Financial StatementsFinancial Statements

ByBy

John C. KellyJohn C. Kelly

Discussion QuestionDiscussion Question

How do you measure your How do you measure your

personal financial condition?personal financial condition?

Net WorthNet Worth

Cash + investments + propertyCash + investments + property

MinusMinus

Bills + loans + mortgagesBills + loans + mortgages

EqualsEquals

Your Net WorthYour Net Worth

Discussion QuestionDiscussion Question

How much of your net worth is usable?How much of your net worth is usable?

Usable Net WorthUsable Net Worth

That which is That which is liquidliquid

That which can be easily converted to That which can be easily converted to cashcash

Cash in the bank

Investments you can sell

Amount you can borrow

Financial StatementsFinancial Statements► Sources and Uses of FundsSources and Uses of Funds – – WhatWhat money do money do

you need to start your business and you need to start your business and wherewhere will will you get it.you get it.

► Balance SheetBalance Sheet – Snapshot of financial – Snapshot of financial conditioncondition► Income StatementIncome Statement – Financial – Financial performanceperformance over over

an interval of time. Also called profit and loss or an interval of time. Also called profit and loss or P&L.P&L.

► Cash Flow StatementCash Flow Statement – Similar to P&L but – Similar to P&L but includes cash includes cash expendituresexpenditures which are not which are not expenses buying capital equipment and loan expenses buying capital equipment and loan principle payments. principle payments.

The Balance SheetThe Balance Sheet

►A snapshot of the financial condition of A snapshot of the financial condition of the company at a moment in time.the company at a moment in time.

►You can think of it as a statement of You can think of it as a statement of what would be left if all the assets what would be left if all the assets were sold and all the bills paid. An were sold and all the bills paid. An individualindividual would call this a net worth would call this a net worth statement. statement.

Net worth = Asset - Liabilities

Balance Sheet FormatBalance Sheet FormatASSETSASSETS

► Cash in BankCash in Bank► Accounts Accounts

ReceivableReceivable► Prepaid ExpensesPrepaid Expenses► InventoryInventory► EquipmentEquipment► Real Estate Real Estate

LIABILITIESLIABILITIES► Accounts payableAccounts payable► Accrued payrollAccrued payroll► Bank loansBank loans►MortgagesMortgages► Credit Card Credit Card

BalancesBalances

Net WorthNet Worth

Assets = Liabilities + Net Worth

Discussion QuestionDiscussion Question

What does your balance sheet look like What does your balance sheet look like

the day you start your business?the day you start your business?

Initial Balance SheetInitial Balance Sheet

ASSETSASSETS

► CashCash $1000$1000

LIABILITIESLIABILITIES

► Amount OwedAmount Owed $0$0

NET WORTHNET WORTH

► Equity $1000Equity $1000

Balance Sheet TerminologyBalance Sheet Terminology

►Net Worth =Net Worth =►Shareholder’s Equity =Shareholder’s Equity =►Owner’s Equity =Owner’s Equity =►Equity = Equity = ►Book ValueBook Value

All names for the same thing. Think of it like the All names for the same thing. Think of it like the equity in your house, which is the market value equity in your house, which is the market value minus the mortgage amount. It is money you minus the mortgage amount. It is money you could have if you sold your house. Of course, you could have if you sold your house. Of course, you would get a little less because of the cost of would get a little less because of the cost of selling. selling.

Income StatementIncome Statement

►Measures financial performance over time. Measures financial performance over time. Balance sheets are snapshots. Income Balance sheets are snapshots. Income statements are interval oriented. statements are interval oriented.

►Measures profit over an interval of time.Measures profit over an interval of time.

Profit = Revenue – Expenses

Income Statement FormatIncome Statement Format

SalesSalesCost of Goods SoldCost of Goods Sold

Gross ProfitGross ProfitSelling ExpensesSelling ExpensesGeneral & AdministrativeGeneral & Administrative

Net ProfitNet ProfitProvision for Income TaxProvision for Income Tax

ProfitProfit

Income Statement Income Statement TerminologyTerminology

► Income, revenue, profitIncome, revenue, profit, and , and earningsearnings are all frequently used interchangeable are all frequently used interchangeable with conflicting meanings.with conflicting meanings.

►The words The words net and grossnet and gross are some are some times used to clarify meaning.times used to clarify meaning.

► I sayI say

Revenue = Sales = Gross Income Revenue = Sales = Gross Income Profit = Earnings = Net IncomeProfit = Earnings = Net Income

Discussion QuestionDiscussion Question

What happens when you make a sale but What happens when you make a sale but don’t receive the money right away?don’t receive the money right away?

Accrual Vs Cash AccountingAccrual Vs Cash Accounting

►Cash accountingCash accounting, like you do in your , like you do in your personal life, says an expense occurs personal life, says an expense occurs when the cash is spent, and income when the cash is spent, and income occurs when the cash is received.occurs when the cash is received.

►Accrual accountingAccrual accounting assigns expenses assigns expenses and income to the period in which they and income to the period in which they occur, whether or not cash is received occur, whether or not cash is received or spent.or spent.

See Pub 583 and Pub538 Accounting Periods

Golden Rule for Golden Rule for Small BizSmall Biz

Use cash accounting Use cash accounting

as long as possibleas long as possible

Discussion QuestionDiscussion Question

How should you account for the How should you account for the

purchase of a car or a large piece purchase of a car or a large piece

of equipment like a pizza oven?of equipment like a pizza oven?

DepreciationDepreciation

Depreciation is classic example of accrual Depreciation is classic example of accrual accounting where the cost of an asset is accounting where the cost of an asset is spread over the expected life of the asset. For spread over the expected life of the asset. For example, a car is not expensed in the year it is example, a car is not expensed in the year it is purchased, rather it is expensed over a period purchased, rather it is expensed over a period of years. If the depreciation period is five of years. If the depreciation period is five years. Only 1/5 of the cash spent will show up years. Only 1/5 of the cash spent will show up as an expense in the year the money is spent. as an expense in the year the money is spent. Therefore, the change in cash on hand shown Therefore, the change in cash on hand shown in the balance sheet will not jive with the profit in the balance sheet will not jive with the profit shown on the income statement. The cash shown on the income statement. The cash flow statement corrects for this.flow statement corrects for this.

Multiple Sets of BooksMultiple Sets of BooksDepending Upon the Depending Upon the

AudienceAudience►ManagersManagers – focus on cash flow – focus on cash flow► InvestorsInvestors – meet SEC requirements – meet SEC requirements►Tax CollectorsTax Collectors – meet IRS requirements – meet IRS requirements

Perfectly legal, perfectly confusing

SEC Financial ReportingSEC Financial Reporting

►10-K10-K Annual financial report Annual financial report►10-Q10-Q Quarterly financial report Quarterly financial report►8-K8-K Unscheduled report of change in Unscheduled report of change in

financial conditionfinancial condition

SEC Edgar Financial Databasehttp://www.sec.gov/cgi-bin/srch-edgar

Discussion QuestionDiscussion Question

How would you use the numbers in the How would you use the numbers in the financial statements to evaluate the financial statements to evaluate the

health of a business?health of a business?

Performance RatiosPerformance Ratios

►Revenue per employeeRevenue per employee►Average sale amountAverage sale amount►Number of sales/deals per monthNumber of sales/deals per month►Survival ratioSurvival ratio►Profit MarginProfit Margin►Return on Equity (ROE)Return on Equity (ROE)► Inventory TurnoverInventory Turnover►P/E RatioP/E Ratio

Tax ReportingTax Reporting

►Small Business Guide – Small Business Guide – Pub 583Pub 583►Sole Proprietorship – Sole Proprietorship – Schedule CSchedule C►Corporation Return – Corporation Return – 11201120►S-Corp Return – S-Corp Return – 1120S1120S►Partnership and LLC - Partnership and LLC - 10651065

Basic Guidelines to Get Basic Guidelines to Get StartedStarted

►Maintain a separate checking accountMaintain a separate checking account►Pay your taxesPay your taxes►Use a payroll serviceUse a payroll service►Start with basic QuickenStart with basic Quicken►Advance to QuickBooksAdvance to QuickBooks