Breaking Into Wall Street - The 3 Financial Statements

($ in Thousands)

Tax Rate: 40.0%

Income Statement: Balance Sheet: How Does This Satisfy the Definitions?
Start of End of
Revenue: $ 700 Assets: Period Period
Cost of Goods Sold (COGS): 70 Current Assets:
Gross Profit: 630 Cash: $ 300 $ 610
Gross Margin %: 90.0% Short-Term Investments: - - Earn interest - more cash - or can be sold for cash.
Accounts Receivable: - 50 Will get more cash from customers eventually.
Operating Expenses: Inventory: - 30 Will turn into products and sell for cash.
Sales & Marketing: 165 Prepaid Expenses: - 30 Will reduce taxes in the future, saving us cash.
Research & Development: 75 Total Current Assets: 300 720
General & Administrative: 50
Total Operating Expenses: 290 Long-Term Assets:
Property, Plant & Equipment: - 30 Can be used to manufacture goods, producing cash.
Depreciation: 10 Goodwill: 100 50 Possible future synergies will produce more cash.
Amortization of Intangible Assets: 10 Other Intangible Assets: 50 40 Customer relationships, brand, etc. result in more sales.
Stock-Based Compensation: 20 Long-Term Investments: - 100 Earn interest - more cash - or can be sold for cash.
Total Long-Term Assets: 150 220
Operating Income (EBIT): 300
Operating Margin: 42.9% Total Assets: $ 450 $ 940

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

Interest Income / (Expense): (20) Current Liabilities:
Goodwill Impairment: (50) Accounts Payable: $ - $ 15 Recorded the expense, but must pay CASH in the future!
PP&E Write-Down: (10) Accrued Expenses: - 10 Recorded the expense, but must pay CASH in the future!
Gains / (Losses) on Investment Sales: (15) Deferred Revenue: - 15 Must pay expenses and taxes on this revenue in the future!
Total Current Liabilities: - 40
Pre-Tax Income (EBT): 225
Long-Term Liabilities:
Income Taxes: 90 Debt: - 240 Must pay interest and repay debt principal.
Current Portion: 40 Deferred Tax Liability: - 50 Must pay higher cash taxes in the future.
Deferred Portion: 50 Total Long-Term Liabilities: - 290

Net Income (Profit After Taxes): $ 135 Equity:

Net Income Margin: 19.3% Common Stock & Additional Paid-In Capital: 50 170 Stock issued to others to fund the business.
Retained Earnings: 400 485 "Saved up, after-tax earnings" - add NI, subtract Dividends.
Treasury Stock: - (50) Always record repurchases as a negative.
Accumulated Other Comprehensive Income: - 5 FX rate effects, unrealized gains/losses, misc. items.
Total Equity: $ 450 $ 610

Total Liabilities & Equity: $ 450 $ 940

BALANCE CHECK: OK! OK!

Key Takeaways from This Lesson:

1. The Balance Sheet shows the company's resources (its Assets) and how it acquired those resources - its Liabilities & Equity - at a
specific point in time.

You might show multiple points in time, as we do here, but a single column of the Balance Sheet only corresponds to a specific date.

So the Income Statement shows revenue and expenses from January 1, 20XX to December 31, 20XX, but the Balance Sheet only shows
the company's resources ON January 1, 20XX… or ON December 31, 20XX.

2. Assets must always equal Liabilities & Equity - if the Balance Sheet does not balance, it's wrong.

Personal Example: Let's say you have $50K in cash and a house worth $450K… so you have $500K of Assets.

How did you buy those assets? Either with after-tax income you earned and saved up, or with borrowing.

So your personal "Retained Earnings" must be $500K… or maybe you've saved up $300K, and then taken on
$200K of debt (mortgage) to buy your house.

3. What is an Asset?

Something that will result in, directly or indirectly, additional cash in the future (or that can be sold for cash).

Typically split into Current (Lasts under 1 year) vs. Long-Term (Non-Current) Assets (Lasts over 1 year).

Please see the notes above for examples of how this condition is true for all these items.

4. What is a Liability?

Something that will result in, directly or indirectly, less cash in the future.

Typically split into Current (Lasts under 1 year) vs. Long-Term (Non-Current) Liabilities (Lasts over 1 year).
Often, related to external parties - lenders, suppliers, the government….

Please see the notes above for examples of how this condition is true for all these items.

5. What is an "Equity Line Item"?

Similar to Liabilities - a funding source - but refer to the company's internal operations rather than funds raised from borrowing,
paying suppliers on credit, etc.

NOT necessarily going to result in less cash in the future… sort of like a funding source without cash payments owed by the company
in the future.
6. More Notes on the Equity section…

Common Stock
Additional Paid-In Capital (APIC)
Retained Earnings
Treasury Stock
Accumulated Other Comprehensive Income (AOCI)

Common Stock - Used for the par value of issued shares * the number of shares issued over time.

Called "Share Capital" for non-US companies.

Additional Paid-In Capital (APIC) - Used for the premium over par value of issued shares * the number of shares issued over time.

Called "Share Premium" for non-US companies.

Here's a Specific Example:

Company issues 100 million of shares, with a par value of $1.00 and a market value of $10.00.

Common Stock (Share Capital): Increases by $1.00 * 100 million = $100 million.

Additional Paid-In Capital (Share Premium): Increases by ($10 - $1) * 100 million = $900 million.

BUT HERE'S THE IMPORTANT PART:

Let's say the stock's market value increases to $20.00… or that it decreases to $5.00…

NEITHER ONE OF THESE ITEMS CHANGES EVEN IF THE MARKET VALUE OF THE STOCK CHANGES AFTERWARD!!!!!

So Common Stock remains at $100 million and APIC remains at $900 million until more shares are issued.

We almost always combine these 2 items into a SINGLE item - Common Stock & APIC (Share Capital & Premium) -
to save time when modeling. Makes absolutely no difference and prevents unnecessary work.

Retained Earnings: "Saved up, after-tax earnings" - add Net Income, subtract Dividends.

Treasury Stock: Used for share repurchases - recorded at MARKET VALUE AT THE TIME OF THE REPURCHASE.

Ex: You repurchase $500 million worth of shares for $50.00 per share (100 million shares).

You record that as a negative $500 million and reduce Treasury Stock by that much.

But if the share price then increases to $60.00 or decreases to $40.00, Treasury Stock does NOT change.

Accumulated Other Comprehensive Income (AOCI): Used for "miscellaneous" items such as the impact of FX rate
fluctuations (e.g., the company is based in Australia, but sells to many US customers and has to keep converting from USD to
AUD… and that exchange rate keeps changing, impacting what they record as revenue).

For non-US companies, this is often called "Reserves" and other variations (Hedging Reserve, Translation Reserves, Other Reserves…).

Also used for: Unrealized Gains and Losses (on certain types of investments), Hedging Gains and Losses, sometimes for
Actuarial Adjustments to Pension Plans…

Lots of items in the "Statement of Comprehensive Income" financial statements - didn't really cover it here because it's not
terribly important for valuing (most) companies in (most) industries.
Cash Flow Statement:

Cash Flow from Operating Activities:

Net Income: $ 135
Depreciation: 10
Amortization of Intangible Assets: 10
Stock-Based Compensation: 20
Goodwill Impairment: 50
PP&E Write-Down: 10
Deferred Income Taxes: 50
(Gains) / Losses on Investment Sales: 15
Change in Operating Assets & Liabilities:
Change in Accounts Receivable: (50)
Change in Inventory: (30)
Change in Prepaid Expenses: (30)
Change in Accounts Payable: 15
Change in Accrued Expenses: 10
Change in Deferred Revenue: 15
Cash Flow from Operations: $ 230

Cash Flow from Investing Activities:

Capital Expenditures (CapEx): $ (50)
Purchases of Short-Term Investments: (100)
Purchases of Long-Term Investments: (100)
Proceeds from ST Investment Sales: 85
Cash Flow from Investing: $ (165)

Cash Flow from Financing Activities:

Debt Raised: $ 300
Debt Principal Repayment: (60)
Equity Issuance: 100
Dividends Issued: (50)
Share Repurchases: (50)
Cash Flow from Financing: $ 240

FX Rate Effects: 5

Net Change in Cash: $ 310

Beginning Cash Balance: $ 300

Ending Cash Balance: $ 610