What Do All the Numbers Mean?
FINANCIAL STATEMENTS are a summary of all financial transactions that have taken place within the company. Before an analysis of the financial statements can be made, you must have a basic understanding of the terminology used. The following list details the most widely used terms in financial statements. This list corresponds to the items listed on the financial statement at the end of this chapter. Make a photo-copy and check against the various categories as you read through the terms and their applications.
(A) The Balance Sheet is a statement of the assets, liabilities, and net worth of the company at any given time.
1. Current assets are assets which will generally convert to cash within twelve months.
2. Property and equipment are assets that have a useful life to the business over a substantial period of time, and which are amortized (or depreciated) over this useful life.
3. Other assets are assets that cannot be listed in categories one and two. They are often not liquid and are held for some purpose other than the general operation of the business. This may include purchased goodwill, securities held for investments, etc.
4. Current liabilities are those liabilities which are expected to be paid within twelve months or within the operating cycle of the business.
5. Long-term debt comprises liabilities which are due to mature beyond twelve months. Only the twelve-month maturities are in the current liability section.
6. Stockholders equity is the book value or book equity of a corporation. It consists of the original investment and subsequent investments by the shareholders, plus the net earnings retained in the business. The stockholders' equity is reduced by any dividends paid.
7. The equivalent of stockholders equity in an unincorporated business is called Proprietor's Equity. This is the money the owners have put into the business, plus profits remaining in the business, less any funds taken by the owners, and less any losses of the business.
(B) The Statement of Income is the statement that shows the final results of all the revenue and expense transactions of the business. They either produce profit or a loss.
1. Sales are generally the first item on the income statement, indicating the amount of sales for the period indicated.
2. Cost of goods sold is the direct cost of the items sold during the period. In a manufacturing business, this would include direct materials, labor, and overhead. A service business generally does not have cost of goods sold.
3. Gross profit is the profit before operating expenses of the business. Gross profit is the result of sales minus the cost of goods sold. This is often called the gross margin.
4. Selling and administrative expenses are the operating expenses of the business.
5. Income before officers compensation is the income before any compensation is paid to officers. Many companies like to have this number shown on the income statement so that they can explain to bankers and other users of the statements what the income of the business is without consideration of the owners or officers compensation.
6. Compensation paid to officers is shown separately to display to the users the amount of monies being taken by officers and/or owners.
7. Income before provision for income tax is the pretax earnings of the business. Proprietorships, partnerships and S Corporations usually do not have this item on their income statement. The proprietors and/or partners of an unincorporated business and the shareholders of an S Corporation report their share of the income on their personal tax returns. Their tax expense is not that of the business.
8. Net income is the bottom line. This is the profit or loss of the business.
(C) Statement of Cash Flows. The Statement of Cash Flows is quite a meaningful statement. It tells you where the cash went. Cash-in vs. cash-out from an historical perspective.
The Statement of Cash Flows includes three sections: cash flows from operating activities, from investing activities and from financing activities.
1. CASH FLOWS FROM OPERATING ACTIVITIES. The cash flows from operating activities will generally include the cash inflows and outflows derived from the actual business activity. The major source of cash for most businesses will be cash receipts from customers. The major expenditure within the operating activities will be cash paid to suppliers and employees.
This section will also include, but will not be limited to, interest paid, interest received, taxes paid and/ or tax refunds received and any other items that would be of an operating nature.
2. CASH FLOWS FROM INVESTING ACTIVITIES. This section in the Statement of Cash Flows will include a summary of cash inflows and outflows from investing activities. Investing activities include:
a) Monies received from the sale of property and equipment used in the business.
b) The receipts from the sale of equity investments in other enterprises and for returns from the investments in those enterprises. It does not include the return on investments. The return on the investments is included in cash flows from operating activities.
Cash outflows include payments for equity interest in other enterprises and disbursements for loans made by the enterprise.
3. CASH FLOWS FROM FINANCING ACTIVITIES. Cash inflows and outflows from financing activities include:
c) Inflows: proceeds from issuing equity instruments, and proceeds from various long or short term borrowings.
d) Outflows: repayment of borrowed funds, dividends or other distributions to owners.
As you can see, the classification of an outflow or inflow of cash between the various sections can be complex. However, for most closely held businesses, the statements should be easy to read and answer the question: Where did the money go?
The Statement of Cash Flows also includes a reconciliation of net in-come to net cash provided by (used in) operating activities with additional information required.
USING RATIOS TO INTERPRET THE DATA
The financial statement alone will give some indication of the company's health, but seeing beyond the raw data, greater analysis is necessary. Most accountants and users of financial statements use ratio analysis. This is an excellent tool to determine the health of the company, and whether management has made good use of company resources.
See ratios here
FINANCIAL STATEMENTS are a summary of all financial transactions that have taken place within the company. Before an analysis of the financial statements can be made, you must have a basic understanding of the terminology used. The following list details the most widely used terms in financial statements. This list corresponds to the items listed on the financial statement at the end of this chapter. Make a photo-copy and check against the various categories as you read through the terms and their applications.
(A) The Balance Sheet is a statement of the assets, liabilities, and net worth of the company at any given time.
1. Current assets are assets which will generally convert to cash within twelve months.
2. Property and equipment are assets that have a useful life to the business over a substantial period of time, and which are amortized (or depreciated) over this useful life.
3. Other assets are assets that cannot be listed in categories one and two. They are often not liquid and are held for some purpose other than the general operation of the business. This may include purchased goodwill, securities held for investments, etc.
4. Current liabilities are those liabilities which are expected to be paid within twelve months or within the operating cycle of the business.
5. Long-term debt comprises liabilities which are due to mature beyond twelve months. Only the twelve-month maturities are in the current liability section.
6. Stockholders equity is the book value or book equity of a corporation. It consists of the original investment and subsequent investments by the shareholders, plus the net earnings retained in the business. The stockholders' equity is reduced by any dividends paid.
7. The equivalent of stockholders equity in an unincorporated business is called Proprietor's Equity. This is the money the owners have put into the business, plus profits remaining in the business, less any funds taken by the owners, and less any losses of the business.
(B) The Statement of Income is the statement that shows the final results of all the revenue and expense transactions of the business. They either produce profit or a loss.
1. Sales are generally the first item on the income statement, indicating the amount of sales for the period indicated.
2. Cost of goods sold is the direct cost of the items sold during the period. In a manufacturing business, this would include direct materials, labor, and overhead. A service business generally does not have cost of goods sold.
3. Gross profit is the profit before operating expenses of the business. Gross profit is the result of sales minus the cost of goods sold. This is often called the gross margin.
4. Selling and administrative expenses are the operating expenses of the business.
5. Income before officers compensation is the income before any compensation is paid to officers. Many companies like to have this number shown on the income statement so that they can explain to bankers and other users of the statements what the income of the business is without consideration of the owners or officers compensation.
6. Compensation paid to officers is shown separately to display to the users the amount of monies being taken by officers and/or owners.
7. Income before provision for income tax is the pretax earnings of the business. Proprietorships, partnerships and S Corporations usually do not have this item on their income statement. The proprietors and/or partners of an unincorporated business and the shareholders of an S Corporation report their share of the income on their personal tax returns. Their tax expense is not that of the business.
8. Net income is the bottom line. This is the profit or loss of the business.
(C) Statement of Cash Flows. The Statement of Cash Flows is quite a meaningful statement. It tells you where the cash went. Cash-in vs. cash-out from an historical perspective.
The Statement of Cash Flows includes three sections: cash flows from operating activities, from investing activities and from financing activities.
1. CASH FLOWS FROM OPERATING ACTIVITIES. The cash flows from operating activities will generally include the cash inflows and outflows derived from the actual business activity. The major source of cash for most businesses will be cash receipts from customers. The major expenditure within the operating activities will be cash paid to suppliers and employees.
This section will also include, but will not be limited to, interest paid, interest received, taxes paid and/ or tax refunds received and any other items that would be of an operating nature.
2. CASH FLOWS FROM INVESTING ACTIVITIES. This section in the Statement of Cash Flows will include a summary of cash inflows and outflows from investing activities. Investing activities include:
a) Monies received from the sale of property and equipment used in the business.
b) The receipts from the sale of equity investments in other enterprises and for returns from the investments in those enterprises. It does not include the return on investments. The return on the investments is included in cash flows from operating activities.
Cash outflows include payments for equity interest in other enterprises and disbursements for loans made by the enterprise.
3. CASH FLOWS FROM FINANCING ACTIVITIES. Cash inflows and outflows from financing activities include:
c) Inflows: proceeds from issuing equity instruments, and proceeds from various long or short term borrowings.
d) Outflows: repayment of borrowed funds, dividends or other distributions to owners.
As you can see, the classification of an outflow or inflow of cash between the various sections can be complex. However, for most closely held businesses, the statements should be easy to read and answer the question: Where did the money go?
The Statement of Cash Flows also includes a reconciliation of net in-come to net cash provided by (used in) operating activities with additional information required.
USING RATIOS TO INTERPRET THE DATA
The financial statement alone will give some indication of the company's health, but seeing beyond the raw data, greater analysis is necessary. Most accountants and users of financial statements use ratio analysis. This is an excellent tool to determine the health of the company, and whether management has made good use of company resources.
See ratios here