3 Financial Statements You Should Understand to Help You Get The IT Finance Team on Your Side
THE LANGUAGE OF BUSINESS
Bottom line, accounting is the language of business. Companies have supporting teams of finance and accounting staff who produce financial data and statements. The accounting records they compile tell a story of cash flows, profits and losses, credits and debits. Are we winning or losing? Understanding these numbers is crucial to recognizing risks and identifying opportunities for any company.
The 3 Main Reports Accounting Departments Prepare Are:
- Balance Sheet
- Profit & Loss Statement
- Cash Flow Statement
Understanding these gives you an idea of the general financial condition of an enterprise and you will be able to talk to their IT finance professionals in their own language.
You are at the top of your game and you have big project plans but you need the support of the IT finance team to make them happen. To increase the odds of a win, begin by understanding how the company’s balance sheet, income and cash flow statements can provide clues to the future success of your project. Your ability to communicate with IT finance professionals at their level will go a long way in getting their support for your next pitch.
1 THE BALANCE SHEET
The balance sheet is a snapshot of the company’s financial position at a point in time. There are three elements of a balance sheet: what the company owns (assets) and owes (liabilities), as well as the amount invested by shareholders (equity).
It is called a balance sheet because the assets the company owns must be equal to the claims against those assets (liabilities and equity). Anything that the company owns is either paid for by borrowing money (liabilities) or by investors (shareholders’ equities).
THE THREE ELEMENTS OF A BALANCE SHEET:
Assets are everything the company owns and are reported in two categories.
These are assets that can be sold, cashed in or liquidated quickly (within a year or less).
Current assets are usually listed in the order of their liquidity, and include:
- Cash and equivalents
- Securities with liquid market value
- Accounts receivable
- Furniture and fixtures
- Prepaid expenses
These are all the other company’s assets that cannot be liquidated quickly (more than a year). Long-term assets found on the balance sheet include:
- Securities with no liquid market value
- Intellectual property
- Other non-tangible assets, like goodwill
Liabilities are the debts a company owes.
They are legal obligations payable to a third party, and are divided into two categories.
These are obligations that are payable within a year, and include:
- Short-term loans
- Accounts payable
- Accrued liabilities
- Accrued wages
- Taxes payable
- Deferred revenue
- Interest payable
- Warranty liabilities
These are obligations that are due in more than one year, and include:
- Long-term loans
- Debts due for payment in over a year
The equity portion of the balance sheet is the value of the company to the shareholders. This is presented as assets less liabilities equal the shareholders’ equity balance. This net equity is further broken down as:
- Retained earnings
- Shares held in the company’s treasury
- Preferred shares
- Equity held by common shareholders
The balance sheet is aptly named.
All assets listed must be equal to the liabilities and shareholders’ equity combined. The report shows what the company owes and owns along with long-term investments and debts, which do not appear in the profit and loss statement.
IN AN IDEAL ACCOUNTING WORLD, CAPITAL EXPENDITURES (CAPEX) COVER FIXED ASSETS AND APPEAR ON THE BALANCE SHEET.
OPERATING EXPENDITURES (OPEX) ARE USUALLY NON-PHYSICAL EXPENSES AND APPEAR IN THE PROFIT AND LOSS STATEMENT.
The Elements of CapEx
CapEx are expenses a company incurs, such as acquiring, upgrading or repairing physical assets to create benefit in the future. However, there are exceptions to this rule, based on individual industries, where nonphysical assets can also be considered CapEx. Items that may be posted under CapEx include patents, licenses or other investments which can be accounted for over an extended life-cycle of more than one year.
The Elements of OpEx
OpEx are the expenses incurred from the day-to-day running of business operations, such as cloud licensing fees, rent, wages, repairs, travel, etc. If the company purchases a perpetual license it is considered CapEx, which can be capitalized. However, if they acquire a subscription or cloud license, the expense will be listed as OpEx on their profit and loss statement.
Only CapEx can be capitalized and depreciated over time – OpEx cannot.
2 THE PROFIT & LOSS STATEMENT (P&L)
The profit and loss statement, also called the income statement, is a financial report that summarizes the company’s financial activity over a certain period of time such as a month, a quarter or a year.
= Revenue Earned
– Cost of Goods Sold (COGS)
= Gross Profit
– Operating Expenses
= Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA)
– Interest, Taxes, Depreciation and Amortization
= NET PROFIT/LOSS
THE PROFIT & LOSS STATEMENT BROKEN DOWN:
The amount of money the company earned by selling products and services.
Cost of Goods Sold
Total amount of money spent to buy or make the products or services the company sells.
Total earnings for the company before expenses.
All the other expenses the company incurs that are not directly related to the production
or sale of the company’s products or services, such as rental agreements, cloud software agreements, marketing costs, payroll and insurance expenses.
Earnings before interest, taxes, depreciation and amortization is a yardstick of the company’s operational health and is used as an indicator of the company’s earning potential. It evaluates the company’s performance without factoring in financing and accounting decisions or tax environments.
This end-result is used to determine the company’s earnings/losses per share by dividing the net income by the total number of shares.
The profit and loss statement is different from the balance sheet in that the balance sheet reflects the financial position of the company at that moment in time. Whereas the profit and loss statement captures the results of a company’s operations over a specified period of time
3 THE CASH FLOW STATEMENT
The cash flow statement is a useful report to analyze the company’s financial health. It portrays the current amount of cash flowing in and out of the business, in comparison to the balance sheet which measures the assets, liabilities and shareholders’ equity at a fixed point in time.
THE THREE ELEMENTS OF THE CASH FLOW STATEMENT:
This section illustrates the cash flow from the company’s core business operations. The cash flow statement is different from the profit and loss statement as it does not take into consideration non-cash income like depreciation.
The financing section reveals changes in the company’s debt, loans or dividends. To illustrate: when the company receives cash from the issuing of debt this will add to their current cash inflow, but when they later repay that debt their cash balance is reduced.
The investing section encompasses the company’s expenses associated with purchasing new quipment, buildings or land. It also covers the procurement of securities and any other type of investment that involves a cash expenditure.
The cash flow statement details the exact amount of money the company has spent and received, usually monthly. This report also specifies current operating results and changes to the balance sheet, and is used to establish the liquidity of the company.
Familiarize Yourself with Changes to IFRS and FASB Accounting Standards
These may affect a company’s bottom line in more ways than one. On the 1st of January 2019, the accounting standards for acquiring software will change. Non-US companies will be able to account for software leases under the International Financial Reporting Standard (IFRS).
Whereas, US companies will remain under the control of the Financial Accounting Standards Board (FASB), unless they can meet certain IFRS requirements. All of this will have a major impact on the accounting for software. Check our website for more information on IFRS and FASB.
By understanding these three financial reports you can get a good snapshot of any company’s financial health. By grasping these accounting fundamentals, not only will you be able to analyze the company’s performance in the past, you will have a better insight on current and future opportunities and risks the company faces. But most importantly, you will be able to speak to their financial team in their own language.
How can Central Technology Services help? We are experts in solving the financial, operational and budgetary issues associated with acquiring enterprise software and related technology assets. We provide customized licensing solutions for enterprise software.
Contact us today to find out how we can help you.