How to Read Financial Statements

HOW TO READ FINANCIAL STATEMENTS

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A Portfolio for Life

HOW TO READ FINANCIAL STATEMENTS A Portfolio for Life

INCOME STATEMENT

Actual

Forecast

Forecast

2013

2014

2015

Jenny Smith established London Coffee Co. in 2011. At the end of 2013, London Coffee made £10,000 in sales from selling its coffees, teas and sandwiches. On average, 20 customers visited the store each day and spent £2 each on average. The store is open 250 days each year.

Sales

10,000

15,000

20,000

Cost of Goods Sold

(5,000)

(6,000)

(7,000)

Gross Profit

5,000

9,000

13,000

Selling General & Administration

(2,500)

(3,000)

(3,500)

Operating Profit (EBIT)

2,500

Interest Expense

(270)

6,000 (253)

9,500 (157)

Profit Before Tax

2,230

5,747

9,343

Tax

(446)

(1,149)

(1,870)

Net Income

1,784

4,598

7,475

Jenny spent £5,000 in 2013 in cost of goods sold: raw materials such as coffee beans, milk, raw food ingredients and cups, napkins etc. To keep the business running, Jenny paid selling, general & administration costs of £2,500. These include rent, salaries, business insurance, utilities and advertising. From its £2,500 operating profit, London Coffee paid £270 in interest on the bank loan it took out to finance the company’s setup costs. Of its £2,230 in profit before tax, it paid £446 in corporation tax at 20%. At the end of 2013, London Coffee generated £1,784 in Net Income. Jenny decided to pay herself a dividend of 20%. The rest was kept as retained earnings and reinvested in the business. Using London Coffee’s previous financial performance, Jenny made forecasts for the next two years: ABOUT FORECASTING

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HOW TO READ FINANCIAL STATEMENTS A Portfolio for Life

BALANCE SHEET

Actual

Forecast

Forecast

2013

2014

2015

Current assets Cash and cash equivalents Accounts Receivable Inventories Other Current Assets

500 400 1,000 2,000

6,926 600 1,200 3,000

15,733 800 1,400 4,000

Long-term assets Deferred taxes Goodwill Property, plant and equipment

1,000 2,000 30,000

1,500 2,000 28,000

2,000 2,000 26,200

42,900

49,226

58,133

Current liabilities Short-term debt Accounts payable Income taxes payable

0 3,000 2,000

0 4,800 4,598

0 5,600 7,475

Long-term liabilities Long-term debt Provisions

15,000 500

14,000 750

13,000 1,000

Total Liabilities

21,500

24,148

27,075

Equity Common stock Share premium Retained earnings

100 11,000 5,300

100 11,000 13,978

100 11,000 19,598

21,400

25,078

31,058

USES OF FUNDS

Total Assets SOURCES OF FUNDS

Total Equity

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Current Assets At the end of 2013, London Coffee had £500 in cash and cash equivalents in its bank account. Jenny delivers coffees to employees in a nearby office block twice a month. The office pays the total cost at the end of the month. Jenny is expecting this £400 in accounts receivable. London Coffee has £1,000 of inventories including dairy products, coffee beans and food ingredients in the shop. There is also £2,000 in other current assets in the form of restricted cash, earmarked for payroll. Long-term Assets In the coffee shop, there was £30,000 worth in furniture and equipment (fridges, espresso machine and till). The company has £2,000 in goodwill from the value of its brand name and customer relations. London Coffee recorded a loss in the previous year which it can use to offset its 2013 tax bill as a deferred tax asset of £1,000. Current Liabilities London Coffee has no short-term debt as it has a positive cash balance of £500. It purchases its coffee beans on credit and owes the suppliers £3,000 in accounts payable. London Coffee owes the government £2,000 in income taxes for the period. Long-term Liabilities Jenny borrowed £15,000 from the bank to setup London Coffee as long-term debt. She has also set aside £500 as provisions to renew the lease on the property in four years time. Equity As the sole owner, Jenny paid in £100 as share capital when she started the business in 2011. In 2013, another investor injected £11,000 in equity as a share premium. The company has retained earnings of £5,300 since it opened. Jenny made a series of assumptions to model out the balance sheet for 2014 & 2015:

ABOUT FORECASTING

HOW TO READ FINANCIAL STATEMENTS A Portfolio for Life

CASH FLOW STATEMENT

Actual

Forecast

Forecast

2013

2014

2015

1,752 3,200 952 (150) 200

4,610 2,980 2,257 (500) 250

7,487 2,782 2,278 (500) 250

(1,000)

(1,000)

(1,000)

Change in short-term debt Change in long-term debt Dividends Issue / Repurchase of shares

0 (1,000) (350) 0

0 (1,000) (922) 0

0 (1,000) (1,497) 0

Net cash flow

3,604

6,675

8,800

Beginning cash Ending cash

250 3,854

3,854 10,529

10,529 19,329

OPERATING CASH FLOWS Net Income Depreciation and amortisation Change in working capital Change in other assets Change in other liabilities INVESTING CASH FLOWS Capital expenditures FINANCING CASH FLOWS

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Operating Cash Flows From London Coffee’s cash flows from operations, the company generated £1,752 in net income. Due to aging of its property, plant and equipment, assets lost £3,200 in value from depreciation. There was an increase in cashflow from working capital due mainly to an increase in the amount the company owed to creditors.

Investing Cash Flows For general maintenance of the coffee shop, the company invested £1,000 in its property, plant & equipment through capital expenditure. Financing Cash Flows From debt and equity sources of funds, Jenny paid down £1,000 of the long-term debt (bank loan). She paid out £350 in dividends from the net income generated in 2013. There were no repurchases or sales of shares to investors during the year. London Coffee had a net cash flow of £3,604 to add to beginning cash of £250. For 2013 London Coffee Co had ending cash in the bank of £3,854.

Jenny made cash flow forecasts of the company’s operating, investing and financing activities: ABOUT FORECASTING