2008 TAB Boards International, Inc Balance Sheet Liabilities Long-term liabilities  Obligation under capital lease 7,000 (less current portion)  Mortgage payable 21,000 TOTAL LONG-TERM LIABLITIES 28,000 TOTAL LIABILITIES360,000

© 2008 TAB Boards International, Inc Balance Sheet Equity  Issued capital stock outstanding 353, ,000 shares  Retained earnings 654,000 TOTAL EQUITY (Net Worth)1,007,000 TOTAL LIABILITIES AND EQUITY 1,367,000

© 2008 TAB Boards International, Inc Retained Earnings Statement Last YearThis Year Balance Jan 1 515,000496,000 Prior period adj.35,00094,000 Adj. Balance Jan 1 550,000590,000 Net profit for year 102,000104,000 Total 652,000694,000 Less Distributions 040,000 Balance Dec ,000654,000 Less appropriations:116,0000 Unrestricted balance Dec 31496,000654,000

© 2008 TAB Boards International, Inc Statement of Cash Flow Net Income (per operating statement) 104,000 Adj. to reconcile net income to net cash Provided by operating activities Decrease in inventory 10,000 Increase in accumulated depreciation 34,000 Increase in accounts payable 58,000 Increase in accrued salaries and expenses 6,000 Increase due to prior year adjustment 94,000 Decrease in notes payable (2,000) Increase in accounts receivable (50,000) Increase in notes receivable (10,000) Total Adjustments 140,000 Net cash provided by operating activities 244,000 Cash paid for purchase of equipment (92,000) Cash paid for purchase of equipment (110,000) Net cash provided by investing activities (198,00) Increase in mortgage payable 4,000 Cash paid for distribution (40,000) Net cash provided by financing activities (36,000) Net increase in cash 10,000 Cash at start of the year 30,000 Cash at year end 40,000

© 2008 TAB Boards International, Inc Key Financial Ratios: Liquidity Current Ratio current assets859 current liabilities389 = good below 1.0 poor Quick Ratio cash + receivables + cash equivalent 490 total current liabilities368 = good 1.0 or less poor

© 2008 TAB Boards International, Inc Key Financial Ratios: Efficiency Accounts receivable days (Receivable 330 sales ) * * 365 = 91 days The lower the days the better. Accounts payable days (Accounts payable 127 COGS) * * 365 = 80 days The lower the better as it shows how company is meeting its obligations.

© 2008 TAB Boards International, Inc Key Financial Ratios: Profitability Return on assets Net Income 104 Total assets1287 = 8.0% This number should grow. The higher the better. Return on equity Net income 104 Total equity1007 = 10.3% The higher the better.

© 2008 TAB Boards International, Inc Key Financial Ratios: Profitability Gross profit margin Gross profit 643 Sales1325 = 48.5% The higher is normally better. Net profit margin Adj. net profit 104 Sales1325 = 7.8% This is the most important statistic. The higher the better.

© 2008 TAB Boards International, Inc Key Financial Ratios: Leverage Debt to equity Total Liabilities360 Total Equity129 = 2.8 Creditors like a lower ratio for reduced risk investor and they like a higher ratio for financial leverage. Debt leverage ratio Total Liabilities360 EBITDA138 = 2.6 The ability to repay your debt obligations from an operating cash flow (EBITDA).

© 2008 TAB Boards International, Inc How Can I Help You Better Understand Financial Statements?