This document provides an overview and introduction to understanding financial statements. It begins with an agenda that outlines topics to be covered including the accounting equation, financial statement relations, ratio analysis, and cash flow analysis. It then discusses key concepts like the accounting equation that balances assets with liabilities and equity. The three main financial statements are introduced as the balance sheet, income statement, and statement of cash flows. Common components of each statement are defined. The rest of the document discusses how financial statements link business decisions and valuation, and provides examples of analyzing elements like return on equity, working capital management, and cash-to-cash cycles.

1. Understanding
Financial Statements
Phil Drake (ASU)
Tom Contiliano (Bloomberg)
A R I Z O N A S T A T E
Reynolds Business Journalism Week

2. • Welcome & Introduction
– Speak the Language of FinanceTM
– Linking Business Decisions to Valuation
• The Accounting Equation
• Financial Statement Relations
• Ratio Puzzle Exercise
• Financial Statement Analysis
• Cash Flow Analysis aka “Follow the Money”
Agenda

3. When financial matters come up at work,
you …

4. Can you read an annual report …
with understanding?

5. How do they determine value so quickly?

6. Debt
Providers
Equity
Providers
Capital Markets
Customer
s
Suppliers
Financial
Assets &
Liabilities
Operating
Assets &
Liabilities
Product MarketsThe Firm
FCF
$
$
OI
OE
Financing Investing Operating
An Overview of the Marketplace

7. Essence of Valuation
 Businesses invest in assets (people, ideas,
equipment, and companies) that produce cash
flows.
 What is the right price to pay for (or, “fair value”
to place on) an asset whose cash flows are
expected in the future?

8. Three Behavioral Assumptions
Cash flows: want more rather than less
• “greed”
Risk: want less rather more
• “fear”
Timing: want now rather than later
• “impatience”

9. Net Present Value of an Asset Formula
T
PV (asset) = Σt = 0
________1
(1 + r )t
CFt
Sum from now
(t = 0) to a
future time T
Present value
of an asset
Cash flow
at time t
Discount to the
present

10. Behavioral assumptions captured in formula
Present value
of an asset
“Greed”
“Fear” “Impatience”
PV (asset) = Σt = 0
________1
(1 + r )t
CFt
T

11. Financial Statements: The Link between
Business Decisions and Valuation:

12. Seeing the World as an Accountant Does

15. INFORMATION

16. The Fundamental Accounting Equation
Assets = Liabilities + Shareholders’ Equity
In essence, everything that the firm owns
(i.e., assets) it owes to it creditors (e.g., banks,
vendors, employees, bondholders) or it owners.
Everything You Need to Know
About Accounting

17. • Balance Sheet
– Reports the resources the firm controls at a point in
time and the claims against those resources.
The Financial Statements

18. Fundamental Accounting Equation
Assets = Liabilities + Shareholders’ Equity

19. • Balance Sheet
– Reports the resources the firm controls at a point in
time and the claims against those resources.
• Income Statement
– Reports revenues less expenses that result in net
income (or profits). The profits increase shareholders’
equity on the balance sheet.
The Financial Statements

20. Let’s Look at Amazon’s Financials

22. • Balance Sheet
– Reports the resources the firm controls at a point in
time and the claims against those resources.
• Income Statement
– Reports revenues less expenses that result in net
income (or profits). The profits increase shareholders’
equity on the balance sheet.
• Statement of Cash Flows
– Explains the change in cash (from two balance sheets)
over a period of time, in terms of cash provided by or
used for operating, investing, and financing activities.
The Financial Statements

24. • Assets
– Probable future economic benefit
– Obtained or controlled by the entity
– As a result of past transactions
• Historical Cost vs. Fair Value (Mark to
Market)
Definitions – Assets

25. • Cash
• Accounts receivable
• Inventory
• Prepaid expenses
• Property, plant and equipment
• Investments
• Goodwill & intangible assets
Example – Assets

26. • Liabilities
– Probable future economic sacrifice
– That is the responsibility of the entity
– As a result of past transactions
• Parallels the asset definition
Definitions – Liabilities

27. • Accounts payable
• Accrued expenses
• Unearned revenues
• Taxes payable
• Bonds payable
• Pensions
• Capitalized leases
Example – Liabilities

28. • Equity is the owner’s contribution in the
company.
– Paid in Capital
• Common stock
• Preferred stock
• Treasury stock
– Retained earnings (undistributed profits)
– Other comprehensive income (items impacting
the wealth of the shareholders, but not meeting the
revenue or expense criteria)
Definitions – Shareholders’ Equity

29. • Assets listed in order of liquidity
• Separation of current assets (liabilities)
and non-current assets (liabilities)
• Assets on the left hand side (top) and
Liabilities and Equity on the right hand side
(bottom)
The Balance Sheet – Typical Format

30. Definitions – Revenue
Revenue, generally, is realized or realizable and
earned when all of the following criteria are
meet:
1. There is persuasive evidence that an arrangement exists,
2. Delivery has occurred or services have been rendered,
3. The seller’s price to the buyer is fixed or determinable, and
4. Collectability is reasonable assured.
Cash basis of accounting recognizes revenues
when cash is received.

31. • Cost of goods and services used or
consumed to generate the revenues
recognized.
• Matching Concept – Expenses are
recognized in the income statement their
association with the revenues for which
there incurred.
Definitions – Expenses

32. Typical Income Statement Format
Sales
- Cost of goods sold
Gross margin
- Operating expenses
Operating income
+/- Other revenues (gains) /expenses (losses)
Income before taxes
- Income tax expense
Net Income (loss)

33. Income Statement
For the Year Ended
Revenue
- Expenses
Net Income
Statement of Retained Earnings
For the Year Ended
Beginning Retained Earnings
- Dividends
Ending Retained Earnings
+ Net Income
Retained Earnings
Balance Sheet
As of December 31
Assets Liabilities
Shareholder’s Equity
Paid-in Capital

34. Business Decisions
in Financial Statements
“owns” “owes”
others
“owes”
owners
Investment Financing
Operations
Income Statement
Revenues
- Expenses
Net Income
employees
suppliers
lenders
govt.
customers
owners

35. Statement of Cash Flows
• Purpose is provide information regarding the
sources and uses of cash.
• Summary of inflows and outflows of cash
– Reconciles beginning and ending cash flows
• Segmented by activity
– Operating
• Direct v. Indirect presentation
– Investing
– Financing

36. Break

37. Financial Statement Analysis

38. Decomposition of
Return on Common Equity
ROCE =
Net income
Average Shareholders' Equity
ROCE =
Net income
Net sales
x
Net sales
Avg Total Assets
x
Avg Total Assets
Avg Shareholders' Equity
ROCE can be rewritten into its drivers
Profit Margin Asset Turnover Leverage
Return on Assets

39. Return on Equity & Its Drivers
Add high margin
sales; improve mix;
reduce costs per
sales dollar
How much of
each sales
dollar is retained
as profit?
How many
sales dollars are
generated by
each $1 of
assets
Cut unproductive
assets; manage
receivables and
inventory
How well do
we leverage
equity with
liabilities to
fund assets?
Borrow to increase
leverage; manage
payables
ROCE =
Net Income
Sales
x
Sales
Ave. Assets
x
Ave. Assets
Ave. Equity
Ultimate goal: More output (income) for less input (equity).

40. Working Capital Management
- Operating Cycle
Day 0
Purchase
Inventory
on credit
Day 30
Pay
A/P
Day 75
Sell
Inventory
on credit
Day 90
Collect
A/R
Inventory Days ++ Receivable Days
Operating Cycle
(75 + 15 = 90 days)

41. Working Capital Management
- Cash-to-Cash Cycle
Day 0
Purchase
Inventory
on credit
Day 30
Pay
A/P
Day 75
Sell
Inventory
on credit
Day 90
Collect
A/R
Inventory Days ++ Receivable Days
Cash-to-Cash Cycle
(75 + 15 = 90 – 30 = 60 days)
AP Days

42. Breakout

43. Whew … It’s Over!!
No wait, it has just began!
Enjoy your Reynolds’ Week experience.