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 OverviewHow 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. 2
Agenda
Introduction
Key concepts
Financial statements
Income statement Balance sheet Cash flow statement
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. 3
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
-Debt or equity?
• Accounting shows us how the business makes money
• Accounting shows us how money is returned to investors
-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. 4
There are two types of accounting, our focus in this section is on financial accounting
Intended audience:
Key questions (examples):
What is it?
FINANCIAL ACCOUNTING MANAGERIAL ACCOUNTING
• External: Shareholders, banks, analysts, regulators
• Internal: Executives, Managers
• 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?
• Financial reports mainly for external stakeholders such as creditors, investors, lenders, and regulators
• Financial information required by managers to make day-to-day and short-term decisions
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. 5
Businesses are money-making “machines,” financial statements show how they work
Cash flow statement
• How much money does the “machine” make?
• How does cash move in and out of the “machine”?
• How are the assets making up the “machine” funded?
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. 6
Financial statements provide an excellent source of information
• How much money does the company make?
• How efficient are the company’s 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. 7
Now let’s turn our attention to the business world
Shows:
Timeframe:
Basic equation: Assets
Liabilities
Equity
= +
Revenues
Expenses
Profit
- +/- Operating cash flow
+/- Investing cash flow
+/- Financing cash flow
Beginning cash
Ending cash
BALANCE SHEETINCOME
STATEMENTCASH FLOW STATEMENT
• Resources available for use
• Claims of parties against resources
• Financial results from business operations
• Sources and uses of cash
• Flows over a period of time
• Flows over a period of time
• Snapshot at a 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. 8
Agenda
Introduction
Key concepts
Financial statements
Income statement Balance sheet Cash flow statement
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. 9
The income statement shows how money is made
Profit
Millions of individual transactions
Revenues and
expenses
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. 10
The income statement summarizes revenues and expenses
Revenues Expenses Profit (loss)- =
• Outflows of money or other resources
• Made by a company to:
-Purchase supplies or services (including labor)
-Account for the use of a fixed asset (depreciation)
-Pay other obligations (interest, taxes)
• Amount left over for investors after business costs are covered
• Inflows of money or other assets
• Received in exchange for goods sold or services rendered
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. 11
To summarize, the income statement shows how the business "machine" makes money
Net income=
Extraordinary items+/-
Provision for taxes-
Income before extraordinary items=
Non-operating revenues+
Non-operating expenses-
Operating expenses (OpEx)-
Operating profit (EBIT)=
Revenues
Cost of goods sold (COGS)-
Gross profit=
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. 12
Agenda
Introduction
Key concepts
Financial statements
Income statement Balance sheet Cash flow statement
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. 13
The balance sheet shows a snapshot in time of the basic accounting equation
Assets
Liabilities
Owners’ equity=
+
Shows the financial position (resources and claims on those resources) of a company at a specific point in time
• Claims of the owners on the resources of the firm
• Results from direct investment and reinvestment of earnings
• Claims of creditors on the assets of the firm
• Liabilities are the firm’s debts
• Resources available for use by the business
• Resources whose sale, consumption or utilization will yield a benefit for the firm
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. 14
Agenda
Introduction
Key concepts
Financial statements
Income statement Balance sheet Cash flow statement
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. 15
What is cash flow?
We care about cash flow because CASH IS KING!
•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 company’s 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
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. 16
What is cash flow?
Major sources
• Operating activities
- Operating profits
- Decrease in working capital
• Investing activities
- Sale of fixed assets
• Financing activities
- Long-term borrowing
- Issue of shares
• Operating activities
- Operating losses
- Increase in working capital
• Investing activities
- Purchase of fixed assets
• Financing activities
- Repayment of loans
- Payment of dividends
Major uses
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. 17
Cash flow varies over a company’s business cycle
Newbusiness
• 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
Growingbusiness
• 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
Maturebusiness
• Positive cash flow• May begin to pay backdebt and loans
Decliningbusiness
• 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
Rela
tive c
ash p
ositio
n
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. 18
Earnings do not equal cash flow - examples
• 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
• Coke -$813M • Nil• Write down of impaired assets and inventory--adjustment of bottling facilities and inventory in Russia and Japan to fair value
• BC Rail (Canada)
-$600M • Nil
• Change of accounting for deferred revenue contracts
• First America Bank
$56M • Nil
Company Accounting decision Earnings impact Cash impact
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. 19
What does cash flow tell us?
• Ability of business’ investment decisions to generate cash
• Ability of business’ recurring operations to generate cash
• How company is funding its operations
FINANCIALCASH FLOW
INVESTINGCASH FLOW
OPERATINGCASH FLOW
Financial strategy
Financial and operational
strategies of business
Strategic value 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. 20
Cash flow cookbook
*Cash is defined as “cash plus marketable securities minus short-term notes”
Financing 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
Net cash flow (which will reconcile with change in cash*)
-
=
+/-
+/-
+/-
+/-
+/-
1. Earnings before interest and tax (EBIT)
2. Depreciation
3. Other non-cash operating income/expenses
4. Increase in working capital (excluding cash)
5. Taxes paid
6. Tax impact of interest income/expense
+/-
-
+
+/-
= Operating cash flow
-
Investing cash flow=
7. Capital expenditure-
8. Proceeds from sales+
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. 21
The short-term cash situation is mainly depending on working capital (and working capital days)
Net working capital days outstanding
Days sales outstandingDays inventory
outstanding+
=
+ Days payable outstanding
Account receivables
Sales* 365
Inventory
COGS* 365
Account payables
COGS* 365
Average number of days the company holds
its inventory before selling it
Average number of days a company takes
to pay its suppliers
Average number of days a company takes to collect money from
its clients
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. 22
WC performance driven by industry, but also huge differences within industries
220 180
NWC days = DSO + DIO - DPOSource: CFO Europe
Net working capital days outstanding
