Understanding Financial Information

Question 1

What is the balance sheet?

Answer 1

The balance sheet is a financial snapshot at a point in time, showing what the business owns (assets) and owes (liabilities)
If there are more assets than liabilities, the balance belongs to the shareholders and is called equity
You’ll normally see 2 balance sheets – a snapshot at the beginning of the year and another at the end of the year
Between the 2 snapshots (i.e. during the year), things happen - these events are captured in the income statement and cash flow statement.

Question 2

What is the income statement?

What is it’s other name?

Answer 2

The income statement (P&L) shows what happened in terms of EARNED income and INCURRED expenses (i.e. regardless of whether or not the money was received or paid).

Question 3

What is the cash flow statement?

Answer 3

The cash flow statement shows what happened in terms of RECEIVED income and PAID expenses (i.e. regardless of whether the money was earned in the year).

Question 4

Give four possible words for revenue.

Answer 4

1) Revenue
2) Sales
3) Turnover
4) Top line

Question 5

Give four possible words for profit.

Answer 5

1) Profit
2) Earnings
3) Income
4) Bottom Line

Question 6

Give four possible words for operating profit.

Answer 6

1) EBIT (earnings before interest & tax)
2) PBIT
3) Operating income
4) Trading profit

Question 7

Give three possible words for profit before tax.

Answer 7

1) PBT/EBT
2) Pre-tax profit
3) Income before tax

Question 8

Give five possible words for net profit.

Answer 8

1) Earnings
2) Profit after tax
3) Attributable profit
4) Net income
5) Bottom line

Question 9

How would you assess how well a company is doing from the income statement?

Answer 9

1) Look at revenue growth - how does this compare to the increase in cost of sales.
2) Has opex increased? - If so, in what areas?
3) Has EBIT increased?
4) Has EBIT Margin Increased?

Question 10

How would you calculate EBIT margin?

Answer 10

Operating Profit (EBIT) / Revenue

Question 11

How would you calculate EBITDA from a company’s income statement?

Answer 11

EBIT + Depreciation.

Question 12

What is the income statement useful in showing?

Answer 12

The income statement (P&L) shows how revenue earned less expenses incurred makes profits/losses
It shows various levels of profit with operating profit (EBIT) most useful to assess operational performance

Question 13

When is EBITDA useful?

Answer 13

EBITDA is useful when comparing businesses with different depreciation rates and is a proxy for ‘cash’ operating profit.

Question 14

What are the two key drivers of profits?

Which has the biggest impact?

Answer 14

Price reductions have the biggest impact on profits – they fall straight through to profit £ for £ (unless you can cut costs quickly)
When volume falls, cost of sales falls too – so there’s less impact on profits

Question 15

What are the two sources of capital?

Answer 15

Capital comes from equity and debt

Question 16

In what two ways can capital be spent?

Answer 16

Capital is spent on capex and working capital (assets) and opex (expenses)
Capital expenditure can be large and lumpy and can be a major use of cash

Question 17

What is the main effect of depreciation?

Answer 17

Long-term assets are depreciated (affecting profits but not cash flows).

Question 18

What is working capital?

Answer 18

Working capital (inventories, + receivables – payables) control is crucial – it helps convert profits into cash.

Question 19

What is bad debt?

Answer 19

Bad debts (a receivable not paying) are disastrous – the full sales amount comes off profit.

Question 20

How does profit not paid out in dividends affect the balance sheet?

Answer 20

Profits not paid out by way of dividends are retained and reinvested on the shareholders’ behalf (i.e. they increase the equity).

Question 21

What is a balance sheet?

Answer 21

Balance sheet shows what’s owned and owed at a moment in time
Assets = liabilities + equity (or assets – liabilities = equity)
Capex spend appears as a long term (non-current) asset
Tangible assets are depreciated and intangible assets are amortised though the income statement
Not a valuation statement - there is often hidden value in properties at historic cost & ‘investment’ in marketing, R&D etc through the P

Question 22

What is an income statement?

Answer 22

Income statement (P&L) shows how revenue earned less expenses incurred makes profits/losses
Shows various levels of profit with operating profit (EBIT) most useful to assess operational performance
EBITDA is useful when comparing businesses with different deprecation rates and is a proxy for ‘cash’ operating profit

Question 23

What is a cash flow statement?

Answer 23

Cash flows show cash in and cash out
Profits & cash flows differ because of D&A, capex timing and cash tied up/released from changes in working capital

Question 24

Name and define what typically appears on a balance sheet under assets? (4)

Answer 24

1) Goodwill and other intangibles - Most of these arise whena company makes an acquisition (brands, customer relationships, patents, licenses & goodwill)
2) PP&E - Property, plant & equipment, factories, offices, vehicles etc
3) Inventories - Stock of goods to be sold (may include work-in-progress).
4) Receivables - Money owed to the business by customers.

Question 25

Name and define what typically appears on a balance sheet under liabilities? (4)

Answer 25

1) Payables - Money owed to suppliers.
2) Short-term debt and Long-term debt - loans from banks and bond issues.
3) Long term liabilities - could include legal and environmental liabilities, pensions and post-retirement healthcare and long-term tax.
4) Equity - shareholders capital and retained profits.