Financial Intelligence for Entrepreneurs10/30/2012 12:12:00 PM

Part 1: The Art of Finance (and Why It Matters)

Chapter 1: What is Financial Intelligence?
Financial Intelligence
a set of skills that can be learned.
Income Statement
o Shows revenues, expenses, and profit for a period of time,
such as a month, quarter, or year.
o Its also called a profit and loss statement, P&L, statement of
earnings, or statement of operations.
Balance Sheet
o Reflects the assets, liabilities, and owners equity at a point in
time.
o It shows, on a specific day, what the company owned, what it
owed, and how much it was worth.
o Assets always must equal liabilities plus owners equity.
Cash/Cash Flow Statement
o Cash means the money a company has in the bank, plus
anything else (like stocks and bonds) that can readily be
turned into cash.
o The Cash Flow Statement shows cash coming in, cash going
out, and the difference between them.
The Art of Accounting and Finance
- The art of using limited data to come as close as possible to an accurate
description of how well a company is preforming.
- Complications arise because accountants/bookkeepers must make
educated guesses relating to the numbers side of business all day long.
- Financially intelligent entrepreneurs are prepared, when appropriate, to
question and challenge the numbers they get from their accountants or
financial folks.

Chapter 2: A Primer on the Art of Finance
Operating Expenses
Operating expenses are the costs that are required to keep a
business going day to day.
They include salaries, benefits, and insurance costs, among a host
of other items. Operating expenses appear on the income
statement.
Operating expense reduces profit immediately and a Capital
expenditure spreads the hit over several accounting periods.
Capital Expenditures
A capital Expenditure is the purchase of an item thats considered a
long-term investment, such as computer systems and equipment.
Most companies follow the rule that any purchase over a certain
dollar amount counts as a capital expenditure, while anything less
is an operating expense.
Operating expenses show up on the income statement and thus
reduce profit.
Capital expenditures show up on the balance sheet; only the
depreciation of a piece of capital equipment appears on the income
statement.
Depreciation
Depreciation allows accountants to spread the cost of equipment
and other assets over more than one accounting period.
Most capital expenditures are depreciated (land is an example of
one that isnt).
Accountants attempt to depreciate the item over what they believe
will be its useful life.

Toolbox
Owner Financing
o Entrepreneurs often put a lot of their own money into their
businesses.
o Their contributions of cash can be structured as equity
investments in the business or as loans from the entrepreneur
to the business.
Other Equity Investment
o If you get friends, family, or so-called angel investors to put
money into the business, they will expect shares of stock in
return.
o They will be co-owners of the business with you.
o If their investment is large enough, they may be entitled to a
seat on the board of directors, a say in major decisions, or
both.
Debt
o Of course, you can also ask for loans from friends and family,
or from your local bank.
o Banks wont normally lend money to startup businesses, but
they will often lend to a start-up entrepreneur provided that
the entrepreneurs personal finances are healthy enough to
ensure repayment of the loan whatever the fate of the
business.
Chief Financial Officer
o CFOs in many companies are in charge of other internal
departments as well, such as human resources and
information technology.
o But their chief job is to oversee the management and strategy
of the organization from a financial perspective.
o They are ultimately responsible for all the financial functions.
Treasurer
o The treasurer is the financial person who deals with the
outside world-meeting with analysts (for public companies),
communicating with investors, and negotiating with bankers.
Controller
o His or her job is providing reliable and accurate financial
reports. The controller is responsible for general accounting,
financial reporting, business analysis, financial planning, asset
management, and internal controls.

Financial Intelligence for Entrepreneurs 10/30/2012 12:12:00 PM
Part 2: The (Many) Peculiarities of the Income Statement

Chapter 3: Profit Is an Estimate
The Matching Principle
The matching principle is a fundamental accounting rule for
preparing an income statement.
It simply states, Match the costs with the associated sale to
determine profits in a given period of time-usually a month,
quarter, or year.
In other words, one of the accountants primary jobs is to figure out
and properly record all the costs incurred in generating sales.

Chapter 4: Cracking the Code of the Income Statement
Fiscal Year is a 52-53 week reporting period.
Interest Income is recorded when it is earned and deemed
realizable by the Company
Retail Revenue Recognition Net retail sales are net of discounts,
exclude sales tax, and are recognized at the time of sale. Shipping
and handling costs billed to customers are included in net retail
sales.
Many numbers on the statement reflects estimates and
assumptions.

Chapter 5: Revenue The Issue Is Recognition
Sales or revenue is the dollar value of all the products or services a
company provided to its customers during a given period of time.
In a publicly traded company, earnings per share (EPS) is a
companys net profit divided by the number of shares outstanding.
Its one of the numbers that Wall Street watches most closely. Wall
Street has expectations for many companies EPS, and if the
expectations arent met, the share price is likely to drop.

Chapter 6: Costs and Expenses (No Hard-and-Fast Rules)
Cost of Goods Sold (COGS) and Cost of Services (COS)
o Cost of goods sold or cost of services is one category of
expenses. It includes all the costs directly involved in
producing a product or delivering a service
Operating Expenses
o Operating Expenses are the other major category of
expenses. The category includes costs that are not directly
related to making a product or delivering a service.
GAAP
o GAAP stands for generally accepted accounting principles.
GAAP defines the standard for creating financial reports in the
United States. It helps ensure the statements validity and
reliability, and it allows for easy comparison between
companies and across industries. But GAAP doesnt spell out
everything; it allows for plenty of discretion and judgment
calls.
Above the Line, Below the Line
o The line generally refers to gross profit. Above that line on
the income statement, typically, are sales and COGS or COS.
Below the line are operating expenses, interest, and taxes.
Whats the difference? Items above the line tend to vary more
(in short term) that many of those below the line and so tend
to get more managerial
Noncash Expense
o A noncash expense is one that is charged to a period on the
income statement but is not actually paid out in cash. An
example is depreciation: accountants deduct a certain amount
each month for depreciation of equipment, but the company
isnt obligated to pay out that amount, because the
equipment was acquired in a previous period.

Chapter 7: The Many Forms of Profit
Profit is the amount left over after expenses are subtracted from
revenue. There are three basic types of profit: gross profit,
operating Profit, and Net Profit. Each one is determined by
subtracting certain categories of expenses from revenue.
Gross Profit is sales minus cost of goods sold or cost of services. It
is what is left over after a company has paid the direct costs
incurred in making the product or delivering the service. Gross
profit must be sufficient to over a businesss operating expenses,
taxes, financing costs, and net profit.
Operating Profit, or EBIT
o Operating profit is gross profit minus operating expenses,
which include depreciation and amortization. In other words,
it shows the profit made from running the business.
Net Profit is the bottom line of the income statement: whats left
after all costs and expenses are subtracted from revenue. Its
operating profit minus interest expenses, taxes, one-time charges,
and any other costs not included in operating profit.
Financial Intelligence for Entrepreneurs10/30/2012 12:12:00 PM
Part 3: The Balance Sheet Reveals the Most

Chapter 8: Understanding Balance Sheet Basics
Equity is the shareholders stake in the company as measured by
accounting rules. Its also called the companys book value. In
accounting terms, equity is always assets minus liabilities; it is also
the sum of all capital paid in by shareholders. Thats the accounting
formula, anyway; remember that what a companys shares are
actually worth is whatever a willing buyer will pay for them.
A Fiscal Year is any twelve-month period that a company uses for
accounting purposes. Many companies use the calendar year, but
some use other periods. Some retailers use a specific weekend,
such as the last Sunday of the year, to mark the end of their fiscal
year. You must know a companys fiscal year to ascertain how
recent the information you are looking at is.

Chapter 9: Assets (More Estimates and Assumptions Except for Cash)
Smoothing Earnings
o You might think that Wall Street would like a big spike in a
public companys profits-more money for shareholders, right?
But if the spike is unforeseen and unexplained-and especially
if it catches Wall Street by surprise-investors are likely to
react negatively, taking it as a sign that management isnt in
control of the business. So companies like to smooth their
earnings-that is, their profit-thus maintaining steady and
predictable growth.
An acquisition occurs when one company buys another. Often youll
see in the newspaper the words merger or consolidation. Dont be
fooled: one company still bought the other. A more neutral-
sounding term may make the deal seem more palatable to the
owners, employees, or customers of the acquired company, but it is
still an acquisition.
A companys intangible assets include anything that has value but
that you cant touch or spend: employees, proprietary knowledge,
patents, brand names, reputation, strategic strengths, and so on.
Most of these assets are not found on the balance sheet unless an
acquiring company pays for them and records them as goodwill.
The exception is intellectual property, such as patents and
copyrights, which can be shown on the balance sheet and amortized
over its useful life.

Chapter 10: On the Other Side (Liabilities and Equity)
The word Capital means a number of things in business. Physical
capital is plant, equipment, vehicles, and the like. Financial capital
from an investors point of view is the stocks and bonds he holds;
from a companys point of view, it is the shareholders equity
investment plus whatever funds the company has borrowed.
Sources of capital in an annual report shows where the company
got its money. Uses of capital shows how the company used its
money.
Dividends are funds distributed to shareholders taken from a
companys equity Public companies typically distribute dividends at
the end of a quarter or year. Privately held companies can
distribute them at any time, but many do it monthly or annually.

Chapter 11: Why the Balance Sheet Balances

Chapter 12: The Income Statement Affects the Balance Sheet
Financial Intelligence For Entrepreneurs10/30/2012 12:12:00 PM
Part Four: Cash Is King

Chapter 13: Cash Is a Reality Check
Owner Earnings is a measure of the companys ability to generate
cash over a period of time. We like to say it is the money an owner
could take out of his business and spend, say, at the grocery store
for his own benefit. Owner earnings is an important measure
because it allows for the continuing capital expenditures that are
necessary to maintain a healthy business. Profit and even operating
cash flow measures do not. More about owner earnings in the
toolbox at the end of this part.

Chapter 14: Profit does not equal Cash ( and you need both )

Chapter 15: The Language of Cash Flow
Buying Back Stock
o If a public company has extra cash and believes that its stock
is trading at a price that is lower than it ought to be, it may
buy back some of its shares. The effect is to decrease the
number of shares outstanding so that each shareholder now
owns a larger piece of the company. Privately held companies
can also do stock buybacks-for example, when an owner or
investor is bought out of the business. The price in this case
would be negotiated by the parties involved, since there is no
market-based share price for a private company.

Chapter 16: How Cash Connects with Everything Else
Reconciliation
o In a financial context, reconciliation means getting the cash
line on a companys balance sheet to match the actual cash
the company has in the bank-sort of like balancing your
checkbook, but on larger scale.

Chapter 17: Why Cash Matters

Financial Intelligence For Entrepreneurs10/30/2012 12:12:00 PM
Part 5: Ratios: Learning What Numbers Are Really Telling You

Chapter 18: The Power of Ratios

Chapter 19: Profitability Ratios (The Higher the Better Mostly)
Gross Margin
Operating Margin
Net Margin
Return on Assets
Return of Equity

Chapter 20: Leverage Ratios
Debt-to-Equity Ratio
Interest Coverage

Chapter 21: Liquidity Ratios (Can We Pay Our Bills?)
Current Ratio
Quick Ratio

Chapter 22: Efficiency Ratios (Making the Most of Your Assets)
DII (Days in inventory)
Inventory Turns
Days Sales Outstanding
Days Payable Outstanding
PPE Turnover
Total Asset Turnover
Financial Intelligence For Entrepreneurs10/30/2012 12:12:00 PM
Part Six: How to Calculate (and really understand) Return on Investment

Chapter 23: The Building Blocks of ROI