© 2008 tab boards international, inc understanding financial statements

© 2008 TAB Boards International, Inc

Understanding Financial Statements


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.


GAAP (Generally Accepted Accounting Principles)

The sets of standards that govern how most businesses manage their accounting.


The Three EquationsThe Accounting Equation

1. Assets = Liabilities + Owner Equity

The Profit Equation2. Profit = Income – Expenses

The Tax Equation3. Taxable Income = Revenue – Deductions


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.


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


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 BalanceLiability SheetEquity StatementsIncome OperatingExpense Statements

DebitCreditCreditCreditDebit

CreditDebitDebitDebitCredit


Cash or AccrualCash

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


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


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


Capital ExpendituresThree Minimum Criteria

1. Tangible asset2. Minimum useful life of one year3. Meet the minimum monetary cutoff in

accordance with company policy

Six Elements Included in a Capital Budget1. Net purchase price 4. Installation2. Shipping 5. Insurance during shipping3. Sales tax 6. Costs that extend useful life


Lease ExpendituresCapital 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


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.


Four Common Financial Statements

1. Operating Statement (Income Statement or P & L)

2. Balance Sheet

3. Retained Earnings Statement

4. Statement of Cash Flow


Operating Statement (EBIT) Sales:

Service 402,000 Machines 923,000TOTAL SALES 1,325,000

Cost of sales: Purchases (COG) 330,000 Direct Labor 352,000

TOTAL COST OF GOODS 582,000

GROSS PROFIT 743,000


Operating Statement (EBIT) Operating expenses:

Advertising 109,000 Commissions 55,000 depreciation 34,000 Insurance 38,000 Repairs & maintenance 192,000 Salaries 145,000 FICA tax 29,000 Unemployment tax 12,000 Legal & accounting 26,000 Miscellaneous 7,000TOTAL OPERATING EXPENSE 647,000

OPERATING PROFIT 96,000


Operating Statement (EBIT)

Other income: (Not from operations) Interest 8,000

TOTAL OTHER INCOME 8,000

NET PROFIT 104,000Common shares outstanding 100,000Earnings per share 1.04


Balance Sheet

AssetsCurrent 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


Balance Sheet

AssetsFixed 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


Balance Sheet

AssetsIntangible assets

Franchisee fee 10,000 Goodwill 0

TOTAL INTANGIABLE ASSETS 10,000

TOTAL ASSETS 1,287,000


Balance SheetLiabilitiesCurrent liabilities

Notes payable 10,000 Accounts payable 207,000 Accrued salaries and expenses 113,000 Current portion under capital lease 2,000

TOTAL CURRENT LIABLITIES 332,000


Balance SheetLiabilitiesLong-term liabilities

Obligation under capital lease 7,000 (less current portion) Mortgage payable 21,000

TOTAL LONG-TERM LIABLITIES 28,000

TOTAL LIABILITIES360,000


Balance SheetEquity

Issued capital stock outstanding 353,000

100,000 shares Retained earnings 654,000

TOTAL EQUITY (Net Worth) 1,007,000

TOTAL LIABILITIES AND EQUITY 1,367,000


Retained Earnings Statement

Last Year This Year

Balance Jan 1 515,000 496,000

Prior period adj. 35,000 94,000

Adj. Balance Jan 1 550,000 590,000

Net profit for year 102,000 104,000

Total 652,000 694,000

Less Distributions 0 40,000

Balance Dec 31 652,000 654,000

Less appropriations: 116,000 0

Unrestricted balance Dec 31 496,000 654,000


Statement of Cash FlowNet Income (per operating statement) 104,000

Adj. to reconcile net income to net cashProvided by operating activities

Decrease in inventory 10,000Increase in accumulated depreciation 34,000Increase in accounts payable 58,000Increase in accrued salaries and expenses 6,000Increase 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 140,000Net 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 4,000Cash paid for distribution (40,000)Net cash provided by financing activities (36,000)Net increase in cash 10,000Cash at start of the year 30,000Cash at year end 40,000


Key Financial Ratios: Liquidity

Current Ratiocurrent assets 859current liabilities 389 = 2.22.0 + good below 1.0 poor

Quick Ratiocash + receivables + cash equivalent 490total current liabilities 368 = 1.331.2-1.3 good 1.0 or less poor


Key Financial Ratios: Efficiency

Accounts receivable days(Receivable 330 sales ) * 365 1325 * 365 = 91 daysThe lower the days the better.

Accounts payable days (Accounts payable 127 COGS) *365 582 * 365 = 80 days

The lower the better as it shows how company is meeting its obligations.


Key Financial Ratios: Profitability

Return on assetsNet Income 104 Total assets 1287 = 8.0%This number should grow. The higher the better.

Return on equityNet income 104Total equity 1007 = 10.3%The higher the better.


Key Financial Ratios: ProfitabilityGross profit margin

Gross profit 643 Sales 1325 = 48.5%The higher is normally better.

Net profit marginAdj. net profit 104 Sales 1325 = 7.8%This is the most important statistic. The higher the better.


Key Financial Ratios: Leverage

Debt to equityTotal Liabilities 360 Total Equity 129 = 2.8Creditors like a lower ratio for reduced risk investor and they like a higher ratio for financial leverage.

Debt leverage ratioTotal Liabilities 360 EBITDA 138 = 2.6The ability to repay your debt obligations from an operating cash flow (EBITDA).


How Can I Help You Better Understand

Financial Statements?

© 2008 tab boards international, inc understanding financial statements

Documents

tab boards international

debit entry

credit entry

fixed expense

indirect expense

cell phones slide

semivariable expense

accounting equation