Financial Statements to Evaluate a Company (4) - Balance Sheet, Cash Flow Statement, Income Statement, Statement of Shareholder's Equity (Rare) 4 Statements Publishing - Published in periodic and annual filings for companies, often accompanied with fi

Financial Statements to Evaluate a Company (4) - Balance Sheet, Cash Flow Statement, Income Statement, Statement of Shareholder's Equity (Rare) 4 Statements Publishing - Published in periodic and annual filings for companies, often accompanied with financial footnotes and management discussion & analysis (MD&A) Fundamental Accounting Equation - Assets = Liabilities + Shareholders' Equity Assets - the resources a company uses to operate its business and includes cash, accounts receivable, property, plant & equipment (PP&E) Liabilities - the company's contractual obligations and include accounts payable, debt, accrued expenses Shareholder's Equity - the value of the business available to the owners (shareholders) after debts (liabilities) have been paid off Liability/Equity Priority - Liabilities (like debt) are contractual obligations that have priority over equity. Equityholders, on the other hand, are not promised contractual payments. Equity holders are more risk than debt holders. Income Statement - Profitability of a company over a period of time: Net Income = Revenue - Expenses Revenue - Represents the sale of goods and services. It is recorded when earned Expenses - Netted against revenue to arrive at net income Common expenses: cost of goods sold (COGS); selling, general, and administrative (SG&A); interest expense; and taxes. Net income - The "bottom-line." It is revenue - expenses. It is the profitability available to common shareholder's after debt payments have been made Earnings per Share - Portion of a company's profit allocated to each outstanding share of common stock. (net income - dividends on preferred stock) / weighted average shares outstanding) Balance Sheet and Income Statement Relationship - Retained earnings in shareholder's equity, specifically net income. Any profits not distributed to shareholders in the form of dividends should be accounted for in retained earnings. Cash Flow Statement - Reconcile the income statement to cash inflows and outflows. Net Change in Cash Over the Period = Cash Flow from Operating Activities + Cash Flow from Investing Activities + Cash Flow from Financing Activities Cash from operating activities (Indirect) - Section of a company's cash flow statement that explains the sources and uses of cash from ongoing regular business activities in a given period. This typically includes net income from the income statement, adjustments to net income, and changes in working capital. Positive is desirable Cash from investment activities - Cash related to investments in the business. Negative is desirable Cash from financing activities - Cash related to capital raising and payments of dividends. No positive/negative desirability Statement of Shareholder's Equity - Ending Retained Earnings = Beginning Retained Earnings + Net Income - Dividends Why do capital expenditures increase assets (PP&E), while other cash outflows, like paying salary, taxes, etc., do not create any asset, and instead instantly create an expense on the income statement that reduces equity via retained earnings? - A: Capital expenditures are capitalized because of the timing of their estimated benefits - the lemonade stand will benefit the firm for many years. The employees' work, on the other hand, benefits the period in which the wages are generated only and should be expensed then. This is what differentiates an asset from an expense. What is working capital? - A: Working capital is defined as current assets minus current liabilities; it tells the financial statement user how much cash is tied up in the business through items such as receivables and inventories and also how much cash is going to be needed to pay off short term obligations in the next 12 months. Q: Is it possible for a company to show positive cash flows but be in grave trouble? - A: Absolutely. Two examples involve unsustainable improvements in working capital (a company is selling off inventory and delaying payables), and another example involves lack of revenues going forward in the pipeline. Q: I buy a piece of equipment, walk me through the impact on the 3 financial statements. - Initially, there is no impact (income statement); cash goes down, while PP&E goes up (balance sheet), and the purchase of PP&E is a cash outflow (cash flow statement) Over the life of the asset: depreciation reduces net income (income statement); PP&E goes down by depreciation, while retained earnings go down (balance sheet); and depreciation is added back (because it is a non-cash expense that reduced net income) in the cash from operations section (cash flow statement).