Income Statement
What is the importance of the income statement?
Facilitates analysis of a company’s growth prospects, cost structure, and profitability
Summarizes P&L
Shows changes in line items and key ratios across time and tells if operations have been changing, essential for forecasting
What are the 3 parts of the statement of cash flows?
Cash from operating activities, cash from investing activities, cash from financing activities
What are the major components of the balance sheet?
Assets (Inventory, Cash, A/R), Liabilities (Debt, A/P, N/P, R/P), Shareholder’s equity (Common Stock, RE, Treasury Stock, APIC)
How do the 3 statements weave together?
The income statement ends with net income, which shows up in the top line of the statement of cash flows as well as shareholders equity on the balance sheet. Changes in the balance sheet are shown as changes in working capital on statement of cash flows. Investing and financing activities affect balance sheet items such as PPE, debt, and shareholders equity.
If you could only choose 1 statement, which would it be? If you could only have 2 statements which would they be?
Cash flow statement; income statement and balance sheet (can construct statement of cash flows from these 2)
What is EBITDA?
Gross Profit – Operating Expenses
Represents a business’ overall operating profitability that does not include the impact of financing (interest) or accounting technicalities (depreciation)
If depreciation is a non-cash expense, why does it affect cash balance?
Depreciation is tax-deductible, and taxes are a cash expense. Depreciation reduces the amount of taxes you pay
What’s the difference between accounts receivable and deferred revenue?
A/R: not been collected yet, money company is waiting on
Deferred revenue has been collected, money company is waiting to record
How does depreciation increasing by $10 affect the 3 statements?
IS: Decrease pretax income by $10, assume tax rate is 40%, net income goes down by $6.
SCF: NI down by $6, but $10 add back of D&A so cash goes up by $4
BS: cash increase by $4, PPE down $10, NI down $6
What is working capital?
Current assets - current liabilities
What are the major line items on the Income Statement?
Revenue, COGS, Gross profit, Operating expenses, EBITDA, D&A, EBIT, Other income, Non-operating gains and losses, Interest expense, Pre-tax income, Taxes, Net income
Why would the number associated with depreciation and amortization on the income statement not be the same as the number for d&a on the statement of cash flows?
Often d&a is embedded in other items on the income statement. We need to use the number on the statement of cash flows, or else we would underestimate D&A
What is the difference between cash-basis accounting and accrual basis accounting?
Cash: recognize revenue and expenses when cash is actually received/paid out
Accrual: record revenue when collection is reasonably certain; record expenses as incurred rather than when paid in cash
*large companies use accrual due to widespread credit card use and small companies typically use cash-based accounting to simplify financial statements
How does an increase of inventory of $10 paid with cash affect the 3 statements?
No change in income statement, PPE increase so cash from operations decrease by $10, so net change in cash is $10 increase. BS: increase in $10 in cash but decrease in inventory by $10, so assets cancel out
What are the major items in the shareholders equity portion of the balance sheet?
Common stock, retained earnings, treasury stock, additional paid in capital, accumulated other comprehensive income (FX)
Where does depreciation show up on the income statement?
Can be a separate line item or COGS or operating expense; either way, depreciation always decreases pretax income
What is the difference between cash flow (CF) and free cash flow (FCF)?
CF: The net amount of cash equivalents being transferred into or out of a company
FCF: Cash left over after a company has paid its operating expenses and capital expenditures, cash the company is producing
How would recording a TV with a credit card change on the cash-basis versus accrual basis?
Cash basis: revenue does not show up until the credit card is charged, receives authorization, and deposit s funds in their bank account (revenue on income statement and cash on balance sheet)
Accrual: revenue shows up immediately, in accounts receivable and then cash when paid/deposited
Apple sells iPods for $20 revenue at $10 cost. How does this affect their statements? (assume 40% tax rate)
IS: revenue increase by 20, COGS increase by 10, so GP, EBITDA, EBIT all increase by 10. 40% tax rate gives NI up by $6.
SCF: NI up by $6, CFO up $10 (sale of an asset for $10); net cash up $16
BS: Cash down $16, Inventory down $10; NI up $6
When is it possible to have negative working capital? (3 reasons)
Deferred revenue (subscription model); business efficiency; financial distress & potential bankruptcy
What is an example of when collecting cash from customers is not recorded as revenue?
Deferred revenue (shows up on Balance Sheet as a liability)
Any company that offers services in the future and collects cash upfront (ensures stable revenue)
Subscription software, cell phone carriers with annual contracts, magazine publishers that sell subscriptions
Classify the following activities as operating, investing, or financing activities and as inflows or outflows:
$100 equity injection and $100 debt raising with 5% interest
§ $100 purchase of a food truck
§ $60 purchase of raw denim to manufacture jeans
- Financing Inflow, Investing Outflow, Operating Outflow
How would you project balance sheet items like A/R and A/P?
A/R: % of revenue
A/P: % of COGS
Deferred Revenue: % of revenue
Accrued Expenses: % of operating expenses or SG&A
How does a $100 write-down of debt affect the 3 statements?
A liability write-down is a gain on the income statement (whereas an asset write-down is a loss on the IS). so pretax income increases by $100
Why do companies report both GAAP and non-GAAP earnings?
Companies have non-cash charges such as amortization of intangibles, stock-based compensation, and deferred revenue write-down in their income statements; some argue Income statements under GAAP no longer reflect company profitability. Non-GAAP earnings are almost always higher because those expenses are excluded