I am sure this is a Blog that Readers will find extremely useful, especially those who are fairly new to the Great Game and want to get their head around the whole ‘Accounting’ thing a bit more. This Blog arose after some conversations on Twitter and Justin (who has an Accounting background) said he had produced this a while ago and that if peeps wanted it then he would send it over to me and I could shove it on my Site - thanks Justin, you saved me writing a Blog this Week !!
You can find Justin on the Tweets as @justinscarboro2 and he is well worth following because he is very knowledgeable on the Stocks and I think until just a few years ago he was an Analyst in the Retail Sector and he has also worked in many Senior Roles in various Companies, most recently with Air Partner AIR.
After reading it through I decided it was pretty involved and made the decision to chop it into 2 Parts - next Week I will published the bit on Company Valuation.
I hope you enjoy it and huge thanks again to Justin for providing this excellent material.
Finance for Non-Finance People
The thought of Profit & Loss accounts, Balance Sheets and Cash Flow Statements often fills people’s minds with dread and that is before information is extracted from these vehicles to try to understand the valuation(s) of a company. This paper was put together so that colleagues who were not familiar with the financial world, would gain a greater insight. Operational decisions in every organisation should be supported by information and data so that the financial effects are understood.
We will also look at Company Valuations and Acquisitions.
This paper will try to provide a simple guide to show how operational and financial decisions are interlinked. Do not be daunted, once finished you will be an expert!
First some basics in order to understand Profit & Loss accounts, Balance Sheets and Cash Flow statements – the ‘financial statements’, which in the case of a company cover an ‘accounting period’, typically referred to as a company’s financial year (FY).
The best way to think about these statements is by looking at them from a personal perspective and how your own financial statements compare to a company’s.
The Profit & Loss account
Look at this as though it is a summary bank statement which over any specific period shows income and expenses or revenue and costs. The summary lines for both personal and a company P&L’s are the same, they are just called different things:
The net result of all the components that go through the P&L is in the case of an individual ‘Leftovers’ or in the case of a company ‘Profit’. I will come onto different profit definitions later but just remember the D and the A.
The Balance Sheet
How much are you worth? How much is a company worth? The same question but how you arrive at the answers are very different.
If we compare the basic Balance Sheet of an individual and a company, you can see that they are different, with the company balance sheet being far more complex (even in this simple example).
The Cash Flow statement
Profits do not equal Cash, certainly not in the case of a company. You only need to think about the ‘D’ and the ‘A’ in the P&L account or the ‘accruals and provisions’ in the balance sheet to now understand this.
The definition of a cash flow statement is a financial statement that shows how changes in the balance sheet and P&L account affect cash and cash equivalents – it is a cash reconciliation between the balance sheet and P&L account. After all, a P&L account may have recorded revenues where the cash had not yet been received and a balance sheet may have a provision which could be a non-cash item.
The Basics Conclusion
Do not get het up with the complexities of financial statements. They can be complex and they are all inter-related but always think of them in your own personal terms. Yes some of the terminology is confusing but at least now you should know about and understand EBIT versus EBITDA, that Profit does not equal Cash and that your personal leftover or spare cash is your own Free Cash Flow!
Financial Statement terminologies and what they mean
All financial terminology used stems from the P&L account, Balance Sheet and Cash Flow statement. So, if you have a rudimentary understanding of the financial statements then you will be able to understand the terminologies:
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