Walk me through the three statements

  • The Income Statement shows revenue and profitability metrics over a period.
  • The Balance Sheet is a snapshot at a point in time and shows the assets and liabilities + equity of a company. The Net Income from the Income Statement flows into Retained Earnings on the Balance Sheet.
  • The Cash Flow Statement starts with Net Income and shows actual cash out flows or inflows from operations, investing and financing activities. The net changes in cash will be netted with cash beginning of period resulting in cash end of period, which is then linked to the Balance Sheet

Walk me through the Income statement

  • Revenues – Cost of Goods Sold = Gross Profit – Selling General and Administrative expenses = EBITDA – Depreciation & Amortization = EBIT – Interests expenses – Other Income or Expense = Pre-tax income – Taxes = Net Income

Walk me through the Balance Sheet

  • Assets = Liabilities + Equity. Current assets (cash, accounts receivable, inventory, prepaid current assets). Long-term assets (property, plant & equipment, goodwill, intangible assets). Current liabilities: (accounts payable, current accrued liabilities, current debt). Long-term liabilities: (long-term debt). Shareholders Equity

Walk me through the Cash Flow Statement

  • (1) Cash Flow from Operations (Net Income, D&A, changes in Working Capital), (2) Cash Flow from Investing (Capital Expenditure, purchase or sale of marketable securities), (3) Cash Flow from Financing Activities (equity or debt raises, dividend payments), (4) Net changes in cash for the period, which then needs to be netted with the cash balance at the beginning of the period to result in cash at the end of the period

How the three statements work together

How would a EUR 1k depreciation on a truck impact the three statements? (assume a 30% tax rate)

  • Income Statement >> EBIT minus EUR 1K, Net Income minus EUR 0.7k
  • Cash Flow Statement >> Net Income minus EUR 0.7k, D&A plus EUR 1k (because non-cash), so cash is plus EUR 0.3k
  • Balance Sheet >> PP&E minus EUR 1k, Cash plus EUR 0.3k, so assets are minus EUR 0.7k. This is offset by minus EUR 0.7k from Net Income flowing to Retained Earnings

A company generates EUR 100m revenues. What happens to the Income Statement? Assume 40% gross margin, no changes to OPEX, 30% tax rate

  • Revenues plus EUR 100m, COGS plus EUR 60m, Gross Profit plus 40m, with no changes to OPEX EBITDA plus EUR 40m, Pre-tax Income plus EUR 40m, taxed at 30% equals Net Income plus EUR 28m

How does Inventories impact the Income Statement?

  • No changes to Income Statement. Cash flow from operations decreases. Cash declines and Inventories on the Balance Sheet increases. When Inventories are used to create products then it would be recognized as COGS

What happens to the three statements if a company initiates a Dividend?

  • Income Statement >> no changes
  • Cash Flow Statement >> Cash Flow from Financing decreases by Dividend
  • Balance Sheet >> Cash declines by Dividend and is balanced by decrease in Retained Earnings

What happens to the three statements if a company initiates a share repurchase program? (more advanced)

  • Income Statement >> no changes
  • Cash Flow Statement >> Cash Flow from Financing decreases
  • Balance Sheet >> Cash declines and is balanced by decrease in Shareholders’ Equity via Treasury Stocks

What is EBITDA? Why do you we use it? What are its flaws?

  • EBITDA is the quickest proxy for cash flow by just adding back D&A from EBIT. By excluding taxes and interest expenses, companies become more comparable. However it does not reflect CAPEX. A company can be EBITDA positive and still go bankrupt

What is Working Capital? What happens if Accounts Receivables increase?

  • Working Capital is a metric that shows if a company can pay off its short-term liabilities with its short-term assets. Simply speaking, Accounts Receivables + Inventory – Accounts Payables. If Accounts Receivables increase it means that more customers are going to pay in the future, however it also means a cash out flow because the company has not received the money yet

If you could choose one financial statement to value a company, which one would you choose?

  • Cash Flow Statement because (1) at the end of the day cash is king and (2) cashflow can be used for a DCF or even LBO. Income statement because (1) visibility on revenues and profitability and (2) can be used for multiples. Only wrong answer is Balance Sheet because it a snapshot of the company’s assets and liabilities

If you could choose two statements, which would you choose?

  • Balance Sheet and Income Statement because you can derive the Cash Flow Statement with those two

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