"the income statement and cash flows" in minneapolis 2011

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Boot Camp The Income Statement And Cash Flows Oct. 4, 2011

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Jimmy Gentry presents "The Income Statement and Cash Flows" in Minneapolis on Oct. 4, 2011 at the Star Tribune during the Reynolds Center's free workshop, "Business Journalism Boot Camp."For more information about free training for business journalists, please visit businessjournalism.org.

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Page 1: "The Income Statement and Cash Flows" in Minneapolis 2011

Business Journalism Boot Camp

The Income StatementAnd Cash Flows

Oct. 4, 2011

Page 2: "The Income Statement and Cash Flows" in Minneapolis 2011

Donald W. Reynolds National Center For Business Journalism At Arizona State University

Income Statement and Cash Flows

Page 3: "The Income Statement and Cash Flows" in Minneapolis 2011

Income Statement and Cash Flows

James K. Gentry, Ph.D. Clyde M. Reed Teaching Professor School of Journalism and Mass Communication University of Kansas [email protected]

Page 4: "The Income Statement and Cash Flows" in Minneapolis 2011

Income Statement and Cash Flows

Types of Companies Public Private

Financial statements conforming to public company statements

Non-profits

Page 5: "The Income Statement and Cash Flows" in Minneapolis 2011

Income Statement and Cash Flows

Important Terms Unaudited Audited Accountants Certified Public Accountants (CPAs) GAAP, FASB, AICPA, PCAOB

Page 6: "The Income Statement and Cash Flows" in Minneapolis 2011

Income Statement and Cash Flows

Assessing a Company Context Trends Rules Outsiders Insiders

Page 7: "The Income Statement and Cash Flows" in Minneapolis 2011

Income Statement and Cash Flows

Annual Report (or 10-K) Auditor’s report: Clean, qualified? MD&A or Management’s Discussion

and Analysis Financial statements and footnotes Management’s letter if annual report

Page 8: "The Income Statement and Cash Flows" in Minneapolis 2011

Income Statement and Cash Flows

MD&A Must read it Often a source of good information and

insights Densely written Explains financial information SEC says it wants greater transparency

Page 9: "The Income Statement and Cash Flows" in Minneapolis 2011

Income Statement and Cash Flows

Goal of Accounting Record, classify and report financial

transactions. To provide managers across the organization with information that facilitates: Control of activities and expenditure Refinement of operational plans Accountability Reporting on project outcomes Writing of bids for new funds

Page 10: "The Income Statement and Cash Flows" in Minneapolis 2011

Income Statement and Cash Flows

Goal of Finance Maximize shareholder wealth as

reflected in market price of the stock Achieving this goal requires financial

manager to focus on economic profit, not accounting profit

Page 11: "The Income Statement and Cash Flows" in Minneapolis 2011

Income Statement and Cash Flows

Financial Decisions Long-term investment decisions

Capital budgeting: Assets company wants to hold

Long-term financing decisions Capital structure: Funds for long-term

investments Working capital management decisions

Net working capital

Page 12: "The Income Statement and Cash Flows" in Minneapolis 2011

Income Statement and Cash Flows

Generally Accepted Accounting Principles Guidelines based on theory and

practice Evolved over time Procedures, concepts and standards

Page 13: "The Income Statement and Cash Flows" in Minneapolis 2011

Income Statement and Cash Flows

GAAP: Assumptions Periodicity Going concern Economic entity Monetary unit

Page 14: "The Income Statement and Cash Flows" in Minneapolis 2011

Income Statement and Cash Flows

GAAP: Principles Full disclosure Matching Historical cost Revenue realization Consistency

Page 15: "The Income Statement and Cash Flows" in Minneapolis 2011

Income Statement and Cash Flows

GAAP: Underlying Considerations Materiality Industry practices Conservatism

Page 16: "The Income Statement and Cash Flows" in Minneapolis 2011

Income Statement and Cash Flows

Cash or Operating Cycle Cash Purchase inventory Produce product Sell product Cash

Page 17: "The Income Statement and Cash Flows" in Minneapolis 2011

Income Statement and Cash Flows

Cash or Operating Cycle (cont.) “Cash”

Cash Receivables Debt

Inventory Raw materials Work in progress Finished goods

Page 18: "The Income Statement and Cash Flows" in Minneapolis 2011

Income Statement and Cash Flows

Cash or Operating Cycle (cont.) Sell product

Accounts receivable Cash

Cash Collect receivables as cash

Pay off payables Start over

Page 19: "The Income Statement and Cash Flows" in Minneapolis 2011

Income Statement and Cash Flows

Accrual Method Records revenues as soon as the “sale”

occurs Records expenses as soon as the bill is

received IE, transactions enter the financial

records when they occur, not when cash changes hands

Accrual method, therefore, shows “scores,” not real spendable dollars

Page 20: "The Income Statement and Cash Flows" in Minneapolis 2011

Income Statement and Cash Flows

About These Numbers: They’re Squishy Goods will not necessarily be paid for Goods are not necessarily going to be

kept Inventory might be out of date, obsolete

or unsellable Status of some inventory may be

uncertain Intangible assets are estimates

Page 21: "The Income Statement and Cash Flows" in Minneapolis 2011

Income Statement and Cash Flows

About These Numbers: They’re Squishy (cont.) Machinery or other fixed assets might be

obsolete or falling apart long before the so-called useful life is up

Goodwill Accounting conventions Timing issues Bottom line: In many ways, statements

are a collection of estimates.

Page 22: "The Income Statement and Cash Flows" in Minneapolis 2011

Income Statement and Cash Flows

Because They’re Squishy You need to know the rules and

assumptions used to create the numbers

Page 23: "The Income Statement and Cash Flows" in Minneapolis 2011

Income Statement and Cash Flows

Income Statement or ... Statement of earnings Statement of operations Statement of income and

comprehensive income

Page 24: "The Income Statement and Cash Flows" in Minneapolis 2011

Income Statement and Cash Flows

Income Statement Covers a period of time, typically a year

or quarter Reports income from ongoing activities Reports income from activities beyond

management’s control (comprehensive income)

Involves estimates

Page 25: "The Income Statement and Cash Flows" in Minneapolis 2011

Income Statement and Cash Flows

Basic Income Statement Sales or revenues Expenses Taxes Net income or profit

Page 26: "The Income Statement and Cash Flows" in Minneapolis 2011

Income Statement and Cash Flows

Income Statement Sales or revenues Cost of goods sold Gross profit Operating expenses

Sales, general and administrative Depreciation, amortization

Operating profit Other income/expenses Interest Income taxes Net income or profit

Page 27: "The Income Statement and Cash Flows" in Minneapolis 2011

Income Statement and Cash Flows

Cost of Goods Sold Expenses incurred in the cost of

manufacturing or creating or acquiring the product the company sells.

Page 28: "The Income Statement and Cash Flows" in Minneapolis 2011

Income Statement and Cash Flows

Cost of Goods Sold Manufacturer: What the company pays

for inventory, i.e. raw materials and supplies used to make its product(s). Includes price of raw materials plus cost of turning it into a product, and transportation costs, i.e. direct factory labor, overhead costs, energy costs. Inventory is largest percent of CGS for manufacturer.

Page 29: "The Income Statement and Cash Flows" in Minneapolis 2011

Income Statement and Cash Flows

Cost of Goods Sold Retailer: What the company pays

suppliers for the products it sells on its shelves. Only the cost of merchandise purchased for resale, not the cost of providing the service to customers.

Service business: Since it doesn’t make or sell a product per se, typically find a modest CGS.

Page 30: "The Income Statement and Cash Flows" in Minneapolis 2011

Income Statement and Cash Flows

SGA Includes office expenses, accounting,

shipping department, advertising, R&D, depreciation and other expenses that can’t be directly attributed to particular items for sale.

Often includes depreciation and amortization.

Page 31: "The Income Statement and Cash Flows" in Minneapolis 2011

Income Statement and Cash Flows

Other Income/Expenses Discontinued items Unusual/extraordinary items Changes in accounting principle Impairment charge Sale of investment Minority interest

Page 32: "The Income Statement and Cash Flows" in Minneapolis 2011

Income Statement and Cash Flows

Thinking Inside the Box Revenues Minus cost of goods sold Equals gross profit Minus operating expenses Equals operating profit Minus or plus other expenses/income Minus or plus interest expenses/income Minus income taxes Net income

Page 33: "The Income Statement and Cash Flows" in Minneapolis 2011

Income Statement and Cash Flows

Inside the Box Earnings Sales or revenues Cost of goods sold Gross profit Operating expenses

Sales, general and administrative Depreciation, amortization

Operating profit

Page 34: "The Income Statement and Cash Flows" in Minneapolis 2011

Income Statement and Cash Flows

‘One-Time’ Gains That Reoccur Don’t be fooled by extraordinary items

that make the net income look better than it really is

Extraordinary items should be both unusual in nature and infrequent in occurrence

Examples: Writedowns, restructurings, etc.

Page 35: "The Income Statement and Cash Flows" in Minneapolis 2011

Calculating Earnings Per Share

Basic EPS: Net income for period divided by weighted average number shares outstanding.

Diluted EPS: Net income for period divided by weighted average number shares outstanding for period, plus assumption of exercise of all potentially dilutive instruments.

Income Statement and Cash Flows

Page 36: "The Income Statement and Cash Flows" in Minneapolis 2011

Income Statement and Cash Flows

Pro Forma Results Expenses against earnings are not

standardized across an industry Selectively defined earnings SEC’s Regulation G (1/03) states that

non-GAAP numbers used in an earnings release must be accompanied by, and reconciled with, the “most directly comparable GAAP number”

Page 37: "The Income Statement and Cash Flows" in Minneapolis 2011

Income Statement and Cash Flows

Pro Forma Results

Recommendation: GAAP results should precede pro forma results in earnings releases

Headlines should show GAAP earnings Pro forma has value for many companies Common pro forma: EBITDA “As a matter of form”

Page 38: "The Income Statement and Cash Flows" in Minneapolis 2011

Other ‘Nonstandard’ Measures Groupon – Adjusted CSOI or Adjusted

Consolidated Segment Operating Income

Zynga – Bookings Facebook – Monthly active users Pandora – Total listener hours and total

registered users

Income Statement and Cash Flows

Page 39: "The Income Statement and Cash Flows" in Minneapolis 2011

Analyzing the Numbers Note changes in amounts year to year,

especially revenues and expenses Note numbers that are significantly larger or

smaller than the previous period Look at trend line for sales/revenues,

operating income and net income. Calculate percentage change for each.

Tie the numbers to the footnotes.

Income Statement and Cash Flows

Page 40: "The Income Statement and Cash Flows" in Minneapolis 2011

Income Statement and Cash Flows

Statement of Cash Flows Record of cash provided by cash

sources and of cash consumed by cash uses.

Page 41: "The Income Statement and Cash Flows" in Minneapolis 2011

Income Statement and Cash Flows

Cash Flows (cont.) Information about use of cash Information about investing and financing Ability to continue as a going concern Ability to generate future positive cash

flows Ability to meet obligations and pay

dividends

Page 42: "The Income Statement and Cash Flows" in Minneapolis 2011

Income Statement and Cash Flows

Cash Flows From operations From investing From financing

Page 43: "The Income Statement and Cash Flows" in Minneapolis 2011

Income Statement and Cash Flows

Flexibility Companies have some flexibility in

categories for entries. Total change in cash, however, will not

change. Overwhelming majority of all accounting

standards deal with balance sheet and income statement, not cash flows statement.

Page 44: "The Income Statement and Cash Flows" in Minneapolis 2011

Income Statement and Cash Flows

Free Cash Flow Powerful tool for making a company

successful Powerful indicator for investors Cash that is left over after productive

capacity is maintained or expanded Permits expansion, paying down debt,

buying back shares, etc.

Page 45: "The Income Statement and Cash Flows" in Minneapolis 2011

Income Statement and Cash Flows

Free Cash Flow (cont.) Several ways to calculate it Companies create their own models Gross way to do it:

Cash from operating activities Minus capital expenditures Equals free cash flow

Page 46: "The Income Statement and Cash Flows" in Minneapolis 2011

Income Statement and Cash Flows

American Standard Model

Cash from operating activities Minus capital expenditures Plus proceeds from disposal of property Plus proceeds from sale and

leasebacks Equals free cash flow

Page 47: "The Income Statement and Cash Flows" in Minneapolis 2011

Free Cash Models ‘Gross’ method American Standard method VF method

Cash from operating minus cash from investing

Income Statement and Cash Flows

Page 48: "The Income Statement and Cash Flows" in Minneapolis 2011

Income Statement and Cash Flows

Techniques Calculate percentage change Trend analysis Common size analysis Ratio analysis