Financial Statement Basics Roy Williams – FHA Deputy Chief Underwriter

1 HUD Guidance For Financial Statement Analysis  MAP Guide Chapter 8.4 – Firm Commitment Processing Financial Statements  MAP Guide Appendix 8C – How To Analyze Financial Statements

HUD Guidance For Financial Statement Analysis  CPA Audited or Reviewed Financial Statements  Internal Unaudited Financial Statements 2

3 Types of Financial Statements  Balance Sheet  Also referred to as Statement of Financial Position  Provides financial balances as of a specific date – “snapshot in time”  Account balances generally in order of liquidity  Operating Statement  Also referred to as Income Statement or Profit and Loss (P&L)  Provides income and expenses during a particular period  Includes both cash and non-cash expenses  Personal Financial Statement  Balance Sheet format for an individual  Individual income and expenses can be analyzed on Income Tax Return

4 Balance Sheet Basics  Total Assets = Current Assets + Long-Term Assets  Current Assets – Cash and other assets convertible into cash during the normal operating cycle of business operations or 1 year, whichever is less (MAP Appendix 8C.A)  Long-Term Assets – Assets that are not easily converted into cash.

5 Balance Sheet Basics  Total Liabilities = Current Liabilities + Long-Term Liabilities  Current Liabilities – Payables due during the normal operating period or 1 year, whichever is less (MAP Appendix 8C.B)  Long-Term Liabilities – Liabilities with a future benefit exceeding one year

6 Current Assets Cash and Cash Equivalents  Cash In Bank – Operating and Savings Accounts  Money Market Holdings  Treasury Bills  Short-Term Bonds Near Maturity  Escrow Deposits – Taxes, Insurance, Reserve for Replacement

7 Current Assets – Cont. Marketable Securities  Equity Securities – Common Stocks  Debt Securities - Bonds  Derivative Contracts – Forwards, Options, Futures and Swaps  Are these securities publically traded or privately held?

8 Current Assets – Cont. Accounts Receivable  Amounts owed to a business by its clients (customers or debtors) for goods or services purchased on credit  Detail support for account balance is listing of clients to whom credit has been extended and passage of time from the date credit was extended (A/R Aging Schedule)  Credit can be extended to officers, employees or related entities  Balance often shown net of Allowance for Bad Debts

9 Current Assets – Cont. Notes Receivable  Amounts owed to a business with a principal amount secured by a promissory note  Terms of note may stipulate that a portion of the principal is not due within one year of the balance sheet date  As with Accounts Receivable, notes can be entered into with officers, employees or related entities

10 Current Assets – Cont. Inventory  In process or finished goods held for sale  Not typically found on the financial statement of a real estate related entity

11 Current Assets – Cont. Work In Process – General Contractors Only  Costs in Excess of Billings – job costs for work that has been completed but has not been billed  Also referred to as under-billings  Billings in Excess of Costs – work has been billed but has not been completed  Also referred to as over-billings

12 Current Assets – Cont. Prepaid Expenses  An asset that arises on a balance sheet as a result of payments for goods or services for which the benefit will be received in the future  Insurance is the most common form of prepaid expense  The benefit of the good or service is re-classified to the Income Statement over time as the benefit is realized

13 Non-Current Assets Fixed Assets  Long-term property that is not easily converted to cash  Examples: Land, Buildings, Machinery, FF&E  Accounting rules stipulate that these assets are recorded on the balance sheet at cost  The cost is then depreciated over time based on the estimated life of the fixed asset  Land is similarly recorded at cost but is not depreciated

14 Intangible Assets  Common examples are goodwill, patents and trademarks  An economic benefit of the intangible is estimated over a period of time  The benefit is then amortized over time based on the estimated life of the intangible

15 Current Liabilities Accounts Payable  Amounts owed by a business to its suppliers  Similar to receivables, detail support for account balance is listing of suppliers to whom monies are owed and passage of time from the date goods or services were purchased (A/P Aging Schedule)  Monies can be payable to officers, employees or related entities  Detail is a valuable indicator of an entity’s ability to meet its ongoing obligations

16 Current Liabilities – Cont. Accrued Expenses  Expenses which are anticipated thus are recognized on the balance sheet before they are actually paid for  Accrued expenses are typically paid for within 1 year  Common accrued expenses are bonuses, interest and taxes  An accrual should be made for any expense that is reasonably probable and that can be reasonably estimated

17 Non-Current Liabilities Long-Term Debt  Loans that have maturities more than one fiscal year into the future  Scheduled principal payments to be made during the current fiscal year are classified as current liabilities

18 Non-Current Liabilities Other Examples  Leases – Certain long-term leases are accounted for similarly to loans. These leases have a current and long-term portion depending on the schedule of lease payments to be made.  Employee Benefits – Companies may offer long-term benefit plans to employees which are not payable to the beneficiary until retirement

19 Operating Statement Basics  Net Income = Revenue Less Expenses  Total revenue includes both operating revenue and financial revenue  Expenses include operating expenses, financial expenses and non-cash expenses

20 Revenue Operating Revenue  Rents  Miscellaneous Income Items – Application Fees, NSF Charges, Pet Fees, Laundry & Vending Income Financial Revenue  Interest Income

21 Expenses Operating Expenses  Administrative – Advertising, Management Fees, Other  Operating – Utilities, Payroll, Other  Maintenance – Repairs, Exterminating, Insurance, Grounds  Replacement Reserve Deposits  Real Estate Taxes  Other Taxes – Payroll, Personal Property

22 Expenses – Cont. Financial Expenses  Interest  Mortgage Insurance Premiums

23 Expenses – Cont. Non-Cash Expenses  Depreciation  Amortization

24 Financial Statement Ratios Balance Sheet  Working Capital = Current Assets less Current Liabilities  Equity or Net Worth = Total Assets less Total Liabilities Income Statement  Operating Expense Ratio = Operating Expenses divided by Operating Revenue

Personal Financial Statements  Follow format outlined on HUD Form  Personal Financial Statements are typically not audited but are compiled by a CPA based on information provided  In the absence of a current statement an individual can sign a certification of no significant change 25