Breaking Into Wall Street - The 3 Financial Statements

($ in Thousands)

Concept: We take a step back to look at our company's cash flows and how much money we're actually making with it…

And we notice that we have a large cash balance, and our generating more cash flow than we need each year!

So, what to do about this? Many options (we'll cover some of them in the upcoming lessons)…

We could hire more employees and spend more on sales & marketing, research & development, and so on…

Or we could spend more on Capital Expenditures (CapEx) and ramp up our purchases of equipment, classrooms, etc. to do

But another option is to buy other types of "investments" - stocks, bonds, real estate, stakes in other companies, etc.

So you'll often see a line item for this, called "Purchases of (Long-Term / Short-Term) Investments."

Question: How does this impact a company's cash and Net Income vs. cash generated?

It doesn't appear on the Income Statement because it has NOTHING to do with the company's core business operations… b

These purchases are not taxable events. Think about when you buy a stock: you're taxed if you sell the stock for a profit…

So for purchases, the treatment is pretty simple: reflect a use of cash on the Cash Flow Statement, and increase the corresp

So, as always, as an asset increases, our cash generated from the business decreases.

These are ASSETS because they could potentially generate cash for us in the future (via interest or dividends, selling them f

Is there EVER an Income Statement impact? Yes:

1. When they're sold (we'll look at this in an upcoming lesson).

2. When we start earning interest on these investments, or otherwise start receiving income from them.

Just like how you have to report your own interest income when filing taxes, companies must do the same… and pay taxes

Here's our super-aggressive example of putting a lot of our company's cash flows into "investments"!

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): $ 15
Prepaid Expense Additions (Year 2): $ 30 Purchases of Short-Term Investments (Year 2):
Accounts Receivable Additions (Year 2): $ 50 Purchases of Long-Term Investments (Year 2):
Interest Income Earned on Investments (Year 2):

Income Statement: Balance Sheet:

Year 1 Year 2
Revenue: $ 650 $ 700 Assets:
Cost of Goods Sold (COGS): 70 70 Current Assets:
Gross Profit: 580 630 Cash:
Gross Margin %: 89.2% 90.0% Short-Term Investments:
Accounts Receivable:
Operating Expenses: Inventory:
Sales & Marketing: 150 165 Prepaid Expenses:
Research & Development: 75 75 Total Current Assets:
General & Administrative: 50 50
Total Operating Expenses: 275 290 Long-Term Assets:
Property, Plant & Equipment:
Depreciation: - Long-Term Investments:
Total Long-Term Assets:
Operating Income (EBIT): 305 340
Operating Margin: 46.9% 48.6% Total Assets:

Other Income / (Expenses): 20 20 Liabilities & Equity:

Interest Income / (Expense): -
Current Liabilities:
Pre-Tax Income (EBT): 325 360 Accounts Payable:
Deferred Revenue:
Income Taxes: (130) (144) Total Current Liabilities:

Net Income (Profit After Taxes): $ 195 $ 216 Long-Term Liabilities:

Net Income Margin: 30.0% 30.9% Debt:
Total Long-Term Liabilities:

Equity:

Total Liabilities & Equity:

Key Takeaways from This Lesson:

When a company starts amassing a cash balance or generating excess cash flow, it can start putting some of that cash in
(stocks, bonds, money-market accounts, real estate, etc.).

Purchasing them makes no impact on the IS, but it does reduce cash flow on the CFS, and increases the relevant BS line
Why? Because you're not taxed on that initial purchase, so no IS effect.

And if you earn interest, you ARE taxed on that, so it does show up on the Income Statement.

You may also be taxed when you sell off the investments, but we'll look at that later.

Bottom-line: Purchasing these investments can substantially decrease cash flow, so there better be a good reason for d

Yes, you'll get some income from them eventually… but uncertain as to when, how, and how much.

And in big enough quantities, you can easily "over-spend" on these investments and run into a cash flow shortfall
e're actually making with it…

we need each year!

ment, and so on…

uipment, classrooms, etc. to do more offline training.

kes in other companies, etc.

y's core business operations… but more importantly…

you sell the stock for a profit… but not if you just buy and hold it.

ement, and increase the corresponding Balance Sheet item.

rest or dividends, selling them for a higher price, etc.).

e from them.

st do the same… and pay taxes on it.

res (Beginning of Year 2):

chased PP&E (# Years):

on from Year 2 CapEx:
t-Term Investments (Year 2): <--- Mature in under 1 year (e.g. money market accounts or CDs...)
-Term Investments (Year 2): <--- Mature in over 1 year (stocks, long-term bonds, illiquid real estate…)
arned on Investments (Year 2):

Cash Flow Statement:

Year 1 Year 2 Year 1 Year 2
Cash Flow from Operating Activities:
Net Income: $ 195 $ 216
$ 300 $ 451 Depreciation: -
Investments: - Change in Operating Assets & Liabilities:
- 50 Change in Accounts Receivable: - (50)
- Change in Prepaid Expenses: - (30)
- 30 Change in Inventory: -
300 531 Change in Accounts Payable: - 15
Change in Deferred Revenue: -
Cash Flow from Operations: $ 195 $ 151
ant & Equipment: -
nvestments: - Cash Flow from Investing Activities:
- - Capital Expenditures (CapEx): $ -
Purchases of Short-Term Investments: -
$ 300 $ 531 Purchases of Long-Term Investments: -
Cash Flow from Investing: $ - $ -

Cash Flow from Financing Activities:

Cash Flow from Financing: $ - $ -
$ - $ 15
- Net Change in Cash: $ 195 $ 151
- 15

- -
m Liabilities: - -

300 516

$ 300 $ 531

tart putting some of that cash into investments

d increases the relevant BS line items.

e better be a good reason for doing so.

how much.

into a cash flow shortfall

d real estate…)