General 3 Statements
Walk me through the 3 financial statements; what do they do, how do they function?
The 3 major financial statements are the Income Statement, Balance Sheet and Cash Flow Statement.
The Income Statement gives the company’s revenue and expenses, and goes down to Net Income, the final line on the statement.
The Balance Sheet shows the company’s Assets – its resources – such as Cash, Inventory and PP&E, as well as its Liabilities – such as Debt and Accounts Payable – and Shareholders’ Equity. Assets must equal Liabilities plus Shareholders’ Equity.
The Cash Flow Statement begins with Net Income, adjusts for non-cash expenses and working capital changes, and then lists cash flow from investing and financing activities; at the end, you see the company’s net change in cash.
If I were stranded on a desert island, only had 1 statement and I wanted to review the overall health of a company – which statement would I use and why?
You would use the Cash Flow Statement because it gives a true picture of how much cash the company is actually generating, independent of all the non-cash expenses you might have. And that’s the #1 thing you care about when analyzing the overall financial health of any business – its cash flow.
Walk me through how Depreciation going up by $10 would affect the statements.
Income Statement: Operating Income would decline by $10 and assuming a 40% tax rate, Net Income would go down by $6.
Cash Flow Statement: The Net Income at the top goes down by $6, but the $10 Depreciation is a non-cash expense that gets added back, so overall Cash Flow from Operations goes up by $4. There are no changes elsewhere, so the overall Net Change in Cash goes up by $4.
Balance Sheet: Plants, Property & Equipment goes down by $10 on the Assets side because of the Depreciation, and Cash is up by $4 from the changes on the Cash Flow Statement.
Overall, Assets is down by $6. Since Net Income fell by $6 as well, Shareholders’ Equity on the Liabilities & Shareholders’ Equity side is down by $6 and both sides of the Balance Sheet balance.
Who provides a significant portion of the bant in meetings?
Sophia (duh)
What is the formula for EBITDA from operating income?
EBITDA = operating income + depreciation and amortization
What is working capital? How is it used?
Working Capital = Current Assets – Current Liabilities.
If it’s positive, it means a company can pay off its short-term liabilities with its short-term assets. It is often presented as a financial metric and its magnitude and sign (negative or positive) tells you whether or not the company is “sound.”
Bankers look at Operating Working Capital more commonly in models, and that is defined as (Current Assets – Cash & Cash Equivalents) – (Current Liabilities – Debt).
Why is the Income Statement not affected by changes in Inventory?
In the case of Inventory, the expense is only recorded when the goods associated with it are sold – so if it’s just sitting in a warehouse, it does not count as a Cost of Good Sold or Operating Expense until the company manufactures it into a product and sells it.
If cash collected is not recorded as revenue, what happens to it?
Usually it goes into the Deferred Revenue balance on the Balance Sheet under Liabilities.
Over time, as the services are performed, the Deferred Revenue balance “turns into” real revenue on the Income Statement.
Which partner is the most hardcore value investor?
Rahul
What is the formula for Gross Profit?
Gross Profit = Revenue – Cost of Goods Sold
Can you give examples of major line items on each of the financial statements?
Income Statement: Revenue; Cost of Goods Sold; SG&A (Selling, General & Administrative Expenses); Operating Income; Pretax Income; Net Income.
Balance Sheet: Cash; Accounts Receivable; Inventory; Plants, Property & Equipment (PP&E); Accounts Payable; Accrued Expenses; Debt; Shareholders’ Equity.
Cash Flow Statement: Net Income; Depreciation & Amortization; Stock-Based Compensation; Changes in Operating Assets & Liabilities; Cash Flow From Operations; Capital Expenditures; Cash Flow From Investing; Sale/Purchase of Securities; Dividends Issued; Cash Flow From Financing.
Let’s say I could only look at 2 statements to assess a company’s prospects – which 2 would I use and why?
You would pick the Income Statement and Balance Sheet, because you can create the Cash Flow Statement from both of those (assuming, of course that you have “before” and “after” versions of the Balance Sheet that correspond to the same period the Income Statement is tracking).
Let’s say a customer pays for a TV with a credit card. What would this look like under cash-based vs. accrual accounting?
In cash-based accounting, the revenue would not show up until the company charges the customer’s credit card, receives authorization, and deposits the funds in its bank account – at which point it would show up as both Revenue on the Income Statement and Cash on the Balance Sheet.
In accrual accounting, it would show up as Revenue right away but instead of appearing in Cash on the Balance Sheet, it would go into Accounts Receivable at first. Then, once the cash is actually deposited in the company’s bank account, it would “turn into” Cash.
Wesley
What is the formula for EBIT?
Take the value for revenue or sales from the top of the income statement. Subtract the cost of goods sold from revenue or sales, which gives you gross profit. Subtract the operating expenses from the gross profit figure to achieve EBIT.
A company has had positive EBITDA for the past 10 years, but it recently went bankrupt. How could this happen?
Several possibilities:
1. The company is spending too much on Capital Expenditures – these are not reflected at all in EBITDA, but it could still be cash-flow negative.
2. The company has high interest expense and is no longer able to afford its debt.
3. The company’s debt all matures on one date and it is unable to refinance it due to a “credit crunch” – and it runs out of cash completely when paying back the debt.
4. It has significant one-time charges (from litigation, for example) and those are high enough to bankrupt the company.
Remember, EBITDA excludes investment in (and depreciation of) long-term assets, interest and one-time charges – and all of these could end up bankrupting the company.
Could you ever end up with negative shareholders’ equity? What does it mean?
Yes. It is common to see this in 2 scenarios:
1. Leveraged Buyouts with dividend recapitalizations – it means that the owner of the company has taken out a large portion of its equity (usually in the form of cash), which can sometimes turn the number negative.
2. It can also happen if the company has been losing money consistently and therefore has a declining Retained Earnings balance, which is a portion of Shareholders’ Equity.
It doesn’t “mean” anything in particular, but it can be a cause for concern and possibly demonstrate that the company is struggling (in the second scenario).
When would a company collect cash from a customer and not record it as revenue?
Three examples come to mind:
1. Web-based subscription software
2. Cell phone carriers that cell annual contracts
3. Magazine publishers that sell subscriptions
Companies that agree to services in the future often collect cash upfront to ensure stable revenue – this makes investors happy as well since they can better predict a company’s performance.
Per the rules of GAAP (Generally Accepted Accounting Principles), you only record revenue when you actually perform the services – so the company would not record everything as revenue right away.
Who out of the partners has the worst precedent based on portfolio returns?
Andrew <3
What is the formula for FCF?
FCF = EBIT*(1- TaxRate) + D/A - Capex - CWC
FCF = Cash flow from operations - Capex + Interest expense*(1-t)
Why do companies report both GAAP and non-GAAP (or “Pro Forma”) earnings?
These days, many companies have “non-cash” charges such as Amortization of Intangibles, Stock-Based Compensation, and Deferred Revenue Write-down in their Income Statements. As a result, some argue that Income Statements under GAAP no longer reflect how profitable most companies truly are. Non-GAAP earnings are almost always higher because these expenses are excluded.
What’s the difference between cash-based and accrual accounting?
Cash-based accounting recognizes revenue and expenses when cash is actually received or paid out; accrual accounting recognizes revenue when collection is reasonably certain (i.e. after a customer has ordered the product) and recognizes expenses when they are incurred rather than when they are paid out in cash.
Most large companies use accrual accounting because paying with credit cards and lines of credit is so prevalent these days; very small businesses may use cash-based accounting to simplify their financial statements.
What happens when Inventory goes up by $10, assuming you pay for it with cash?
No changes to the Income Statement.
On the Cash Flow Statement, Inventory is an asset so that decreases your Cash Flow from Operations – it goes down by $10, as does the Net Change in Cash at the bottom.
On the Balance Sheet under Assets, Inventory is up by $10 but Cash is down by $10, so the changes cancel out and Assets still equals Liabilities & Shareholders’ Equity.
What brokerage do we use?
Fidelity
What is the formula for Levered FCF? (hint, think about formulas from FCF)
Levered FCF = Cash flow from operations - Capex + Net Debt
Levered FCF = FCF - Interest expense*(1-t) + Net Debt