Digging Into The Balance Sheet and Income Statement Jim Menard, CCE email: jsmenard62@gmail.com The Balance Sheet Also called the statement of condition or statement of financial position Financial Condition Shows the financial condition or financial position of a company on a particular date 2-2
2-3 Financial Condition (cont.) Assets = Liabilities + Stockholders equity Assets = What the firm owns Liabilities = What the firm owes to outsiders Stockholders equity = What the firm owes to the owners 2-4
Assets Generally presented in order of liquidity Common Balance Sheet Accounts/Groupings Current Assets Cash and Marketable Securities Accounts Receivable Inventories Prepaid Expenses Long-Term Assets Property, Plant, and Equipment Other Assets 2-5 A Few Definitions Current Assets-Cash or other assets expected to be converted into cash within one year or one operating cycle, whichever is longer Operating Cycle-Time required to purchase or manufacture inventory, sell the product, and collect the cash 2-6
A Few Definitions (cont.) Working Capital (Net working capital) designates the amount by which current assets exceed current liabilities Current Assets Current Liabilities 2-7 Cash and Marketable Securities Two accounts are often combined as Cash and Cash Equivalents cash in any form Also called short-term term investments Temporarily invested to earn a return Have short-term term maturities May include T-bills, T certificates, notes, bonds, CD s s and commercial paper 2-8
Accounts Receivable Arise from sales transactions to customers on credit Reported on the balance sheet at NET REALIZABLE VALUE Net Realizable Value = Accounts Receivable - Allowance for Doubtful Accounts 2-9 A Word on the Allowance Management must estimate the dollar amount of accounts receivable they expect to be uncollectible Affects balance sheet valuation AND bad debt expense on income statement Can be important in assessing earnings quality-- --changes should be analyzed 2-10
Inventories Items held for sale or used in the manufacture of products that will be sold Retail Company One type of inventory: Finished goods Manufacturing Company Three types of inventories: Raw materials Work-in in-process Finished goods 2-11 Inventories (cont.) Accounting method chosen to value inventory and the associated measurement of cost of goods sold have a considerable impact on a company s s financial position and operating results 2-12
Inventory Accounting Methods Three cost flow assumptions: FIFO (First In, First Out) LIFO (Last In, First Out) Average cost 2-13 Inventory Accounting Methods (cont.) LIFO During Inflation Produces the highest COGS expense and the lowest ending inventory valuation Matches current costs to current sales 2-14
Inventory Accounting Methods (cont.) FIFO During Inflation Produces the lowest COGS expense and the highest ending inventory valuation Values ending inventory at current cost 2-15 Inventory Accounting Methods (cont.) Inventory valuation may significantly affect BOTH the balance sheet and the income statement Disclosure of inventory cost flow assumption found in notes Inventory reported on balance sheet at LOWER OF COST OR MARKET 2-16
Prepaid Expenses Represent expenses paid in advance-- included in current assets if they expire within one year or one operating cycle Usually not a material item Present few or no reporting or valuation issues 2-17 Property, Plant, and Equipment (PP&E) Encompasses a company s s fixed assets Also called tangible, long-lived, lived, and capital assets Fixed assets other than land are depreciated over the period of time they benefit the firm process of depreciation is method of allocating the cost of long-lived lived assets 2-18
Property, Plant, and Equipment (PP&E) (cont.) On any balance sheet date, PP&E is shown at BOOK VALUE Book value = original cost - accumulated depreciation to date 2-19 Property, Plant, and Equipment (PP&E) (cont.) Depreciation methods: Straight line spreads the expense evenly by periods Accelerated yields higher depreciation expense in the early years of an asset s useful life, and lower depreciation expense in the later years Units of production bases depreciation expense for a given period on actual use 2-2020
Other Assets Can include multitude of other noncurrent items such as: Property held for sale Start-up costs in connection with a new business Cash surrender value of life insurance policies Long-term advance payments Long-term investments Intangible assets 2-2121 Other Assets Intangible Goodwill Most important for analytical purposes because of its real VALUE! Arises when one company acquires another company for a price in excess of the fair market value of the net identifiable assets acquired 2-2222
Liabilities Represent claims against assets by creditors Current Liabilities must be satisfied in one year or one operating cycle and include: Accounts Payable Notes Payable Current Portion of Long-Term Debt Accrued Liabilities Unearned Revenue Deferred Taxes 2-2323 Liabilities (cont.) Accounts Payable Short-term term obligations that arise from credit extended by suppliers for the purchase of goods and services Account is eliminated when the bill is satisfied Significant changes from period to period often result from changes in sales volume, economic conditions or credit policies available to firm from its suppliers 2-2424
Liabilities (cont.) Notes Payable Short-term term obligations in the form of promissory notes and/or lines of credit to suppliers or financial institutions 2-2525 Liabilities (cont.) Current Maturities of Long-Term Debt When a firm has bonds, mortgages, or other forms of long-term debt outstanding, the portion of the principal that will be repaid during the upcoming year is classified as a current liability 2-2626
Liabilities (cont.) Accrued Liabilities Result from recognition of expenses before they are actually paid Under accrual accounting, expenses are recognized when INCURRED and thus ACCRUED, not when paid in cash In this case, cash flow succeeds expense recognition 2-2727 Liabilities (cont.) Unearned Revenue or Deferred Credits Result from prepayments received in advance for services or products Under accrual accounting, revenue is recognized when EARNED, not when cash is received In this case, cash flow precedes revenue recognition 2-2828
Liabilities (cont.) Deferred Federal Income Taxes Result of temporary differences in the recognition of revenue and expense for taxable income relative to reported financial income 2-2929 Noncurrent Liabilities Long-Term Debt Bonds Long-Term Notes Payable Mortgages Obligations under leases Pension Liabilities Long-Term Warranties 2-30
Stockholders Equity Ownership equity is the residual interest in assets that remains after deducting liabilities 2-31 Statement of Shareholder s Equity Exhibit 4-10 METRO ONE TELECOMMUNICATIONS, INC. Statement of Shareholders' Equity Shareholders' Equity (in thousands) Common Stock Retained Earnings (Accumulated Shareholders' Shares Amount Deficit) Equity Balances at December 31, 1998 16,782 $ 38,477 $ (10,235) $ 28,242 Employee stock options exercised, net 339 $ 1,831 $ - $ 1,831 Net income - $ - $ 1,906 $ 1,906 Balances at December 31, 1999 17,121 $ 40,308 $ (8,329) $ 31,979 Employee stock options exercised, net 587 $ 3,426 $ - $ 3,426 Employee stock purchase plan 39 $ 257 $ - $ 257 Net income - $ - $ 9,742 $ 9,742 Balances at December 31, 2000 17,747 $ 43,991 $ 1,413 $ 45,404 Issuance of common stock, net 6,000 $ 64,607 $ - $ 64,607 Shares issued in business combination 155 $ 3,200 $ - $ 3,200 Employee stock options exercised 510 $ 3,300 $ - $ 3,300 Tax benefit from stock plan - $ 1,730 $ - $ 1,730 Employee stock purchase plan 51 $ 706 $ - $ 706 Net income - $ - $ 28,422 $ 28,422 Balances at December 31, 2001 24,463 $ 117,534 $ 29,835 $ 147,369 Caution should be exercised not to confuse retained earnings or appropriated retained earnings with cash or any other asset. There is no cash or any other asset in retained earnings. 2-32
Stockholders Equity (cont.) Common Stock Shareholders: Do not ordinarily receive a fixed return Have voting privileges in proportion to ownership interest Dividends are declared at the discretion of a company s s board of directors Additional Paid-In Capital: Reflects the amount by which the original sales price of the stock shares exceeded par value 2-33 Stockholders Equity (cont.) Retained Earnings Is the sum of every dollar a company has earned since its inception, less any payments made to shareholders in the form of cash or stock dividends Beginning retained earnings ± Net income (loss) Dividends = Ending retained earnings 2-34
Stockholders Equity (cont.) Other Equity Accounts Other accounts that can appear in the equity section include: Preferred stock Treasury stock Accumulated other comprehensive income 2-35 Common-Size Balance Sheet Useful analytical tool Expresses each balance sheet item as a percentage of total assets. Shows the relative importance of each line item to the total and magnifies any trends. 2-36
5-1 a. Walgreen Company Vertical Common-Size Balance Sheet - August 31, 2001 and 2000 In percentages 2001 2000 Assets Current assets Cash and cash equivalents 0.2 0.2 Accounts receivable, net 9.0 8.7 Inventories 39.4 39.8 Other current assets 1.1 1.3 Total current assets 49.7 50.0 Common Size Balance Sheet Non-Current Assets P,P&E less depreciation and amortization 49.2 48.3 Other non-current assets 1.1 1.7 Total assets 100.0 100.0 Liabilities and Shareholders' Equity Current Liabilities Short-term borrowing 5.0 0.0 Trade accounts payable 17.5 19.2 Accrued expenses 10.6 11.9 Income taxes 1.0 1.3 Total current liabilities 34.1 32.4 Non-Current Liabilities Deferred income taxes 1.6 1.4 Other non-current liabilities 5.4 6.5 Total non-current liabilities 7.0 7.9 Shareholders' Equity Preferred stock 0.0 0.0 Common stock 0.9 1.1 Paid-in capital 6.8 5.2 Retained earnings 51.2 53.4 Total shareholders' equity 58.9 59.7 Total liabilities and shareholders' equity 100.0 100.0 2-37 The Income Statement Also called the Statement of Earnings Presents: Revenues Expenses Net Income 2-38
Exhibit 4-5 DANA CORPORATION Statement of Income Equity Income In millions Year Ended December 31, 1999 2000 2001 Net sales 13,159 12,317 10,271 Revenue from lease financing 111 143 115 Other income, net 83 231 83 13,353 12,691 10,469 Cost and expenses Cost of sales 10,964 10,599 9,268 Selling, general and administrative expenses 1,192 1,132 985 Restructuring and integration changes 181 173 390 Interest expense 279 323 309 12,616 12,227 10,952 Income (loss) before income taxes 737 464 (483) Estimated taxes on income 251 171 (161) Income (loss) before minority interest and equity in earnings of affiliates 486 293 (322) Minority interest (13) (13) (8) Equity in earnings of affiliates 40 54 32 Net income (loss) 513 334 (298) When a firm accounts for its investments in stocks using the equity method (the investment is not consolidated), the investor reports equity earnings (losses). Equity earnings (losses) are the investor s share of the investee s earnings (losses). 2-39 Net Sales Sales are generally reported net of sales returns and sales allowances A sales return is a cancellation of a sale A sales allowance is a deduction from the original sales invoice price 2-40
Cost of Goods Sold (COGS) Also called Cost of Sales Cost to seller of products or services sold to customers Important for profit determination Largest expense item for many firms Impacted by cost flow assumption used to value inventory Cost of goods sold percentage is: Cost of goods sold Net sales 2-41 Gross Profit First step of profit measurement Difference between net sales and COGS Key analytical tool in assessing a firm s operating performance Gross Profit Margin is: Gross profit Net sales 2-42
Operating Expense Have considerable impact on the firm s current and future profitability Important to track carefully-- --trends, absolute amounts, relationship to sales, relationship to industry competitors 2-43 Operating Expense (cont.) Examples: Selling and administrative Advertising Operating lease payments Depreciation and amortization Repairs and maintenance 2-44
Depreciation and Amortization Depreciation Used to allocate the cost of tangible fixed assets, other than land, that will benefit a business for more than a year, such as: Buildings Machinery Equipment Furniture and Fixtures Motor Vehicles 2-45 Depreciation and Amortization (cont.). Amortization is the allocation process applied to: Leasehold improvements Patents Copyrights Trademarks Licenses Franchises Goodwill Depletion is the allocation process applied to: Oil, water, gas & minerals 2-46
Operating Profit Second step of profit measurement Also called EBIT Earnings Before Interest and Taxes Measures overall performance of company s s operations: sales revenue less expenses associated with generating sales 2-47 Operating Profit (cont.) Provides a basis for assessing the success of a company apart from its financing and investing activities and separate from tax considerations Operating Profit Margin is: Operating profit Net sales 2-48
Other Income (Expense) Includes Revenues/expenses other than from operations Dividend and interest income Interest expense Investment gains/losses Equity earnings/losses Sales of fixed assets gains/losses 2-49 Special Items If companies are affected by the following three items, they must be disclosed separately on the income statement, net of income tax effects or retrospectively applied to prior periods financial statements: Discontinued operations Extraordinary items Accounting changes 2-50
Discontinued Operations Occur when a firms sells or discontinues a clearly distinguishable portion of its business 2-51 Extraordinary Items Gains and losses that meet two criteria: 1. Unusual in nature 2. Not expected to recur in the foreseeable future, considering the firm s s operating environment 2-52
Net Earnings Also called the bottom line Represents the firm s s profit after consideration of ALL revenue and expense Net profit margin is: Net earnings Net sales 2-53 Earnings Quality, Cash Flow, Segmental Accounting Other topics directly related to the income statement: Earnings quality Earnings quality assessment of the quality of reported earnings is an essential element of income statement analysis Cash flow cash flow from operations is a key ingredient in analyzing operating performance Segmental accounting reviewing the contribution by each segment of a diversified company facilitates the analysis of operating performance 2-54
Common-Size Income Statement Useful analytical tool Expresses each income statement item as a percentage of net sales Shows the relative magnitude of various expenses relative to sales, the profit percentages, and the relative importance of other revenues and expenses 2-55 Income Statement - Common Size Analysis Melcher Company Income Statement For the Years Ended December 31 2005 2004 2003 Sales revenue $ 100,000 100.0% $ 95,000 100.0% $ 91,000 100.0% Cost of goods sold 65,000 65.0% 60,800 64.0% 56,420 62.0% Gross profit 35,000 35.0% 34,200 36.0% 34,580 38.0% Operating expenses: Selling expense 14,000 14.0% 11,400 12.0% 10,000 11.0% General expense 16,000 16.0% 15,200 16.0% 13,650 15.0% Total operating expense 30,000 30.0% 26,600 28.0% 23,650 26.0% Operating Income before taxes 5,000 5.0% 7,600 8.0% 10,930 12.0% Taxes related to operations 1,500 1.5% 2,280 2.4% 3,279 3.6% Net Income $ 3,500 3.5% $ 5,320 5.6% $ 7,651 8.4% 2-56
Conclusion Balance Sheet as a date in time. Assets = Liabilities + Equity Income Statement for a period of time. Revenues Expenses Expenses Bottom line profits Common Size Analysis. Balance Sheet \ Income Statement 2-57 Educational Opportunities NACM Classes now On-Line NACM designations CBA / CBF / CCE NACM Conferences Regional / National Western Regional Conference Las Vegas, NV October 2012 2-58
Time for your Questions and thank you for attending this presentation Jim Menard, CCE 2-59