Breaking Into Wall Street - The 3 Financial Statements

($ in Thousands)

Concept: Now, we want to expand the business by offering in-person classroom training…

So we're going to need classrooms, offices, equipment, and lots of other "assets" to make this work.

Problem: Unlike, say, paying for employees or a new marketing team, or paying for physical products,
these expenses are NOT just a "pay once and you're done" type of thing…

They're going to last and be useful to us for YEARS, so the way we record these expenses on the financial statements
must be different as well.

Earlier, we saw what happens when you have a timing difference between paying/receiving cash and
recording the revenue and expenses over a few months… but this is a much longer-term timing difference.

Going to pay out a HUGE amount in cash here… and then allocate and recognize that expense on the Income Statement
over many years, as opposed to months in the previous examples.

Why? If a factory, computer, or building will be useful to us for many years, we want to reflect the expense of buying it
evenly over that time period… even if we had to purchase it all upfront in cash.

These types of purchases are known as Capital Expenditures (CapEx), the assets we purchase are known as Property, Plan
and the allocation of that expense over many years is known as Depreciation.

Question: How does this affect the cash generated from this business? How does Net Income differ from cash generated n

It depends…. Initially, cash generated will be lower than Net Income because we spent a whole lot of cash on that CapEx.

But then, over time, as we record the Depreciation from that spending, cash generated will be higher than Net Income.

Why? Tax savings! Depreciation reduces our taxable income, but doesn't represent a real cash expense… since we already
for the CapEx in cash in the very beginning.

Similar to the concept behind Prepaid Expenses and how those save us in taxes, but much longer-term here.

Tax Rate: 40.0% Capital Expenditures (Beginning of Year 2):

Inventory Purchases (Year 2): Useful Life of Purchased PP&E (# Years):

Deferred Revenue Additions (Year 2): Annual Depreciation from Year 2 CapEx:
Accounts Payable Additions (Year 2):
Prepaid Expense Additions (Year 2):
Accounts Receivable Additions (Year 2):
Income Statement: Balance Sheet:
Year 1 Year 2
Revenue: $ 650 $ 650 Assets:
Cost of Goods Sold (COGS): 70 70 Current Assets:
Gross Profit: 580 580 Cash:
Gross Margin %: 89.2% 89.2% Accounts Receivable:
Inventory:
Operating Expenses: Prepaid Expenses:
Sales & Marketing: 150 150 Total Current Assets:
Research & Development: 75 75
General & Administrative: 50 50 Long-Term Assets:
Total Operating Expenses: 275 275 Property, Plant & Equipment:
Total Long-Term Assets:
Depreciation: - -
Total Assets:
Operating Income (EBIT): 305 305
Operating Margin: 46.9% 46.9% Liabilities & Equity:
Current Liabilities:
Other Income / (Expenses): 20 20 Accounts Payable:
Interest Income / (Expense): - - Deferred Revenue:
Total Current Liabilities:
Pre-Tax Income (EBT): 325 325
Long-Term Liabilities:
Income Taxes: (130) (130) Debt:
Total Long-Term Liabilities:
Net Income (Profit After Taxes): $ 195 $ 195
Net Income Margin: 30.0% 30.0% Equity:

Total Liabilities & Equity:

Key Takeaways from This Lesson:

When you spend money on a tangible asset that will last for more than 1 year, it's called a Capital Expenditure (CapEx)
asset on the Balance Sheet over time (Property, Plant & Equipment or PP&E).

You pay for it upfront in cash… and then recognize its cost over its useful life (Depreciation).

Ex: Spend $200,000 computer equipment and a new classroom for training that will be good for 5 years, we out that $2
cash (shows up on the Cash Flow Statement), and then on the Income Statement we recognize $200,000 / 5 = $40,000

That Depreciation reduces our taxes and boosts our cash in future years since we've already spent the cash, and now w

So, it's similar to the Prepaid Expense scenario earlier… only over a much longer time-frame since we're dealing with ye
This just scratches the surface of this topic - gets a lot more complex, and we'll look at those added details, separate sch
calculating this, and more, later in this course.

One Final Point: This can happen with other types of expenses as well, namely Research & Development (R&D).

Some people / well-known professors / academic sources argue that you should capitalize R&D that contributes to long
or other assets…

After all, if you spend money to develop software that will be good for 5 years, shouldn't that count as a capital expe

In theory, yes… in practice, hardly any companies actually do this and R&D is just a normal expense on the Income St

Some differences under US GAAP vs. IFRS as well when it comes to this one, so different standards may apply.

Sometimes you'll see people try to "convert" normal R&D spending into capital spending, assume a useful life, and a
like we did here for CapEx.

In practice, very tough to pull that off (how do you know the useful life, for example?), but good to know this just in
n the financial statements

ming difference.

nse on the Income Statement

ect the expense of buying it

ase are known as Property, Plant & Equipment (PP&E),

me differ from cash generated now?

hole lot of cash on that CapEx.

be higher than Net Income.

ash expense… since we already paid

onger-term here.

res (Beginning of Year 2):

chased PP&E (# Years):

on from Year 2 CapEx:
 Cash Flow Statement:
Year 1 Year 2 Year 1 Year 2
Cash Flow from Operating Activities:
Net Income: $ 195 $ 195
$ 300 $ 495 Depreciation: -
- - Change in Operating Assets & Liabilities:
- - Change in Accounts Receivable: - -
- - Change in Prepaid Expenses: - -
300 495 Change in Inventory: - -
Change in Accounts Payable: - -
Change in Deferred Revenue: - -
ant & Equipment: - Cash Flow from Operations: $ 195 $ 195
- -
Cash Flow from Investing Activities:
$ 300 $ 495 Capital Expenditures (CapEx): $ -
Cash Flow from Investing: $ - $ -

Cash Flow from Financing Activities:

$ - $ - Cash Flow from Financing: $ - $ -
- -
- - Net Change in Cash: $ 195 $ 195

- -
m Liabilities: - -

300 495

$ 300 $ 495

d a Capital Expenditure (CapEx), and you must track that

good for 5 years, we out that $200,000 upfront in

cognize $200,000 / 5 = $40,000 per year in Depreciation.

eady spent the cash, and now we're getting the tax benefit.

ame since we're dealing with years, not months.

hose added details, separate schedules for

h & Development (R&D).

ize R&D that contributes to long-term products

dn't that count as a capital expenditure?

ormal expense on the Income Statement most of the time.

ent standards may apply.

ding, assume a useful life, and allocate it over time

), but good to know this just in case you see it.