Financial Statement Analysis and Budget Tracking by Donna M. Ingram, CPA, CFE, Cr.FA, CFF Donna M. Ingram, CPA, PC dingram@cablelynx.com What is Financial Statement Analysis? Financial statement analysis (or financial analysis) is the process of understanding the risk and profitability of a firm (business, sub business or project) through analysis of reported financial information, by using different accounting tools and techniques. Financial Statements Balance Sheet Income Statement Statement of Equity Statement of Cash Flows Disclosures Supplemental Data Federal Funds Budget Analysis Other 1
Presentation of Financial Data Cash Basis Simple No receivables or payables Modified Cash Basis Tax Basis Regulatory Basis Accrual Matching is critical Possible Independence Issues Who prepares your financial statements? Do you have to convert cash basis financial statements to accrual? Who prepares your disclosures Who prepares your Schedule of Federal Funds? Who are the Users of your Financial Statements? Management Grantors Donors Lenders Government Others? 2
Balance Sheet Often described as a snapshot of an entity s financial condition Applies to a single point in time Reports Assets Liabilities Equity Income Statement Shows the entity's revenues and expenses during a particular period. Reports net income (the bottom line) The purpose is to show whether the entity made or lost money during the period being reported. Statement of Cash Flows Shows how changes in balance sheet accounts and income affect cash and cash equivalents. Operating Investing Financing As an analytical tool, it is useful in determining the short term viability of an entity. 3
Disclosures Your financial report is more than just the financial statements Footnotes are explanatory and provide additional information May be more important to your financial statement users than the financial statements themselves Analytical Review Is the testing of relationships amount accounts and identifies material changes that should be considered in the decision making process. It involves analyzing significant ratios and trends for unusual change and questionable items. Includes comparison to prior years and budgets Common Ratios Working Capital Working capital is calculated as current assets less current liabilities. This is the money that the business needs to work. Used to evaluate whether the entity has enough short term assets to cover its short term debt. Anything below 1 indicates negative working capital. 4
Operating Profit Margin Operating Profit/Net Revenue Revenue less SG&A expenses equals operating profit Positive and negative trends usually are directly related to management decisions regarding expenses Return on Assets Net Income/Average Total Assets Trend analysis and peer comparisons are valuable Debt Ratio Total Liabilities/Total Assets Provides a general idea as to the amount of leverage being used by an entity A low percentage means that the entity is less dependent on borrowed money 5
Revenue per Employee Revenue/Number of Employees (Average) Not all ratios use financial information, nonfinancial analysis is valuable Helps you gauge productivity, especially when comparing to historical results and peer groups Risk Analysis Liquidity analysis aims at analyzing whether the firm has enough liquidity to meet its obligations when they should be paid. A usual technique to analyze illiquidity risk is to focus on ratios such as the current ratio and interest coverage. Cash flow analysis is also useful. Solvency analysis aims at analyzing whether the firm is financed so that it is able to recover from a loss or a period of losses. Horizontal Analysis Horizontal analysis allows the assessment of relative changes in different items over time. It also indicates the behavior of revenues, expenses, and other line items of financial statements over the course of time. 6
Vertical Analysis Vertical analysis is the proportional analysis of a financial statement, where each line item on a financial statement is listed as a percentage of another item. Typically, this means that every line item on an income statement is stated as a percentage of gross sales, while every line item on a balance is stated as a percentage of total assets. Budgeting A periodic measure used by governments, corporations or individuals to quantify the difference between budgeted and actual figures for a particular accounting category. A favorable budget variance refers to positive variances or gains; an unfavorable budget variance describes negative variance, meaning losses and shortfalls. Budget variances occur because forecasters are unable to predict the future with complete accuracy. Budget Importance A budget is the key element of many grant proposals. An effective proposal budget outlines a proposed project in fiscal terms and helps reviewers to determine how the project will be conducted. Budget information about activities planned and personnel who will serve on the project provides reviewers with an in depth picture of how the project will be structured and managed. Budget details usually reveal whether a proposed project has been carefully planned and may ultimately be feasible. 7
Variances Budget variances can result from two sources the things that can be controlled and things that cannot. Tips The best strategy is to request a reasonable amount money to do the work, not more and not less because: Grantors look for reasonable costs and will judge whether your request is justified by your aims and methods. Grantors will judge whether the figures are in sync with their expectations. Significant over or under estimating suggests you may not understand the scope of the work. Sample Company Budget What are your concerns? What data should you gather to explain variances? What action could you take in December? What should you not do? 8
Cooking the Books Financial statement fraud can surface in many different forms, although once deceptive accounting practices are initiated, various systems of manipulation will be utilized to maintain the appearance of sustainability. Fraudulent Financial Reporting Done to: Deceive investors, creditors, donors & grantors Cause company stock price to rise Meet cash flow needs Hide losses or problems Job security Increase compensation Misappropriation of assets is committed against an entity, while fraudulent financial reporting is committed to deceive financial statement users. Unauthorized use of material strictly prohibited 9
False Entry An entry in the books or records of a business entity which is intentionally made to represent what is not true or does not exist, with intent to deceive the officers, directors, stock holders, lenders, grantors or other statement users. Unauthorized use of material strictly prohibited Common Techniques Overstating Revenues Understating Expenses Not recording liabilities Misclassification of transactions Knowingly using improper depreciation methods or lives Omission of important disclosures Cookie jar reserves Red Flags Growing revenue without corresponding growth in cash Consistent sales growth when competitors are experience weak performance or inconsistent results A significant surge in the entity s performance within the current period A weak system of internal control Unusual or unnecessary complex transactions Something just feels off 10
Revenue Recognition Frauds Fictitious sales Premature revenue recognition Deferral of revenue Improper cutoff Unauthorized use of material strictly prohibited Overstatement Techniques Recognizing revenue on consignment sales Recognizing revenue on conditional sales Recognizing revenue on bill and hold transactions Recognizing revenue when ownership not passed to customer Recognizing revenue on shipments not ordered by customers or shipping defective product Recognizing revenue upfront on multi year contracts Backdating shipping documents Improper use of percentage of completion Delaying recognition of returns Falsifying journal entries to record fictitious revenue Falsifying sales with related parties Unauthorized use of material strictly prohibited Is scanning the general ledger an analytical tool that can aid in detecting errors or fraud? 11
A Note of Caution When two or more individuals conspire to commit fraud, it can have an especially harmful effect, particularly when the combined efforts of the fraudsters enable them to circumvent or override anti fraud controls. There are no small frauds only large ones that got detected early Unauthorized use of material strictly prohibited Open Forum and Questions Unauthorized use of material strictly prohibited 12
Sample Company Balance Sheets December 31, 2012 and 2011 Assets Current Assets: 2012 2011 Cash $ 103,141.67 $ 11,025.19 Marketable Securties 24,000.00 - Accounts Receivable 47,421.00 11,065.00 Less: Allowance for Uncollectible Amounts (59,491.94) (3,250.81) Inventories 188,500.00 101,681.00 Total Current Asstes 303,570.73 120,520.38 Fixed Assets: Fixed Asstes 382,590.00 320,665.00 Less: Accumulated Depreciation 116,669.00 81,559.50 265,921.00 239,105.50 Total Assets $ 569,491.73 $ 359,625.88 Liabilities And Shareholders' Equity Current Liabilities: Notes Payable $ 70,000.00 $ - Current maturities of long-term debt $ 10,000.00 $ - Accounts Payable 8,767.15 11,279.35 Interest Payable 172.60 - Accrued Payroll Taxes Payable 4,262.22 3,284.54 Federal Income Taxes Payable 36,307.43 29,797.00 Total Current Liabilities 129,509.40 44,360.89 Long-term debt, net of current portion 40,000.00 - Shareholders' Equity: Common Stock 225,000.00 225,000.00 Retained Earnings 174,982.33 90,264.99 Total Shareholders' Equity 399,982.33 315,264.99 Total Liabilities and Shareholders' Equity $ 569,491.73 $ 359,625.88
Sample Company Statement of Income and Retained Earnings For the Year Ended December 31, 2012 2012 Sales Revenue $ 1,516,853.18 Cost of Goods Sold (1,032,114.74) Gross Profit 484,738.44 Operating Expenses: Rent Expense 57,600.00 Advertising Expense 22,155.00 Office Supplies Expense 5,621.45 Depreciation Expense 35,109.50 Wage Expense 141,563.97 Payroll Tax Expense 11,562.27 Bad Debt 60,641.13 Other Expenses 29,287.75 Total Operating Expenses 363,541.07 Operating Income 121,197.37 Other Income (Expense): Interest Expense 172.60 Net Income Before Federal Income Tax Expense 121,024.77 Federal Income Tax Expense 36,307.43 Net Income 84,717.34 Retained Earnings Beginning of Year 90,264.99 Retained Earnings End of Year $ 174,982.33
Sample Company Statement of Cash Flows For the Year Ended December 31, 2012 Cash Flows from Operating Activities: Net Income $ 84,717.34 Adjustments for Non Cash Effects: Depreciation Expense 35,109.50 Allowance for Doubtful Accounts 56,241.13 Changes in Operating Assets and Liabilties: Increase in Accounts Receivable (36,356.00) Increase in Inventory (86,819.00) Decrease in Accounts Payable (2,512.20) Increase in Interest Payable 172.60 Increase in Accrued Payroll Taxes Payable 977.68 Increase in Federal Income Taxes Payable 6,510.43 Net Cash Flows Provided By Operating Activities 58,041.48 Cash Flows from Investing Activities: Purchase of Marketable Securities (24,000.00) Purchase of Fixed Assets (61,925.00) Net Cash Flows Used For Investing Activities (85,925.00) Cash Flows from Financing Activities: Proceeds from Long-term Debt 50,000.00 Proceeds from Note Payable 70,000.00 Net Cash Flows Provided By Financing Activities 120,000.00 Change in Cash 92,116.48 Cash at Beginning of Year 11,025.19 Cash at End of Year $ 103,141.67
SAMPLE ENTITY Budget Comparison of Expense for 1-1-12 through 11-30-12 (11 month) 11 Budget MTD MTD YTD YTD Compare Budget Actual Budget Actual Personnel $2,175,150 $181,263 $206,613.55 $1,993,888 $2,060,377.64 103.33% Fringe Benefits $565,500 $47,125 $57,319.54 $518,375 $679,698.23 131.12% Travel $25,000 $2,083 $1,194.97 $22,917 $17,952.30 78.34% Total $2,765,650 $230,471 $265,128.06 $2,535,179 $2,758,028.17 108.79% 80.74% 83.69% Contract SS Pharmacy $4,000 $333 $0.00 $3,667 $2,000.00 54.55% X-Ray $15,000 $1,250 $816.00 $13,750 $12,600.00 91.64% Lab-Medical $60,000 $5,000 $3,734.32 $55,000 $40,682.75 73.97% Lab-Dental $2,500 $208 $129.24 $2,292 $1,847.72 80.63% Med. Specialty $5,000 $417 $194.00 $4,583 $4,032.00 87.97% Provider $5,000 $417 $0.00 $4,583 $8,325.00 181.64% Waste Mgmt. $12,500 $1,042 $1,428.60 $11,458 $10,539.72 91.98% MIS-Information Mgmt $70,000 $5,833 $4,555.45 $64,167 $59,223.01 92.30% Consultant $2,000 $167 $875.00 $1,833 $1,875.00 102.27% Miscellaneous $100 $8 $42.68 $91.67 $531.84 580.19% Total Contract $176,100 $14,675 $11,775.29 $161,425 $141,657.04 87.75% 5.14% 4.30% Supplies Medical $40,000 $3,333 $3,971.43 $36,667 $32,367.54 88.28% Lab $32,000 $2,667 $1,611.66 $29,333 $26,513.18 90.39% Medical (Inj) $17,500 $1,458 $1,461.93 $16,042 $17,280.50 107.72% Pt. Records $5,000 $417 $0.00 $4,583 $3,351.33 73.12% Office $19,000 $1,583 $3,602.55 $17,417 $14,888.82 85.49% X-Ray $1,500 $125 $175.00 $1,375 $1,106.10 80.44% Facility $16,000 $1,333 $1,432.04 $14,667 $11,567.94 78.87% Dental $14,000 $1,167 $1,735.24 $12,833 $14,007.74 109.15% Total Supplies $145,000 $12,083 $13,989.85 $132,917 $121,083.15 91.10% 4.23% 3.67% Other Audit & Accounting $20,000 $1,667 $0.00 $18,333 $17,875.00 97.50% Legal $5,000 $417 $4,583 $2,200.00 48.00% Rent $30,000 $2,500 $2,650.00 $27,500 $28,700.00 104.36% Utilities $65,000 $5,417 $3,991.13 $59,583 $45,577.77 76.49% Communications $63,000 $5,250 $2,195.06 $57,750 $48,133.45 83.35% Postage $18,000 $1,500 $3,212.00 $16,500 $16,581.30 100.49% Insurance $25,000 $2,083 $2,219.45 $22,917 $18,312.36 79.91% Dues/Memberships $22,000 $1,833 $2,066.06 $20,167 $18,361.94 91.05% Publications $4,000 $333 $34.95 $3,667 $1,077.24 29.38% Marketing $2,500 $208 $100.00 $2,292 $1,332.50 58.15% Equip. Maint. $20,000 $1,667 $1,715.97 $18,333 $17,001.86 92.74% Facility Maint $37,000 $3,083 $6,482.45 $33,917 $41,347.35 121.91% Recruit & Ret $10,000 $833 $0.00 $9,167 $6,417.80 70.01% Continuing Ed. $15,000 $1,250 $1,500.00 $13,750 $8,596.23 62.52% Bank Services $2,000 $167 $201.50 $1,833 $1,789.99 0.00% Pt. Transp. $0 $0 $0.00 $0 $0.00 Cash Reserve $0 $0 $0.00 $0 $0.00 Loss on Fixed Assets $0 $0 $0.00 $0 $1,650.00 Total Other $338,500 $28,208 $26,368.57 $310,292 $274,954.79 88.61% 9.88% 8.34% Operational Budget $3,425,250 $285,438 $317,261.77 $3,139,813 $3,295,723.15 104.97% 98.99% Fixed Assets $35,000 $2,917 $0.00 $32,083.33 $54,942.00 171.25% CIP Grant $0 $0 $0.00 $0 $0.00 TOTAL BUDGET $3,460,250 $288,354 $317,261.77 $3,171,896 $3,350,665.15 105.64%