ACCOUNTING AND MATH part two

Income Statement / Balance Sheet / Cash Flow Statement

Three core financial statements that describe a company’s performance (IS), position (BS), and cash movements (CFS). They are interconnected and used together to understand a business

Balance Sheet

A snapshot of what a company owns (assets), owes (liabilities), and the residual value for owners (equity) at a single point in time. A = L + E

Accounting Identity

Every transaction has at least two effects (double-entry accounting), meaning the balance sheet always stays balanced

Money Market Securities

Very short-term, low-risk investments (≤ 3 months) like Treasury bills or CDs where companies park excess cash temporarily

Accounts Payable (AP)

Current liability representing money owed to suppliers for goods/services received but not yet paid for

Equity

The owners’ claim on the company after liabilities are subtracted from assets

Income Statement

Shows financial performance over a period of time by matching revenues with the expenses incurred to generate them

Matching Principle

Expenses must be recorded in the same period as the revenues they helped generate

Income Statement Structure

Revenue → Cost of Goods Sold → Gross Profit → Operating Expenses → Operating Profit (EBIT) → Interest → Taxes → Net Income

Operating Profit

Profit generated from core business operations before interest and taxes; measures operating performance

EBIT

Earnings Before Interest and Taxes; operating profit adjusted for non-core/non-recurring items when necessary

EBITDA

Earnings Before Interest, Taxes, Depreciation, and Amortization; measures operating cash-like earnings before non-cash expenses

EBITDA Formula

EBITDA = EBIT + Depreciation + Amortization

Operating Working Capital (OWC)

Measures cash tied up in day-to-day operations of the business

Operating Working Capital Formula

OWC = Accounts Receivable + Inventory − Accounts Payable

Positive OWC

When AR + Inventory > AP → company must fund operations using its own cash (cash use situation)

Negative OWC

When AP > AR + Inventory → suppliers are funding operations (cash source situation)

Cash Impact from OWC

Increase in OWC = cash outflow; Decrease in OWC = cash inflow

Cash Flow Statement (CFS)

Reports cash generated or used in operating, investing, and financing activities over a period

Operating Activities

Cash from core business operations (sales, expenses)

Investing Activities

Cash used for or generated from long-term investments (PP&E, acquisitions)

Financing Activities

Cash flows between company and investors (debt, equity, dividends)

Cash Flow Reconciliation Rule

Increase in assets = cash outflow; Increase in liabilities/equity = cash inflow

Tangible Non-Current Assets

Physical assets like buildings, machinery, vehicles, and equipment

Intangible Assets

Non-physical assets like patents, trademarks, copyrights, and licenses

Financial Non-Current Assets

Long-term investments such as equity stakes, joint ventures, and securities

PPE Forecasting (BASE Method)

Beginning + Additions (CapEx) − Subtractions (Depreciation) = Ending PPE

Depreciation

Systematic allocation of an asset’s cost over its useful life

Straight-Line Depreciation

(Asset Cost − Salvage Value) / Useful Life

Debt Holders

Lenders who provide financing and are repaid with interest

Equity Holders

Owners of the company who receive residual profits (dividends) and bear risk

Leverage Effect

Debt amplifies returns

Net Debt

Total debt minus cash and cash equivalents (true measure of indebtedness)

Net Debt Formula

Net Debt = Total Debt − Cash & Cash Equivalents

Present Value (PV)

Value today of future cash flows after discounting for time and risk

Future Value (FV)

Value of a current amount after compounding over time

PV Formula

PV = FV / (1 + r)^n

FV Formula

FV = PV × (1 + r)^n

Perpetuity

Infinite series of equal cash flows

Perpetuity Formula

PV = PMT / r

Growing Perpetuity

PV = PMT₁ / (r − g)

Annuity

Fixed cash flows over a finite period

Annuity PV

PV = PMT × [1 − (1 + r)^−n] / r

Growing Annuity

PV = PMT × [1 − ((1+g)/(1+r))^n] / (r − g)

Yield / Return

The discount rate that equates present value and future value of an investment

IRR (Internal Rate of Return)

The discount rate that makes NPV = 0 for all cash flows

IRR Concept

PV of inflows = PV of outflows