Sebastian Perrier

The Income Statement is not a measure of cash because it is calculated on an accural basis rather than a cash basis. In the accural system, income is recorded when it is earned and expenses when incurred, whether or not the money it has actually been received or paid. In contrast, in the cash-basis system, income and expenses are recorded when cash is received or paid.

Numbers reported through each of these systems will defer because, for example, in the Income Statement:

• sales include both cash sales and credit sales;
• expenses include purchases not yet paid as suppliers offered them in credit;
• depreciation is not a cash movement;
• frequently not all income tax is paid within the reported period;
• among other differences.

The Cash Flow Statement measures the firm’s cash inflows and outflows. The cash flow statement comes from data in the Income Statement and in the Balance Sheets from the beginning and end of the accounting period.

Cash Flow from Operations

• Start with the operating income from the Income Statement
• Add back depreciation expense as it is not a cash movement
• Subtract income tax (we’ll dealt with it later)
• Adjust Working Capital (receivables / payables / inventories) from the Balance Sheet differences in year 1 and year 2 (depending whether they are source or use of cash)

Cash Flow from Investing Activities

When fixed assets are purchased or sold, cash flows that occur are not shown in the Income Statement. Based on the gross change between the fixed assets between the BS in year 1 and 2, we can determine the if the company got cash or used cash for fix asset investing activities.

Cash Flow from Financing Activities

These activities include inflows and outflows coming from i) paying dividends and interests ii) increasing or decreasing of short-term and long-term debts and iii) issuing and repurchasing of shares. These calculations are also done by subtracting BS items of Y1 to BS in Y2.

While the Income Statement reports on the company’s profitability over a certain period of time (in general one year), the Balance Sheet provides a snapshot of a business financial position at a specific point in time. Thus, the balance sheet captures the cumulative effect of financial decisions made in the past.

• Current assets: liquid assets that can be converted into cash within the firm’s normal operating cycle.
• Receivables: payments due from its customers for previous credit sales (current asset).
• Inventories: raw materials, work in progress and finished products held by the company for eventual sale.
• Fixed Assets: gross fixed assets – accumulated depreciation (net book value=non-current asset).
• Payables: outstanding credit payable to suppliers withing 12 months (current liab).
• Accured expenses: short-term liabilities that have been incurred but not yet paid (current liab).
• Long-term debt: loans from banks or other sources with repayment terms of more than 12 months.
• Owners Equity: owners investment in a company plus retained profits reinvested in the firm less dividend paid.

ASSETS=LIABILITIES + EQUITY

Assets are financed by creditors and owners money. Assets are used to generate a profit and thus a return on investment. The best way to measure a company’s profitability is return on assets or operating profit / total assets.

What is the Balance Sheet useful for?

1. A. it allow to see how the company is financed.
2. B. by comparing year 1 BS vs year 2 BS we can see how the company is using/investing the money and how much return is that money generating.

The income statement answers the question:

HOW PROFITABLE IS THE COMPANY?

The best measure of a company’s profitability on its investments (total assets or total debt and equity) is OPERATING INCOME. This figure measures the company profitability before any money is distributed to investors and creditors.

For example, let’s assume that a company’s total assets are $100,000 (financed with $40,000 in debt and $60,000 in equity) and that operating income is $15,000 and net income is $10,000. Thus, the firm’s management used $100,000 of investment to generate $15,000 in operating profits; it generated a 15% return on investment (ROI). The net income figure of $10,000 – on the other hand – is the income that remains for the owners after paying interests and taxes and it does not represent a measure of the return on the company’s investments. The owners can then decide to reinvest this income or take them out as dividends.

The 3 basic financial statements are:

1. Income Statement (or Profit and Loss Account)
2. Balance Sheet
3. Cash-flow Statement

The Income Statement shows the revenues, expenses and profits during a determined period of time. The expenses shown in the Income Statements are those used up in generating the revenue. The revenue, is the revenue earned during that period, independent of whether the money from this revenue was received or not.  Transactions in the Income Statement are recognized when they occur, not when money is received or paid (accural system).  The objective of the Income Statement is to MATCH the revenue with the expenses required to generate it; but it does not deal with whether the money has been paid/received or not.

The Balance Sheet is a snapshot of the financial position of a company at a certain date. The assets are tangible, intangible or financial items owned by the company and that will provide it with future benefits. A fixed assets are th0se which have a useful life of more than one year. Depreciation is a measure (allocation) of the cost of a fix asset used to generate revenue during an accounting period (it has nothing to do with the value of the asset). Liabilities are obligations that the company has with outsiders. Equity is an obligation that the company has with its owners.

The Income Statement and the Balance Sheet are based on the accural system, thus, they do not explain what is happening with the cash. Therefore, it is very important to have an understanding of the Cash Flow Statement, which is mainly a rearrangement of the numbers in the BS and P&L in order to explain what is happening with the cash. And the CASH IS KING, because a company which might be showing profit in the Income Statement may actually be loosing money or going bankrupt (e.g. it has paid to all its providers but the customers have not yet paid to the company and therefore, the company has no money in the bank to pay its employees, etc).

The Manufacturing Account is produced only for internal purposes (its mainly a Management Accounting tool, not a Financial Accounting tool as these 3 which are also for external stakeholders); and it is done mainly because for a manufacturer it is in general quite difficult to calculate exactly how much is the cost of a finished good. Trading companies, which just buy cheap and sell more expensive, do not need to use a manufacturing account.

In the following spreadsheet you can see a summary of the main items included in these statements:

• Financial Statement – Template – Spreadsheet

- definir políticas contables (depreciación, registro de ventas, etc)
- controlar que la contabilidad provea información en tiempo y forma
- una ves tenés los estados financieros, los pasás a excel y:

• ponés todos los números como un % de las ventas (common size statements)
• analizas las tendencias, cambios y requermientos de fondos que tuvo la empresa historicamente
• calculas ratios (profitability, effieciency, solvency y liquidity)
• calculas uso-fuentes de fondos (en qué y para qué gasté la plata?)
• haces pro-forma de dichos estados financieros (estimación para el futuro; proyeccion de ventas)
• con eso determinas la necesidad de fondos para el futuro
• análisis de sensibilidad (que pasa sí…)
• defino cómo y con qué financio eso y cuánto me sale esa financiación
• hago ésto cada cuatrimestre

- manejar las finanzas de una empresa es fácil ; siempre y cuando los estados financieros estén bien diseñados
- diseñar los estados financieros es un arte; porque las politicas contables están sujetas a la subjetividad de los contadores y administradores a cargo
- hay 3 estados financieros fundamentales: ESTADO DE RESULTADOS, BALANCE Y CASH-FLOW STATEMENT
- es imposible hacer cualquier análisis si no se tienen los 3, solo con los tres se puede entender una empresa
- es imposible manegar profesionalmente una empresa sin un corrrecto funcionamiento de las finanzas
- la información contable no es solo para el fisco; es fundamental para la toma de decisiones
- muchas empresas muy rentables, pueden fundirse solo por no manejar bien sus finanzas
- muchas empresas comunes, pueden obtener ventajas competitivas solo con un buena estrategia financiera