Financial Statements Overview

How Companies Keep Score

Leer Ondernemen
November 2013

This information is confidential and was prepared by Bain & Company solely for training purposes; it is not to be relied on by any 3rd party without Bain's prior written consent.

Agenda

Introduction
Financial statements
Income statement

Balance sheet

Cash flow statement

Key concepts
This information is confidential and was prepared by Bain & Company solely for training purposes; it is not to be relied on by any 3rd party without Bain's prior written consent.

Businesses are machines designed to make money,

accounting shows us how they work
Accounting shows
how investors put
money into the
business

Accounting tells us
how the assets are
purchased

Accounting shows us
how money is
returned to investors

Accounting shows us
how the business
makes money

- Debt or equity?

- How much?
This information is confidential and was prepared by Bain & Company solely for training purposes; it is not to be relied on by any 3rd party without Bain's prior written consent.

There are two types of accounting, our focus in this

section is on financial accounting
FINANCIAL ACCOUNTING

MANAGERIAL ACCOUNTING

What is it?

Financial reports mainly for

external stakeholders such as
creditors, investors, lenders,
and regulators

Financial information required

by managers to make day-today and short-term decisions

Intended
audience:

External: Shareholders,
banks, analysts, regulators

Internal: Executives,
Managers

Key questions
(examples):

How profitable is the

business?
How much does the business
owe, or is owed to it?
What is the cash position?

What are the profitable

product lines?
What does it cost to increase
production output?

External audience,
standardized format,
heavily regulated

Internal audience,
individual format,
loosely regulated

This information is confidential and was prepared by Bain & Company solely for training purposes; it is not to be relied on by any 3rd party without Bain's prior written consent.

Businesses are money-making machines, financial

statements show how they work

How are the assets

making up the
machine funded?

How much money

does the machine
make?

Cash flow statement

How does cash move in
and out of the
machine?

This information is confidential and was prepared by Bain & Company solely for training purposes; it is not to be relied on by any 3rd party without Bain's prior written consent.

Financial statements provide an excellent source of

information

How much money does the company make?

How efficient are the companys operations?
Why is the company losing money?
How do they return money to their investors?
And much, much more

This information is confidential and was prepared by Bain & Company solely for training purposes; it is not to be relied on by any 3rd party without Bain's prior written consent.

Now lets turn our attention to the business world

INCOME
STATEMENT

BALANCE SHEET
Shows:

Resources
available for use
Claims of parties
against resources

Timeframe:

Basic
equation:

Snapshot at a
point in time

Financial results
from business
operations

Sources and uses

of cash

Flows over a
period of time

Flows over a
period of time

Liabilities
Assets =

+
Equity

CASH FLOW
STATEMENT

Revenues

Beginning cash

Expenses

+/- Operating cash flow

Profit

+/- Investing cash flow

+/- Financing cash flow

Ending cash
This information is confidential and was prepared by Bain & Company solely for training purposes; it is not to be relied on by any 3rd party without Bain's prior written consent.

Agenda

Introduction
Financial statements
Income statement

Balance sheet

Cash flow statement

Key concepts
This information is confidential and was prepared by Bain & Company solely for training purposes; it is not to be relied on by any 3rd party without Bain's prior written consent.

The income statement shows how money is made

Millions of individual transactions

Revenues
and
expenses

Profit
This information is confidential and was prepared by Bain & Company solely for training purposes; it is not to be relied on by any 3rd party without Bain's prior written consent.

The income statement summarizes revenues and

expenses

Revenues

Expenses

Inflows of money or
other assets

Outflows of money or
other resources

Received in exchange
for goods sold or
services rendered

Made by a company
to:

Profit (loss)
Amount left over for
investors after
business costs are
covered

-Purchase supplies or
services (including
labor)
-Account for the use
of a fixed asset
(depreciation)
-Pay other obligations
(interest, taxes)

This information is confidential and was prepared by Bain & Company solely for training purposes; it is not to be relied on by any 3rd party without Bain's prior written consent.

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To summarize, the income statement shows how the

business "machine" makes money
Revenues
-

Cost of goods sold (COGS)

Gross profit

Operating expenses (OpEx)

Operating profit (EBIT)

Non-operating revenues

Non-operating expenses

Income before extraordinary items

+/-

Extraordinary items

Provision for taxes

Net income

Each line tells something about how the

company functions and makes money
This information is confidential and was prepared by Bain & Company solely for training purposes; it is not to be relied on by any 3rd party without Bain's prior written consent.

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Agenda

Introduction
Financial statements
Income statement

Balance sheet

Cash flow statement

Key concepts
This information is confidential and was prepared by Bain & Company solely for training purposes; it is not to be relied on by any 3rd party without Bain's prior written consent.

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The balance sheet shows a snapshot in time of the

basic accounting equation
Assets

Owners equity

Resources available for use by

the business

Claims of the owners on the

resources of the firm

Resources whose sale,

consumption or utilization will
yield a benefit for the firm

Results from direct investment

and reinvestment of earnings

+
Liabilities
Claims of creditors on the assets
of the firm
Liabilities are the firms debts

Shows the financial position (resources and claims on

those resources) of a company at a specific point in time
This information is confidential and was prepared by Bain & Company solely for training purposes; it is not to be relied on by any 3rd party without Bain's prior written consent.

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Agenda

Introduction
Financial statements
Income statement

Balance sheet

Cash flow statement

Key concepts
This information is confidential and was prepared by Bain & Company solely for training purposes; it is not to be relied on by any 3rd party without Bain's prior written consent.

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What is cash flow?

Cash flow is the measure of a business strategic value
-Investors demand cash returns
-Suppliers and employees require cash compensation
-Investment in new facilities is impossible without cash
-Companies cannot pay down debt without cash
-Companies may miss an acquisition opportunity without
enough cash
-Cash is necessary to survive an economic drought

Accounting can mask a companys true strategic value

-Earnings or net income do not equal cash flow
-Accounting principles can be used to manage earnings, but
cash is harder to manipulate

We care about cash flow because

CASH IS KING!
This information is confidential and was prepared by Bain & Company solely for training purposes; it is not to be relied on by any 3rd party without Bain's prior written consent.

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What is cash flow?

Major sources

Major uses

Operating activities

Operating activities

- Operating profits
- Decrease in working
capital

- Operating losses
- Increase in working
capital

Investing activities
- Sale of fixed assets

Financing activities
- Long-term borrowing
- Issue of shares

Investing activities
- Purchase of fixed assets

Financing activities
- Repayment of loans
- Payment of dividends

This information is confidential and was prepared by Bain & Company solely for training purposes; it is not to be relied on by any 3rd party without Bain's prior written consent.

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Relative cash position

Cash flow varies over a companys business cycle

Positive cash flow

May begin to pay back
debt and loans

Mature
business

Declining
business
Drop in cash in preparation
to exit the industry
Inventories & expenditures
are cut back
Excess cash used to pay
off debt and invest in new
businesses

Growing
business

New
business

Cash inflow now exceeds cash outflow

However cash still not sufficient to cover
purchases, opening of offices, building of
inventory, etc.
May need to borrow from outside sources or issue
stock to raise cash

Need cash to acquire property, plant, equipment, and inventory

Borrow cash or sell stock to finance capital expenditures
Need time to generate revenue as products are developed
This information is confidential and was prepared by Bain & Company solely for training purposes; it is not to be relied on by any 3rd party without Bain's prior written consent.

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Earnings do not equal cash flow - examples

Company

Accounting decision

Earnings impact

Cash impact

Coke

Write down of impaired assets and

inventory--adjustment of bottling
facilities and inventory in Russia and
Japan to fair value

-$813M

Nil

BC Rail
(Canada)

Write down of impaired assets-adjustment of railroad equipment to

ensure value of assets did not exceed
expected value of future cash flows
generated from the railroad equipment

-$600M

Nil

First
America
Bank

Change of accounting for deferred

revenue contracts

$56M

Nil

Cannot use earnings as proxy

for cashflow
This information is confidential and was prepared by Bain & Company solely for training purposes; it is not to be relied on by any 3rd party without Bain's prior written consent.

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What does cash flow tell us?

OPERATING
CASH FLOW
Ability of business
recurring operations
to generate cash

Strategic value
of business

INVESTING
CASH FLOW
Ability of business
investment
decisions to
generate cash

FINANCIAL
CASH FLOW
How company is
funding its
operations

Financial and
operational
strategies of
business

This information is confidential and was prepared by Bain & Company solely for training purposes; it is not to be relied on by any 3rd party without Bain's prior written consent.

Financial
strategy

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Cash flow cookbook

1.

Earnings before interest and tax (EBIT)

2.

Depreciation

+/- 3.
- 4.
-

5.

+/- 6.
=

Other non-cash operating income/expenses

Increase in working capital (excluding cash)
Taxes paid
Tax impact of interest income/expense

Operating cash flow

7. Capital expenditure
+ 8. Proceeds from sales
=

Investing cash flow

+/- 9.

Interest income/expense

+/- 10. Tax impact of interest income/expense

+/- 11. Change in long-term debt/liabilities
+/- 12. Change in outstanding stocks/shares
-

13. Dividends

+/- 14. Change in other accounts

=

Financing cash flow

Net cash flow (which will reconcile with change in cash*)

*Cash is defined as cash plus marketable securities minus short-term notes

This information is confidential and was prepared by Bain & Company solely for training purposes; it is not to be relied on by any 3rd party without Bain's prior written consent.

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The short-term cash situation is mainly depending on

working capital (and working capital days)

Net working capital days outstanding

=
Days sales outstanding

Account receivables
Sales

Days inventory
outstanding
Inventory

* 365

Average number of
days a company takes
to collect money from
its clients

COGS

Days payable
outstanding

Account payables

* 365

Average number of
days the company holds
its inventory before
selling it

COGS

* 365

Average number of
days a company takes
to pay its suppliers

This information is confidential and was prepared by Bain & Company solely for training purposes; it is not to be relied on by any 3rd party without Bain's prior written consent.

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WC performance driven by industry, but also huge

differences within industries
Net working capital days outstanding
220

180

NWC days = DSO + DIO - DPO

Source: CFO Europe
This information is confidential and was prepared by Bain & Company solely for training purposes; it is not to be relied on by any 3rd party without Bain's prior written consent.

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