Finance in High Heels

I am an Electrical Engineer by education, with 11+ year hands-on experience developing web/database technologies. I am also infused with very well established finance principles (Wharton MBA). I have worked in Fortune 500 companies as well as startups. I am a very active entrepreneur and strategic consultant with exceptional client relationship skills and a passion for solving complex business problems, developing strategies, designing technology solutions all while bringing positive energy and enthusiasm to projects.

[finance-in-high-heels]

The Cash Flow Statement...Can We Pay Our Bills?

It would not be fair to start this post without highlighting the importance of understanding the Cash Flow Statement especially to entrepreneurs and new business owners at the beginning of their ventures. Many businesses fails because people fail to understand Cash Flow Management.  Entrepreneurs and business owners often mistake cash and profit however they are not the same. I read the following example and thought it might resonate . Profit is like food while Cash is like Oxygen. if you don't eat for the rest of the day you will still be alive, you will be hungry and maybe in a bad shape but alive nonetheless. However, if you don't get Oxygen even for few minutes and you won't survive. That's true for a business as well. a Business that runs out of cash can not survive, services are cut off, unpaid staff will stop working, overdue suppliers will stop supplying material ... you get the picture.  So Let's keep that in mind when we dive into understanding one of the most important yet highly overlooked statements -- The Cash Flow Statement. 

Definition:  The Cash Flow Statement - also referred to as Funds Flow Statement -is asummary of the actual or anticipated incoming and outgoing of cash over an accounting period. It assess the amount, timing and predictability of cash-inflows and cash-outflows and is used as basis for budgeting and business planning. 

How is the Cash Flow Statement Organized?

After the Heading which contains the company name and the period when the financial data was recorded, the Cash Flow Statement is divided into three main sections:

      Operating Activities - Measuring the cash inflows and outflows caused by core business operations, the operations component of cash flow reflects how much cash is generated from a company's products or services. Generally, changes made in cash, accounts receivable, depreciation, inventory and accounts payable are reflected in cash from operations. 

     Investing Activities - Changes in equipment, assets or investments for example to buy "cash out" new equipment, buildings or short-term assets such as marketable securities. However, when a company divests of an asset, the transaction is considered "cash in".  

     Financing Activities - Changes in debt, loans or dividends are accounted for in cash from financing. Changes in cash from financing are "cash in" when capital is raised, and they're "cash out" when dividends are paid. Thus, if a company issues a bond to the public, the company receives cash financing; however, when interest is paid to bondholders, the company is reducing its cash. 

What Information can we get from the Cash Flow Statement?

How the business is generating its cash? 

Is it from its core business of providing goods and services ( which is the best way for a successful business)? (CFO)

Is it from selling buying and selling assets such as machines, building sand land? (CFI) 

Is it from selling equity in the company or incurring debt? (CFF) The ultimate scenario is for businesses to generate the largest portion of their cash from the day-to-day operating activities with minimal reliance on outside financing.  

How the business use its money and where its priorities lie?

Is it in growth mode hence spending on purchasing equipments?

Is the business distributing wealth to owners (via Dividends), or use the proceeds to generate more growth.  

How Liquid is the organization?

How much cash does the business have this year compared to the previous couple of years?  

Is the Net Income reported on the Income Statement realized in cash?

If the "operating" income and the "operating" cash figures have a huge gap then you should ask some tough questions about inflating income or deflating expenses.  

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The Income Statement ..... Focus on Earning

In the last post we discussed the main financial statement:

      Balance sheet

      Income statement

      Cash flow statement

What they are, the value they provide to both the entrepreneur and the investor, then we dug deeper into the Balance Sheet. It's definition, structure and some of the questions it could help us answer regarding the business.

In this post, we will do the same for the Income Statement. Entrepreneurs and business owners focus the most on the Income Statement because it summarizes the company operation, and shows how well a company has performed over a certain period.

Definition: The Income statement - also referred to as Statement of Earning or Statement of Operation) is a summary of the business profitability -or lack of it - over a past certain period (month, quarter, year) of time. It itemizes the revenues and expenses that led to the current profit or loss.

The first thing we should notice here is unlike the balance sheet which reports a snapshot of the business at a certain date, an income statement depicts what happened over a month, quarter, or year.

The income statement too is based on a fundamental equation

Net Income = Revenue - Expenses

How is the Income Statement Organized?

   After the Heading which contains the company name and the period when the financial data was recorded, the Income Statement is divided into three main Components:

                 Revenues - also referred to as top line - are the income generated from the sales of goods and services associated with the main operation of the business before any cost or expenses are deducted.

     Expenses - are any cost of doing business resulting from revenue-generating activities.

     Net Income - also known as bottom line is the excess of total revenue over total expenses.

If total revenues exceed total expenses => the business generates Net Income

If total expenses exceed total revenues => the business generates Net Loss

If total revenues are equal to total expenses => the business operates at break even

How do we use the Income Statement to make decisions?

The Income Statement tells the business profitability story

It is not accurate to assume two businesses are equally profitable just because they have the same bottom-line Net Income. What is more important is how does a business achieve the final Net Income? is it by excelling at sales and keeping the costs at a reasonable level? Maybe sales stayed at a moderate level but the business was able to reduce the cost of producing each unit and/or the overhead cost (administrative and ongoing cost of operating the business), or perhaps a combination of all. That's why it is not enough to compare businesses based solely on the Net Income but rather we should examine the many types of profits the business genertes:

Gross Profit: It is the difference between revenue and the cost of producing goods or services sold, which what is left after the company has paid the direct costs incurred in making the product or delivering the service. Gross Profit should be large enough to cover business expenses, taxes, financing and a healthy net profit. 

Operating Profit: The profit earned from the normal core business operations. This value does not include any profit earned from the business investments or the effects of interest and taxes. This Operating profit is also known as "earnings before interest and tax" (EBIT). It is calculated by subtracting operating expenses or SG&A (Selling, General & Administrative) from Gross Profit. Operating Profit is a key to the health of the business and it measures both the overall demand for business products or services (sales) and  the efficiency in delivering those products and services (costs).It is an important gauge to how well management is running the business from an operational perspective.  

Operating Profit EBITDA - Another profit metric to measure a business financial performance is EBITDA. Like its "fraternal" twin EBIT, EBITDA calculates operating profit by subtracting operation expenses from gross margin however it also subtracts one time charges, depreciation and amortization. These expenses has no effect on how well the business is running and can easily be manipulated to swing the company's earning in either direction.  EBITDA plays a larger role for businesses with expensive assets that had to be written down over long periods of time, however it became the standard metrics for all industries including technology even when its use is not warranted.

Net Profit - Finally, The bottom-line. It is what is left after all costs have been subtracted. Net Profit is what Wall Street uses to calculate earning per share and P/E ratio for public companies. 

EBITDA is your Friend.... However please remember

BITDA is NOT cash flow

EBITDA gives the appearance of more cash than there actually is by leaving out so many expenses  

Neglects cash required for working capital

Neglects debt payments and other fixed expenses

Neglects capital expenditure  

Since EBITDA is a gross earnings base, it is a large profit metric and makes multiples seem smaller which in turn is a poor choice for making price multiple comparisons.

Investors should focus on other performance measures to make sure the company is not trying to hide something with EBITDA

There are a lot of lessons and insights that could be gleaned from the Income Statement to help examine and calibrate every part of the business from sales, market share to production cost, overhead cost, sales & marketing budget and effectiveness depreciation  method and more. We will explore more of these when we talk about Analyzing Financial Statements.

Until Next post where we will talk about our favorite topic CASH!

Einas Ibrahim

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Where it all Begins ... The Financial Statements

It amazes me how entrepreneurs can bravely enter into the unknown world of inventing new products, bet on customer taste or adoption and creatively come up with winning strategies, but when it comes to reading their financial statement -which is there in black and white-, they think it might as well be written in hieroglyphics! 
What if I told you that if you could read a food label and make an informed decision about what you eat then you could read  financial statements and use the data to stere your business in the right direction?

So what are Financial Statements anyway? Think of financial statements as the report cards for your business which quantitatively describe the financial health of your company. They can be used as a roadmap for your business journey to economic success. Using numbers as navigation aids can steer you in the right direction and help you avoid costly "breakdowns."

Financial statements have a value that goes far beyond their use to prepare tax returns or loan applications such as:

      Monitor company performance

      Estimate ROI (Return on Investment)

      Establish business valuation

Additionally, investors use your financial statements to asses: 

      If your business can generate impressive highly scalable revenues

      If you have projections for healthy margins

      How do you grow the bottom line to ultimate investment liquidity

      When will the business become profitable and generate more cash from operation

So shouldn't you be many steps ahead and understand these metrics?

Financial Statements usually include three main reports:                                                  

      Balance sheet

      Income statement

      Cash flow statement

Sometimes there is a forth one -Statement of Retained Earning- but usually you can find this information in the balance sheet.  

Financial statements are usually compiled on a quarterly and annual basis.

In the next three posts I will describe the general structure and main purpose of the each statement starting with the Balance Sheet in this post.

The Balance Sheet ... The mother of all financial statement

Definition: The Balance Sheet - also called statement of Financial Position- reports a financial snapshot of a business at a certain point in time in terms of what the business owns and owes.

The Balance Sheet expresses the relationship among its three main elements Asset, Liabilities and Stockholders’ Equity through the Balance Sheet equation

Asset = Liabilities + Stockholders’ Equity

At any point in time the two sides of this equation should balance (hence the Balance Sheet name)

How is the Balance Sheet Organized?

After the Heading which contains the company name and the date when the snapshot of the financial data on the Balance Sheet is recorded, the Balance Sheet components are divided into three main sections:

     Assets - Which are economic resources the business owns and it increases its value.

     Liabilities - Which are business’ debt and obligation to others.

     Stockholders’ Equity - Which is the financing or capital provided by the investors in exchange for stocks and retained earning.

  Entries under the Assets section are ordered in terms of ease of liquidity. Items that are liquid (such as cash, treasury bills, Money Market funds) or could be converted to cash in less than a year are called Current Assets.

Similarly, entries under the Liabilities section are ordered in terms of its due date. Items that are due ( or payable) in less than a year are called Current Liabilities

   How do we use the Balance Sheet to make decisions?

The Balance Sheet help answers questions like:

    Who owns the business? 

When you have long-term debt, the debtor (such as the bank) owns your business until you fulfill your obligations. Think of it as the mortgagee on your house.

When you have Stocks (as part of the Stockholder’s Equity), the Stockholders or the investors own the business and you have to deliver to their expectation such as dividends, ROI or certain growth trajectory.

When you have Retained Earning, the business owns the business. That’s the best way to finance the growth and operation of your business. It means your business is self sufficient.

How lean is the business?

You can determine how worthwhile and efficient a business is by examining its Working Capital from the Balance Sheet. Working Capital is a measure of how much in liquid assets a company has available to build its business, or how much money is tied up in things we hope to sell.

To calculate Working Capital from the Balance Sheet subtract Current Liabilities from Current Assets

Working capital = Current Assets – Current Liabilities  ( Can you guess what a positive and negative working capital indicate for a business?)

How liquid is the organization?

Answering this question requires a look at the distribution of the company’s assets from the most liquid (such as cash and Account Receivables) to the least liquid such as buildings, land or event intangible assets such as brand name.  

Until Next post when we will take a closer look at the Income Statement 

[finance-in-high-heels]

Welcome To Finance in High Heels

I am sure I am not the only one who sat in a class/seminar to learn about something new only to find myself drowning on all these acronyms and TLAs (Three Letters Abbreviations); DII, DOS, ROA, ROI, ROE, COGS, EBIT, EBITDA ... Oh My, my head is already spinning.  This is what a lot of you told me as well!! 

I will admit prior to attending business school my knowledge in Finance was limited, I kept my basic personal finance on the straight and narrow, but nothing beyond that. That's why one of my graduation goals was to soak all the finance knowledge I can during those two years. - Oh if it were only that easy !!

What I didn't anticipate is the "Finance and Quant Jockeys". These are the Students  in the classroom who always knew more than the rest of us about the topic, and why wouldn't they? They have been working as Investment Bankers or something similar for few yeas; so of course they don't want to discuss "Compound Interest Rate" or "Annuities". This is basic knowledge, a child play if I may say, for them. They want to move to the heavy stuff like "Hedge funds" and "Default Swaps".  

I have to admit I was very intimidated by what I thought is lack in my abilities to keep up, and because everything was moving so fast I never stopped to think if I should prepare myself better. It wasn't until the second semester when I took some breather and found out there is nothing to be intimidated of, it's just jargon. 

I achieved my goal and graduated with a double major in Finance (focus on Venture Capital and Private Equity) and Entrepreneurship Management..

Now, I consult for entrepreneurs and founders of startups. I see a lot of them allowing themselves to be intimidated by financial jargon, and I give them the tools to break from this serious business obstacle. To succeed in your business you should fully understand everything about it especially the finances, you should understand what the numbers are telling you then make sound business decisions accordingly.

I know you might be the artist, the visionary or the best sales closer ever... however you may not be able to take your business off the ground without having this top level understanding of the numbers.

So, what's with the High Heels? Well, I personally LOVE to wear High Heel, and during my finance days in a fortune 500 I've always roamed the organization with my stilettos refusing to give in the more common image of a finance woman in the department with the more comfortable flat shoes. Although, another reason for the name is that I found when working with my private clients, women tend not to ask questions in public classes or seminars and they are more comfortable asking all the questions in private or 1:1 sessions despite the fact they have very intelligent questions. What's the difference between EBIT and EBITDA? how are the three financial statements linked? which financial ratios are best used for...? ...etc, and I want to encourage women to feel this will be another safe place to ask any Corporate Finance questions that crosses their mind but I also would like to encourage anyone regardless of gender to participate. finance does not discriminate.

Until Next Post 

Einas Ibrahim