Understanding Financial Data

Transcription

1 May 22-25, 2016 Los Angeles Convention Center Los Angeles, California Understanding Presented by Brenda M. Clarke, CPA/ABV/CFF, CVA FM25 5/24/2016 2:30 PM - 3:30 PM The handouts and presentations attached are copyright and trademark protected and provided for individual use only.

2 Brenda M. Clarke CPA/ABV/CFF, CVA Seigneur Gustafson LLP Lakewood, CO May 24, 2016 Seigneur Gustafson LLP Certified Public Accountants 940 Wadsworth Boulevard, Suite 200 Lakewood, Colorado voice fax 2

3 Today s Objectives Overview of basic accounting principles and transactions Double entry accounting Cash vs. accrual methods of accounting Financial statements and what they tell you meaningful financial data 3 What Is Accounting? A comprehensive system for recording, classifying and reporting the financial information of an organization. Users of accounting information include: Business owners Employees and managers Taxing authorities Investors and creditors 4

4 The Primary Objective The primary objective of financial reporting is to communicate understandable information that is useful in making business decisions. To achieve this objective the information must be: Accurate; Timely; and In the proper format 5 Accounting for Law Firms Three different roles: As a business business operations As an employer wages, payroll taxes, employee benefits, contractors As a fiduciary client trust funds, cost advances (legal and ethical considerations). May be responsible for the assets of other individuals or businesses. 6

5 Financial accounting vs. Managerial accounting Financial Used by external decision makers to evaluate the business. Should be / can be comparable to other similar businesses. Usually communicated through financial statements. Managerial Used primarily by internal decision makers. Can be various other types of reports not limited to financial statements. 7 Importance of a Good Record Keeping System Monitor the success or failure of the firm Budgeting purposes Obtaining financing and new sources of capital Tax return preparation and legal requirements Profit Distributions 8

6 The Accounting Process There are six major steps to the accounting process 1. Analyzing Looking at events that have taken place and determining how/if they affect the business. 2. Recording Entering the financial information about the events into the accounting system, through electronic accounting software or other. 3. Classifying Sorting and grouping similar items together rather than merely keeping a simple diary of numerous events. 9 The Accounting Process 4. Summarizing Aggregating many similar events to provide information that is easy to understand. 5. Reporting Report the results, financial statements or other reports. 6. Interpreting Considering the results, possible ratio analysis or other comparisons to industry 10

7 Classification of transactions Transactions are typically recorded in one of five different categories. 1. Assets 2. Liabilities 3. Equity 4. Income / Revenue 5. Expenses 11 Assets Assets are the economic resources that have probable future economic benefits. Current Assets will be consumed within a year (cash, accounts receivable, inventory, prepaid expenses) Long-Term Assets Assets that will last more than one year (computers, furniture, buildings) Long term assets are depreciated over their expected life 12

8 Liabilities Liabilities represent a firm s obligation or debt to pay cash or transfer assets for goods or services. Also current or long term Current payable within a year accounts payable, payroll taxes, other current liabilities, current portion of long term debt Long term payable in longer than a year mortgages and loans 13 Equity Equity is the difference between the value of the assets and the liabilities what s left over for the owners. Think about your house and mortgage. What s left is your equity 14

9 Equity Shareholders Equity (for corporations) is broken down into two main categories: Contributed Capital and Retained Earnings. Contributed Capital - Contributed Capital is further broken down into Common Stock and Additional Paid-in Capital. Retained Earnings - Retained Earnings shows the aggregate amount of net income the company has earned since its formation, less the dividends it has paid out to its shareholders during that time. 15 Equity Partner s Capital is equity in a partnership - It is broken down into three main categories: Contributed Capital, Distributions of Capital and Partner s Capital. Contributed Capital - Contributed Capital is money or other assets contributed to the enterprise. Distributions - Distributions represent cash or other assets distribute to the partners Partner s Capital Partner s Capital is the accumulated amount of contributed capital, plus net income, less net losses, less distributions. 16

10 Revenues and Expenses Revenues are inflows of assets of an entity based on production and delivery of goods and services. Examples of revenues are service fee income, sales, interest revenue, and rent revenue. Expenses are outflows or other uses of assets or incurrence of liabilities (or both) during a period as a result of delivering or producing goods or rendering services. Examples are cost of goods sold, salaries expense, rent, taxes, utilities, and interest expense. 17 Double-Entry Accounting Every transaction has two entries Debits and Credits (left side and right side) Sometimes abbreviated: Dr. and Cr. There is no limit to the number of accounts involved in a transaction - but at a minimum there must be no less than two accounts. 18

11 Double-Entry Accounting The totals of the debits and credits for any transaction must always equal each other, so that an accounting transaction is always said to be "in balance." If a transaction were not in balance, then it would not be possible to create financial statements. 19 Double-Entry Accounting Debit and Credit is not the same as Plus and Minus! If you debit a cash account, then this means that the amount of cash on hand increases. However, if you debit an accounts payable account, this means that the amount of accounts payable liability decreases. 20

12 21 Double Entry Accounting The normal balance of an account is its usual balance and is the side (debit or credit) that increases the account. Also the side that increases that account. Account Category Normal Balance Debit Credit Assets x Liabilities x Stockholder s Equity x Revenue x Expense x 22

13 Double Entry Accounting 23 Double Entry Accounting But why is this so important? Tracks items on the balance sheet instead of just the income statement Gives a more complete narration of the transaction Helps to prevent fraud everything must balance and be accounted for 24

14 Overview of financial statements There are four financial statements that companies prepare: Balance Sheet Income Statement Statement of Cash Flows and the Statement of Owners Equity 25 Overview of financial statements Taken together, these financial statements can tell the reader a lot about a firm s financial health and prospects. We tend to be interested mostly in the income statement don t be fooled looks can be deceiving. 26

15 The Balance Sheet Key Concept: The Balance Sheet is often said to be a snapshot of a company's financial standing, or position, at a particular instant in time. Includes Assets, Liabilities and Equity 27 Accounting Equation The outstanding characteristic of the Balance Sheet is, not surprisingly, that it balances. We refer to this as the Fundamental Accounting Equation: Assets = Liabilities + Owners Equity 28

16 ABC Law Firm, Inc. Balance Sheet December 31, 2015 Assets Liabilities Current Assets Current Liabilities Cash $ 35, Accounts Payable $ 65, Accounts Receivable 17, Credit Cards Payable 5, Prepaid Rent - Current portion of long term debt 3, Other Current Assets 40, Total Current Liabilities 73, Total Current Assets 92, Long Term Debt 50, Long-Term Assets Total Liabilities 123, Computers 10, Furniture 15, Owner's Equity Leasehold Improvements 75, Accumulated Depreciation (9,000.00) Common Stock 10, Current period net income 715, Total Long Term Assets 91, Retained Earnings 86, Shareholder Distributions (740,350.00) Other Assets 11, Total Equity 71, Total Assets $ 194, Total Liabilities and Equity $ 194, Income Statement The Income Statement shows the results of a company s operations for a given period of time, such as a month, three months (a quarter), or one year. Unlike the Balance Sheet, which is a snapshot of the company at a particular moment in time, the Income Statement is more like a movie, showing the company s revenues, expenses, and resulting net income (or net loss) over the period of time covered by the Income Statement. 30

17 ABC Law Firm, Inc. Income Statement For the year ending December 31, 2015 Fee Income $ 2,100, Operating Expenses Salaries and Wages 840, Rent 120, Advertising 168, Client Costs 105, Payroll tax 84, Meals and Entertainment 20, Telephone 18, Office Supplies 15, Depreciation Expense 6, Postage 2, Total Expenses 1,378, Operating Income 721, Other Income/Expenses Interest Income 1, Gain or Loss on Sale of fixed Assets (7,500.00) Other income (expenses) (6,250.00) Net Income $ 715, Income Statement The income statement can be viewed as an expanded picture of the changes in balance sheet equity derived from business operations. The retained earnings component of balance sheet equity is essentially the net result of the entities revenue less expenses between balance sheet dates, prior to any distributions of such net profits for the period. 32

18 Link between the balance sheet and the income statement A critical element in understanding how to comprehend the information conveyed in the balance sheets and income statements of any enterprise is to understand the linkage between these two primary statements. 33 Assets ABC Law Firm, Inc. Balance Sheet December 31, 2015 Liabilities ABC Law Firm, Inc. Income Statement For the year ending December 31, Current Assets Current Liabilities Fee Income $ 2,100, Cash $ 35, Accounts Payable $ 65, Accounts Receivable 17, Credit Cards Payable 5, Prepaid Rent - Current portion of long term debt 3, Other Current Assets 40, Total Current Liabilities 73, Total Current Assets 92, Long Term Debt 50, Long-Term Assets Total Liabilities 123, Computers 10, Furniture 15, Owner's Equity Leasehold Improvements 75, Accumulated Depreciation (9,000.00) Common Stock 10, Current period net income 715, Total Long Term Assets 91, Retained Earnings 86, Shareholder Distributions (740,350.00) Other Assets 11, Total Equity 71, Total Assets $ 194, Total Liabilities and Equity $ 194, Operating Expenses Salaries and Wages 840, Rent 120, Advertising 168, Client Costs 105, Payroll tax 84, Meals and Entertainment 20, Telephone 18, Office Supplies 15, Depreciation Expense 6, Postage 2, Total Expenses 1,378, Operating Income 721, Other Income/Expenses Interest Income 1, Gain or Loss on Sale of fixed Assets (7,500.00) Other income (expenses) (6,250.00) Net Income $ 715,

19 Statement of Cash Flows Understanding cash flow may be the most important aspect of financial performance Often overlooked, or not even prepared Reports the sources and use of cash for a defined period 35 Statement of Cash Flows Activities are defined using three separate classifications Operations typically items found on the income statement Investing purchases and sales of property and equipment and other ventures Financing debt borrowings and repayment, contributions and withdrawal of capital 36

20 ABC Law Firm, Inc. Statement of Cash Flows For the year ending December 31, 2015 Cash Flows from Operating Activities Net Income 715, Adjustment to reconcile net income to net cash provided by operating activities: Depreciation 6, (Increase) decrease in current assets Accounts Receivable (5,000.00) Prepaid Expenses 10, Other Current Assets (30,000.00) Increase (decrease) in current liabilities Accounts Payable 20, Credit Cards Payable 4, Current Portion of Long Term Debt 1, Net Cash from Operating Activities 721, Cash flows from Investing Activities Purchase of Property and Equipment (5,000.00) Other Investments (1,000.00) Net Cash from Investing Activities (6,000.00) Cash Flows from Financing Activities Proceeds from long term debt 25, Issuance of stock 10, Dividends and Distributions (740,350.00) Net Cash from Financing Activities (705,350.00) 10, Beginning cash balance 25, Ending Cash $ 35, Basis of Accounting One of the most fundamental concepts to comprehend is whether an enterprise uses the cash or accrual basis of accounting to record transactions. The difference between these two methods is the timing of when the underlying economic activity is recorded in the general ledger and reflected within the financial statements. 38

21 Basis of Accounting - Cash basis: revenues are recognized when collected and not when invoiced, expenses are recognized when paid and not when incurred. - Accrual basis: revenues are recognized when invoiced and not when collected, expenses are recognized when incurred and not when paid. 39 Which is Best? Accrual basis provides more accurate financial information because it reports revenue when earned and expenses when incurred Cash basis usually better for tax purposes. Concept is you are paying your tax liability based on when you actually get paid. 40

22 Financial Statement Analysis Why?? Look at past performance Cash flow issues Trends Comparative industry analysis Strategic actions 41 Types of Analysis Comparative Analysis Common Size Financial Statements Trend Analysis Ratio Analysis 42

23 Comparative Analysis: Observe activity in comparison with other periods Monthly, quarterly, or annually 43 ABC Law Firm, Inc. Income Statement For the year ending December 31, Fee Income $ 750, $ 1,365, $ 2,100, Operating Expenses Salaries and Wages 337, , , Rent 120, , , Advertising 60, , , Client Costs 20, , , Payroll tax 33, , , Meals and Entertainment 2, , , Telephone 12, , , Office Supplies 2, , , Depreciation Expense 1, , , Postage 1, , , Total Expenses 591, ,108, ,378, Operating Income 158, , , Other Income/Expenses Interest Income , Gain or Loss on Sale of fixed Assets (100.00) 1, (7,500.00) Other income (expenses) , (6,250.00) Net Income $ 159, $ 258, $ 715,

24 45 Common Size Financials: Express all income statement elements as a percentage of revenue Express all balance sheet elements as a percentage of total assets Aids in identifying unusual trends or performance variances 46

25 ABC Law Firm, Inc. Balance Sheet December 31, 2015 Assets Liabilities Current Assets Current Liabilities Cash $ 35, % Accounts Payable $ 65, % Accounts Receivable 17, % Credit Cards Payable 5, % Prepaid Rent - Current portion of long term debt 3, % Other Current Assets 40, % Total Current Liabilities 73, % Total Current Assets 92, % Long Term Debt 50, % Long-Term Assets Total Liabilities 123, % Computers 10, % Furniture 15, % Owner's Equity Leasehold Improvements 75, % Accumulated Depreciation (9,000.00) -4.6% Common Stock 10, % Current period net income 715, % Total Long Term Assets 91, % Retained Earnings 86, % Shareholder Distributions (740,350.00) % Other Assets 11, % Total Equity 71, % Total Assets $ 194, % Total Liabilities and Equity $ 194, % 47 ABC Law Firm, Inc. Income Statement For the year ending December 31, 2015 Fee Income $ 2,100, % Operating Expenses Salaries and Wages 840, % Rent 120, % Advertising 168, % Client Costs 105, % Payroll tax 84, % Meals and Entertainment 20, % Telephone 18, % Office Supplies 15, % Depreciation Expense 6, % Postage 2, % Total Expenses 1,378, % Operating Income 721, % Other Income/Expenses Interest Income 1, % Gain or Loss on Sale of fixed Assets (7,500.00) -0.4% Other income (expenses) (6,250.00) -0.3% Net Income $ 715, % 48

26 Trend Analysis: Observe patterns (revenues and distributable profits) Trends in dollar values Trends in percentages (expenses as a % of gross revenues) Support forecasts Highlight impact of competition and management strategies 49 ABC Law Firm, Inc. Income Statement For the year ending December 31, % of prior year 2015 % of prior year Fee Income $ 1,365, % $ 2,100, % Operating Expenses Salaries and Wages 714, % 840, % Rent 120, % 120, % Advertising 109, % 168, % Client Costs 60, % 105, % Payroll tax 71, % 84, % Meals and Entertainment 5, % 20, % Telephone 16, % 18, % Office Supplies 8, % 15, % Depreciation Expense 2, % 6, % Postage 2, % 2, % Total Expenses 1,108, % 1,378, % Operating Income 256, % 721, % Other Income/Expenses Interest Income % 1, % Gain or Loss on Sale of fixed Assets 1, (7,500.00) % Other income (expenses) 2, % (6,250.00) % Net Income $ 258, % $ 715, % 50

27 Ratio Analysis: Relationship between financial statement accounts Standardized numbers Highlights firm performance Facilitates comparisons Highlights strengths and weaknesses 51 Ratio Analysis: Can be grouped as Performance or profitability how do we compare? Liquidity - Lenders Capital structure or debt management is it appropriate? Debt can cost more than equity 52

28 Industry Analysis 53 Communicating Financial Information Foster an open line of communication make sure you regularly communicate so no one is surprised. Be proactive, and avoid: Oops, we don t have enough cash for payroll on Thursday afternoon at 4:00 Our Server warranty copier lease malpractice insurance expires next week 54

29 Communicating Financial Information Understand what motivates your readers and what they want to know Are they more interested in revenue expenses cash flow Taxable income 55 Communicating Financial Information Be sure you understand it first are there outliers? Research issues first. Try to predict their questions first in order to be prepared Don t get caught with a red herring, that you don t understand 56

30 Communicating Financial Information Describe only the important details Why is your chart of accounts 5 pages long does that give more or less information? Use executive summaries 57 Communicating Financial Information Other tips.. Use less jargon and acronyms a true sign of intelligence is understanding your audience and speaking to them in a manner they understand. Do not try to prove your knowledge by boring your audience 58

31 Communicating Financial Information Other tips.. Be consistent and comparative 59 Communicating Financial Information Other tips.. Use charts and graphs 60

32 Communicating Financial Information Other tips.. Use Benchmarks Use industry resources Local bar association Legal Intelligence 61 Communicating Financial Information Other tips.. Look beyond the numbers Be proactive Be timely 62

33 Weakness in Financial Reporting Basis of accounting may not accurately reflect efforts Balance sheet is based on historical cost Balance sheet doesn t reflect value intangible assets are not reported 63 Weakness in Financial Reporting Past performance is not necessarily a predictor of future performance Research and development doesn t appear on the balance sheet Depreciation and other elections can skew the financial reports be sure to note how things are calculated Future events that could have a significant impact, may not be reflected a lease that is expiring 64

34 Weakness in Financial Reporting Future events that could have a significant impact, may not be reflected a lease that is expiring, etc. Some financial statements don t reflect tax liabilities 65 Seigneur Gustafson LLP Certified Public Accountants 940 Wadsworth Boulevard, Suite 200 Lakewood, Colorado voice fax Brenda.Clarke@cpavalue.com 66

35 Your opinion matters! Please take a moment now to complete the evaluation. Thank You!