1. Basics in Business Finance & Accounting
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2. Goals Read & Understand Financial Statements
Concepts & Practices in Managing Assets & Cash Flow
Finance & Accounting Best Practices
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3. 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)
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4. Balance Sheet
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5. 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
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6. 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?
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7. 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
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8. 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
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9. 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
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10. Income Statements: Ratios
Return on Sales
Return on Assets
Return on Equity
Gross Margin
Operating Margin
Price Per Earning Ratio
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11. 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.
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12. Cash Flow Analysis Free Cash Flow Cash Return on Sales
Current Cash Debt Coverage Ratio
Cash Flow Coverage Ratio
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13. Relationship of Financial Statements
Assets
Current
Cash
$ ,000.00
A/R - Net
$ ,000.00
Inventory
Property ,Plant and Equipment
$ 1,000,000.00
Less: Accumulated Depreciation
$ (100,000.00)
Intangible
$ ,000.00
Goodwill
$ ,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
$ ,000.00
Non-Operating Income/Exp
Interest Income
$ ,000.00
Gain on Sale
$ ,000.00
Interest Expenses
$ (30,000.00)
Net Income
$ ,000.00
Liabilities
Current
N/P
$ ,000.00
A/P
$ ,000.00
W/P
Total Current
$ ,000.00
Long-Term
$ ,000.00
Total Long Term
Total
$ ,000.00
Stock Holders Equity
Common Stock
$ ,000.00
Retained Earnings
$ ,000.00
Beg RE
$ ,000.00
End Retaining Earnings
$ ,000.00
Total SE
$ ,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
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14. 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
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15. 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
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16. 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.
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