UNDERSTANDING FINANCIAL STATEMENTS FOR BUSINESS LAWYERS, PART 1

& PART 2

First Run Broadcast: October 16 & 17, 2012

1:00 p.m. E.T./12:00 p.m. C.T./11:00 a.m. M.T./10:00 a.m. P.T. (60 minutes)

There are deep interrelationships between financial statements and the documents underlying

business deals. Understanding financial reports – cash flow versus income, tax versus

accounting books, the quality of earnings and analytical ratios – is essential to both due diligence

on a transaction and drafting the operative agreements. Without a confident understanding of

balance sheets and income statements, an attorney cannot help ensure that a client is getting the

benefit of his or her economic bargain. This two-part program will provide you with a practical

guide to financial statements and how they specifically relate to, and sometimes create traps in,

major and routine business transactions, including business mergers, commercial borrowing, and

the sale of business ownership interests.

Day 1 – October 16, 2012:

Most important concepts in business finance and financial statements, and how they

relate to transactional documents

Understanding the components of a company’s capital structure

What does – and doesn’t – a balance sheet tell you?

Understanding the essential difference between earnings v. cash flow/EBIDTA

Relationship of financial statements to reps, warranties, financial covenants

Accounting books v. tax books, and how the difference effects sales of business interests

Day 2 – October 17, 2012:

Understanding ratio analysis in financial statements

Spotting red flags in balance sheets and income statements

Quality of earnings and how that impacts financing a deal and structuring earnouts

How do you better protect investors and parties to a deal

Building regular valuations into business documents

Working with auditors & understanding audit standards

Speaker:

C. Travis Webb is the managing partner of the Denver office of BKD, LLP, a national

accounting and consulting firm. Mr. Webb has nearly 20 years’ experience covering a diverse

set of services such as financial statement audit, Sarbanes-Oxley internal control services,

complex financial modeling and fraud and information technology consulting. He serves a client

base of commercial, service and distribution entities and not-for-profit and governmental

organizations. Mr. Webb received his B.S. in accounting and his M.B.A. from Missouri State

University in Springfield.

VT Bar Association Continuing Legal Education Registration Form

Please complete all of the requested information, print this application, and fax with credit info or mail it with payment to: Vermont Bar Association, PO Box 100, Montpelier, VT 05601-0100. Fax: (802) 223-1573 PLEASE USE ONE REGISTRATION FORM PER PERSON. First Name: _____________________ Middle Initial: _____Last Name: __________________________

Firm/Organization:____________________________________________________________________

Address:___________________________________________________________________________

City:__________________________________ State: _________ ZIP Code: ______________

Phone #:________________________ Fax #:________________________

E-Mail Address: ____________________________________________________________________

I will be attending:

Understanding Financial Statements

for Business Lawyers, Part 1 Teleseminar

October 16, 2012

Early Registration Discount By 10/09/2012 Registrations Received After 10/09/2012

VBA Members: $70.00 Non VBA Members/Atty: $80.00

VBA Members: $80.00 Non-VBA Members/Atty: $90.00

NO REFUNDS AFTER OCTOBER 9, 2012

PLEASE NOTE: Due to New Hampshire Bar regulations, teleseminars cannot be used for New Hampshire CLE credit

PAYMENT METHOD:

Check enclosed (made payable to Vermont Bar Association): $________________ Credit Card (American Express, Discover, MasterCard or VISA) Credit Card # ________________________________________Exp. Date_______ Cardholder: ________________________________________________________

Vermont Bar Association

ATTORNEY CERTIFICATE OF ATTENDANCE

Please note: This form is for your records in the event you are audited Sponsor: Vermont Bar Association Date: October 16, 2012 Seminar Title: Understanding Financial Statements for Business Lawyers, Part 1 Location: Teleseminar Credits: 1.0 General MCLE Luncheon addresses, business meetings, receptions are not to be included in the computation of credit. This form denotes full attendance. If you arrive late or leave prior to the program ending time, it is your responsibility to adjust CLE hours accordingly.

VT Bar Association Continuing Legal Education Registration Form

Please complete all of the requested information, print this application, and fax with credit info or mail it with payment to: Vermont Bar Association, PO Box 100, Montpelier, VT 05601-0100. Fax: (802) 223-1573 PLEASE USE ONE REGISTRATION FORM PER PERSON. First Name: _____________________ Middle Initial: _____Last Name: __________________________

Firm/Organization:____________________________________________________________________

Address:___________________________________________________________________________

City:__________________________________ State: _________ ZIP Code: ______________

Phone #:________________________ Fax #:________________________

E-Mail Address: ____________________________________________________________________

I will be attending:

Understanding Financial Statements

for Business Lawyers, Part 2 Teleseminar

October 17, 2012

Early Registration Discount By 10/10/2012 Registrations Received After 10/10/2012

VBA Members: $70.00 Non VBA Members/Atty: $80.00

VBA Members: $80.00 Non-VBA Members/Atty: $90.00

NO REFUNDS AFTER OCTOBER 10, 2012

PLEASE NOTE: Due to New Hampshire Bar regulations, teleseminars cannot be used for New Hampshire CLE credit

PAYMENT METHOD:

Check enclosed (made payable to Vermont Bar Association): $________________ Credit Card (American Express, Discover, MasterCard or VISA) Credit Card # ________________________________________Exp. Date_______ Cardholder: ________________________________________________________

Vermont Bar Association

ATTORNEY CERTIFICATE OF ATTENDANCE

Please note: This form is for your records in the event you are audited Sponsor: Vermont Bar Association Date: October 17, 2012 Seminar Title: Understanding Financial Statements for Business Lawyers, Part 2 Location: Teleseminar Credits: 1.0 General MCLE Luncheon addresses, business meetings, receptions are not to be included in the computation of credit. This form denotes full attendance. If you arrive late or leave prior to the program ending time, it is your responsibility to adjust CLE hours accordingly.

PROFESSIONAL EDUCATION BROADCAST NETWORK

Speaker Contact Information

Understanding Financial Statements for Business Lawyers,Part 1 & Part 2

Travis WebbBKD, LLP – Denver(o) (303) 861-4545TWEBB@bkd.com

Matt KlauserBKD, LLP – Kansas City(o) (816) 221-6300mklauser@bkd.com

acumen

insight

ideas

attention

reach

expertise

depth

agility

talent

Financial Statements for

Transactional Attorneys

What You Need to Know

Session One

Goals

Improve General Understanding of

Financial Statements

Provide Tips on Challenging the #’s

Share Transactional Observations

2

Presenters C. Travis Webb, CPA

Managing PartnerTravis brings more than 18 years of experience to BKD and our

clients. He serves a client base of commercial, service and

distribution entities and not-for-profit and governmental

organizations. Travis has been a firmwide audit and accounting

technical advisor, a Sarbanes-Oxley internal control consultant,

and a fraud and information technology resource. B.S. degree

from Missouri State University, Springfield.

Mathew Klauser, CPA, CM&AA®

Managing ConsultantMatt provides financial planning, consulting and advisory

services. He assists private equity groups and corporate

acquirers during investment decisions and post-acquisition

integrations. Matt provides guidance in structuring and

negotiating letters of intent, completes in-depth due diligence

procedures and performs net working capital adjustments post-

closing. B.A. degree from Drury University, Springfield,

Missouri.

3

Session One Outline

Understanding Basic Financial Concepts –

Base Lining the Discussion

Stories a Balance Sheet Tells

Earnings vs. Cash Flow vs. EBITDA

4

Session Two Outline

Looking at Capital Structure

Tax Considerations

Reliance on Financials

Ratios and Financial Statement Analysis

Quality of Earnings & Transactional

Lessons

Valuations

5

Typical Legal Audiences

• Business litigation

• Contract disputes (business damage)

• Intellectual property

• Patent, trademark, trade name infringement

• Divorce

• Business interruption

• Bankruptcy

• Transactional

6

UNDERSTANDING

FINANCIALS

7

Rule Makers

FASB and IASB

GAAP and IFRS

The codifications

PCAOB and AICPA

8

Financial Statements

Type

Public vs. Private

NFP & Governmental

Types of Private Financials

Generally Accepted Accounting Principles

(GAAP)

Cash, Tax and Other

9

Financial Harmony

• Like Yin & Yang, there must be harmony

Debit = Credit

• Tells the story of what a company owns,

owes and earns

Assets Revenues & Expenses

Liabilities & Equity Net Results

10

Financial Statement Map

Opinion

Basic Statements

Balance Sheet, Profit & Loss, Cash Flow

Footnotes

Supplementary Information

Consolidating information, detailed expenses,

etc.

11

Basic Statements

Balance Sheet @ 12/31 Profit & Loss - Yr. End 12/31

Assets $100 Revenues $ 100

Liabilities $ 50 Expenses $( 75)

Equity $ 50

Total Liab. & Equity $100 Net Results $ 25

12

Basic Statements

Statement of Equity Cash Flows

Beginning Equity $ 25 Results $ 25

Activities

Results $ 25 Operating $ (10)

Other $ – Investing $ (15)

Financing $ 20

Ending Equity $ 50 Net Cash $ 20

13

Big Picture Considerations

Balance Sheet

Point in time

Not fair value (necessarily)

Profit & Loss

Performance over time

Activity, but not necessarily cash

Cash Flow Statement

Bridge for Balance Sheet to Profit & Loss

How’s a Company truly funded?

14

Footnotes

Significant Account Policies

Details on Major Line Items

Debt and Capital Asset Disclosures

Risks and Uncertainties

Litigation and Other Exposures

15

Basic Principles

Accrual vs. cash

Cost Basis vs. Fair Value

Matching principle

Consistency

16

Management Letters

What else do you need to know…

Defining problems

Material Weakness

Significant Deficiency

Other Deficiencies

17

BALANCE SHEET

EXPOSURES

18

Accounts Receivable

Collectability of aged AR

Concern with specific customers?

Rollforward of allowance

Bad debts being replenished to offset

write-offs?

Allowance increase due to economic

uncertainty?

19

Understanding Inventory

When does Inventory not equal Inventory

FIFO, LIFO, Obsolescence, Valuation

Bill and Hold challenges

Cost build up of manufactured inventory

Cost of Goods Sold Variances

20

Capital Assets

Land, Buildings, Equipment, Capital

Leases and Intangibles

Fair Value vs. Stated Value

Types of depreciation

Impairment

Tax basis considerations

21

Accruals and Contingencies

Recognition rules

Vacation accruals

Pensions and Profit Sharing

Reserves and IBNR’s

Revenue recognition – deferrals and

commitments

22

Off Balance Sheet

Contingencies

Leases

23

Other Considerations

Subsidiaries and variable interests

Which assets/liabilities should and should

not be transferred?

Growth financing considered for

companies with large working capital

needs?

24

EARNINGS / CASH FLOW /

EBITDA

25

Basic Considerations

Cash in

Cash out

Cash commitments

26

What Does a Cash Flow

Statement Say?

Direct vs. Indirect

Impact of Working Capital

27

Unfavorable Cash Flow

Trends Transactions based on EBITDA still dependent

on cash flow

Reconcile reported to adjusted financial

statements

Understand changes in discretionary expenses

Working capital trending analysis

Line of credit needs

Cash conversion cycles

28

Session One Outline

Understanding Basic Financial Concepts –

Base Lining the Discussion

Stories a Balance Sheet Tells

Earnings vs. Cash Flow vs. EBITDA

29

Session Two Outline

Looking at Capital Structure

Tax Considerations

Reliance on Financials

Ratios and Financial Statement Analysis

Quality of Earnings & Transactional

Lessons

Valuations

30

QUESTIONS & ANSWERS

31

acumen

insight

ideas

attention

reach

expertise

depth

agility

talent

Financial Statements for

Transactional Attorneys

What You Need to Know

Session Two

Presenters C. Travis Webb, CPA

Managing PartnerTravis brings more than 18 years of experience to BKD and our

clients. He serves a client base of commercial, service and

distribution entities and not-for-profit and governmental

organizations. Travis has been a firmwide audit and accounting

technical advisor, a Sarbanes-Oxley internal control consultant,

and a fraud and information technology resource. B.S. degree

from Missouri State University, Springfield.

Mathew Klauser, CPA, CM&AA®

Managing ConsultantMatt provides financial planning, consulting and advisory

services. He assists private equity groups and corporate

acquirers during investment decisions and post-acquisition

integrations. Matt provides guidance in structuring and

negotiating letters of intent, completes in-depth due diligence

procedures and performs net working capital adjustments post-

closing. B.A. degree from Drury University, Springfield,

Missouri.

33

Session Two Outline

Looking at Capital Structure

Tax Considerations

Reliance on Financials

Ratios and Financial Statement Analysis

Quality of Earnings & Transactional

Lessons

Valuations

34

CAPITAL STRUCTURE

35

Legal Formation

Corporation – C or S Corp or LLC

Partnerships and Joint Ventures

36

Typical Components

Common and other Stock or Partnership /

Member Equity

Additional Paid in Capital

Retained Earnings

Minority Interests

Other Stock Rights

Warrants, options, phantom rights, etc.

37

TAX CONSIDERATIONS

38

Tax Issues to Consider

Flow Thru vs. C Corp

Timing Differences – Understanding the

M’s

Taxes other than income taxes

State nexus and other issues

Uncertain tax positions

39

RELIANCE ON FINANCIALS

40

Typical Levels of Reliance

Tax Returns

Internal Statements

Compiled

Reviewed

Audited

What’s the Quality of Your Review

41

Differentiating Accountant’s

Reports The different levels of reliance

Concept of Materiality

Below the surface – quality of the work

performed

Types of audit opinions

Unqualified vs. Unmodified, etc.

Due Diligence relative to an audit

42

Due Diligence

Purpose of an audit

Accuracy of reported financial statements

Applies materiality

Purpose of due diligence

Accuracy of normalized financial statements

Adjustments must be considered in light of

purchase price multiple

43

Consideration of Fraud

Auditor’s responsibility

Common Concerns

Overstated revenues

Manipulating estimates

Capitalization rather than expense

Misappropriation

44

Interim Financial Statements

Different month-end and year-end closing

procedures?

Can interim statements be relied on for

closing?

Consider impact of posted and passed

audit adjustments from prior years

45

RATIOS AND STATEMENT

ANALYSIS

46

Analyzing Financials

Horizontal (trend) Analysis – Multi-Year

Vertical (ratio) Analysis – Sales / Assets

Watching for trends

Gross margins

Cash Flows

Unusual changes

47

Basic Ratios

Working Capital

Return on assets / equity

Other important ratios

Asset turnover (utilization)

Average receivable collection period

Gross profit %

EBITDA %

48

QUALITY OF EARNINGS &

TRANSACTIONAL LESSONS

49

Proof of Revenues

Provide comfort, particularly if unaudited

Compare net revenues to cash receipts

Evaluate validation needed to gain comfort

50

Things to Watch For…

Nonrecurring expenses

Personal expenses, officer compensation…

Financial related, but not reported

Nonfinancial due diligence

Relationships Vendors, customers, suppliers

Unrecorded agreements Related party transactions

Sales “understandings”

Conservative vs. appropriate

51

Document Considerations

References to GAAP

Current or Future?

Is that what you really want (subject tointerpretation)

Poor terminology

Structuring an LOI

Avoid specific targets – build flexibility andprotection

Working Capital Needs – Post-Close

52

Budgeting

How consistent are historical results with

budgeting – future is often more critical than the

past

Sensitivity of assumptions?

How repeatable are the results?

What’s the impact of a backlog?

How do historical and budgeted results compare

to industry benchmarks?

53

Business Combinations

Understand how financials of an acquirer

are impacted

Historical basis vs. Step Up

Appropriate cut-off

54

VALUATIONS

55

Considerations

Normalized, not reported earnings

Seller aggressive “add-backs”

EBITDA multiples

What’s the “value” of the management

team

Relevant for post-close salaries, etc.?

56

QUESTIONS & ANSWERS

57

Thank You

Contact Us

Travis Webb

Colorado Managing Partner

1700 Lincoln Street

Suite 1400

Denver, CO 80203

303.861.4545

FAX 303.832.5705

Matt Klauser

Managing Consultant

1201 Walnut Street

Suite 1700

Kansas City, MO 64106

816.221.6300

FAX 816.221.6380

58