Planning, Budgeting and Forecasting 101
Lesson
Outline
Lesson 1:
Introduction
to Planning,
Budgeting,
and
Forecasting
Lesson 2:
Strategic
Planning and
Budgeting
Lesson 3:
Performance
Target
Setting
Lesson 4:
Forecasting
Financial
Indicators
Lesson 5:
Evolution of
Budgeting
Lesson 6:
Integrated
Financials
Agenda
Module Overview
Lesson 1: Introduction to Planning, Budgeting, and Forecasting
Introduction to Planning, Budgeting, and Forecasting (PBF)
Importance of Planning, Budgeting, and Forecasting
Benefits of Planning, Budgeting, and Forecasting
Differences between Budgeting and Forecasting
Challenges of Planning, Budgeting, and Forecasting
Check Your Understanding
Lesson 2: Strategic Planning and Budgeting
Changing Role of Finance
Performance Optimization
Pain Points: Challenges of Spreadsheets
Lesson 3: Performance Target Setting and Reporting
Target Setting process
Target Setting Leading practice
Check Your Understanding
Agenda
Module Overview (Continued)
Lesson 4: Forecasting Financial Indicators
Rolling Forecasting
Barriers to Implementing Rolling Forecasts
Check Your Understanding
Lesson 4: Forecasting Financial Indicators
Lesson 5: Evolution of Budgeting
Evolution of Budgeting
Check Your Understanding
Lesson 6: Integrated Financials
Understanding the Income statement
Understanding the Balance sheet
Understanding Cash Flow Statement
Financial Statement Interconnectivity
Check Your Understanding
Assessment
Lesson
Outline
Lesson 1:
Introduction
to Planning,
Budgeting,
and
Forecasting
Lesson 2:
Strategic
Planning and
Budgeting
Lesson 3:
Performance
Target
Setting
Lesson 4:
Forecasting
Financial
Indicators
Lesson 5:
Evolution of
Budgeting
Lesson 6:
Integrated
Financials
Introduction to Lesson 1
Welcome to Lesson 1: Intro to planning, budgeting and forecasting
•
This lesson will provide you with an overview of three processes in an organization—
Planning, Budgeting, and Forecasting (PBF).
•
After you have gained a conceptual understanding of these three processes, you will
better understand how trends and the evolution of tools shape how our customers
make strategic decisions as part of the planning cycle.
•
From an operational perspective, you will gain an understanding on how to drive the
Target Setting process, and what analytics drive performance and reporting.
•
In addition, You will learn about the broader role the forecasting process has in the
org, and its impact on managerial decision-making
Key Definitions
Lets start with some definitions commonly used within Planning, Budgeting and Forecasting
1
Planning
Planning is the measurement and strategy set forth along for the organization with communication of business
performance to ensure that results are aligned with the organization’s objectives.
2
Budgeting
Budgeting is a plan expressed in financial terms. During budgeting, all actions and requirements need to be translated
into financial numbers such as costs, revenues, amount of capital and number of people. This establishes baseline
expectations that can be used to measure other numbers against it.
3
4
Forecasting
Forecasting is a set of target numbers for relevant performance metrics, predicted for a fixed time period in the
future. The target numbers are computed on the basis of modeling of historical and/or external benchmarking data.
Planning, Budgeting, and Forecasting process
Planning, Budgeting, and Forecasting is a key process which helps businesses answer three basic questions:
1. Where do we want to go? 2.How do we get there?, and 3. How can we be better prepared?
5
Rolling Forecasts
A rolling forecast creates an ongoing cycle of planning, conducting, evaluating and updating organization-wide
operations. Rolling Forecasts are primarily financial forecasts, usually including metrics like sales, costs and cashflows that are updated on a rolling basis. Typical rolling forecasts are not tied to a particular fiscal year and are
prepared each quarter to cover the following five quarters.
Introduction to Planning, Budgeting and Forecasting
Here is a look at the formal definitions of the three processes and the relationships among them
Planning
Budgeting
Is a set of statements
and actions performed
to define aspired targets
for the organization or
business unit for future
periods.
Planning does not need
to be expressed in
financial terms.
Is expressed in financial
terms. All budgeting
actions need to be
translated into financial
numbers such as costs
and revenues which
establishes baseline
expectations that can be
used to measure other
numbers against it.
Forecasting
• Is a set of target
numbers for relevant
performance metrics,
predicted for a fixed
time period in the
future. The target
numbers are computed
on the basis of modeling
of historical and/or
external benchmarking
data.
Importance of PBF
Planning, Budgeting, and Forecasting is a key process which helps businesses answer three basic
questions.
Where do we want to go?
Planning
How can we be better?
(monitor progress)
Forecasting
Budgeting
Key answers for the
business
How do we get
there?
Benefits of PBF
Planning, budgeting, and forecasting processes drive an organization’s annual performance cycle.
➔ An effective set of PBF processes ensure that:
• Operational and financial plans are in synch with the overall business strategy
• Plans and forecasts are linked and aligned to business drivers or key performance
indicators (KPI’s)
• Frequent updates to plans and forecasts are made in response to changes in
business and market conditions
• Better transparency and integrity is achieved to enable smooth regulatory
compliance
Differences between budgeting and forecasting
Here is a look at the differences between budgeting and forecasting
Budgeting
Forecasting
•
Is based on strategy
•
Is based on events
•
Fine-tunes the strategy/plan
•
•
Helps to coordinate/align parts of
the organization
Reflects/guides changes to get
back on plan
•
Presents scenarios based on
strategy and economic conditions
•
Provides inputs on possible future
results to everyone
•
Means of predicting and updating
expected results and targets
•
•
Assigns ownership to people
Provides a basis for evaluating
performance
Challenges of budgeting and forecasting
Most organizations face a range of challenges with their PBF processes. Here are a few:
• Low value administrative tasks take up the greatest portion of time.
• Only about one-third of the time is devoted to conducting value-added analysis.
• Incomplete view of business drivers as they are often buried in several spreadsheets and disparate databases.
• Varying budget cycles and formats across business units hindering cross-functional
planning.
• Plans become quickly outdated as employees perceive PBF processes to be time
consuming.
• Passive participation from line-managers leading to inaccurate inputs.
Check your
understanding
Check your understanding
______ answers the question of how to get to a particular goal and is expressed in
financial terms like cost and revenues.
•
Select the best answer from the options below.
A. Planning
B. Budgeting
C. Forecasting
Check your understanding
______ answers the question of how to get to a particular goal and is expressed in
financial terms like cost and revenues.
A. Planning
B. Budgeting
C. Forecasting
Planning: Incorrect. Planning is a set of statements and actions performed to define aspired targets for the organization
or business unit for future periods.
Budgeting: Correct! Budgeting is expressed in financial terms of cost and revenue and establishes baseline expectations
that can be used to measure other numbers against.
Forecasting: Incorrect. Forecasting is a set of target numbers computed on the basis of modeling of historical/ external
benchmarking data and is predicted for a fixed time period in the future.
Check your understanding
•Which process is based on events and Presents scenarios based on strategy and economic
conditions?
•
Select the best answer from the options below.
A. Planning
B. Budgeting
C. Forecasting
Check your understanding
•Which process is based on events and Presents scenarios based on strategy and economic
conditions?
A. Planning
B. Budgeting
C. Forecasting
Planning: Incorrect. Planning is a set of statements and actions performed to define aspired targets for the organization
or business unit for future periods.
Budgeting: Incorrect. Budgeting is based on strategy and Helps to coordinate/align parts of the organization
Forecasting: Correct! Forecasting is based on events. It also reflects/guides changes to get back on plan
Lesson
Outline
Lesson 1:
Introduction
to Planning,
Budgeting,
and
Forecasting
Lesson 2:
Strategic
Planning and
Budgeting
Lesson 3:
Performance
Target
Setting
Lesson 4:
Forecasting
Financial
Indicators
Lesson 5:
Evolution of
Budgeting
Lesson 6:
Integrated
Financials
Introduction to Lesson 2
Welcome to Lesson 2: Strategic Planning and Budgeting
•
This lesson will introduce you to the role that Finance plays to develop an
organization’s strategy, how they make decisions and what tools are used to do so.
•
You will also learn why spreadsheets still dominate the analytical tools space and
some of the challenges that businesses experience when working with spreadsheets to
you to add value in Anaplan as a result of their pain points.
Changing Role of Finance
With the growing availability of data and tools to analyze data, finance functions have more opportunities to
influence and shape organizational strategy. This is shown through multiple trends. Here is a look at a few of
these trends:
Trend 1
Finance functions are transforming their roles from being a supplier of financial information
to a provider of business insights.
Trend 2
Trend 3
Chief Financial Officers (CFOs) of top-performing companies have credited their success
to their ability to integrating information company-wide, having a integrated business
platform and converting it to a competitive asset-new intelligence.
Finance functions are frequently alerting management to “possible futures” and supporting
efforts to respond to such scenarios.
Performance Optimization
Planning, Budgeting, and Forecasting processes are aimed are aimed at measuring organizational
performance. However, A key tactic to achieving optimization as a part of these measures is to
integrate related activities across the organization in a efficient, objective, and transparent way.
Use of data analysis has represented an objective approach for a long time. However, recent
analytics tools are presenting great opportunities to make the processes more synchronized and
transparent. Here is a look at the differences between analytics tools–then and now.
THEN
•
Focus on key performance indicators (KPIs) to
track performance of internal departments
•
Targets set and investments budgeted based
on the aspired levels of KPIs by department
•
Management focus on KPIs often resulted in
departments tracking specific measures.
These do not always provide insight into
larger, organization-wide performance
objectives, esp. when isolated
NOW
•
Increased focus on understanding the business
drivers behind KPIs
•
KPI Relationships taken into account as they
seldom operate independent of each other
•
Actionable change is based on comprehensive
picture than on granular metrics
Challenges of Spreadsheets
The top three challenges with using spreadsheets are displayed below.
Workflow
Contributions from multiple people across the
organization and departments from several as
they work in the same spreadsheet can not
be tracked easily, leading to inconsistent
versions with increased data risk.
Implementing an automated or controlled workflow
in a spreadsheet environment is nearly impossible.
Governance becomes complex and time consuming
with minimal auditability.
Collaboration
Revision
Difficult to revise, correct, understand, and recreate logic based on the spreadsheet’s origin and
associated personnel; this hinders advancing the
process and gradual improvements in the long run.
Pain Points
The top issues related to Organization and People are as follows:
1. Unclear hand-offs within Finance or across other teams
2. Need to restructure organizational reporting lines
3. Redundancy caused by acquisition
4. Cost pressure or headcount reduction targets
5. Inefficient legal entity structure
6. Sub-optimal or unclear Operating Model
7. In need of CoE Model
8. Insufficient People Strategy (Roles, Responsibility and Training)
9. Inappropriate Finance capabilities, behaviors and talent
10. Developing FP&A / Business Partnering role
Pain Points
The top issues related to Process are as follows:
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
Slow financial reporting / late results
Weak SOX controls
Sub-optimal audit and global compliance controls
Non-compliance with regulatory reporting requirements
Excessive intercompany breaks (e.g., reconciling items)
Large volume of manual journals
Revenue leakage (lost revenue)
Inefficient Order to Cash and / or Purchase to Pay processes
Complex, inconsistent or manual processes
Inefficient cost center structure
CoA structure does not adequately meet needs of business
Unclear cost allocations with limited transparency on linkage to ability to control costs
Weak intercompany and transfer pricing policies / processes
Inability to report under different reporting standards (e.g., IFRS vs. GAAP)
Pain Points
The top issues related to systems and information gathering are as follows:
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
No corporate wide ERP (GL) System
Limited integration of systems between Close, Consolidation and Reporting processes
No central data warehouse and BI Systems
No globally consistent Finance IT landscape
Data (systems / reports) do not reconcile and require rework
Unreliable financial reporting, no trust in Finance
Limited use of performance management tools (KPI / Dashboard / Balance Score Card)
Limited Analytics Capabilities
Inaccurate and late budgets, plans or forecasts
Insufficient information to manage working capital
No Master Data Management strategy
No Project Accounting and Billing system
Lack of fully automated Budgeting and Forecasting Systems
Check your
understanding
Check your understanding
•One of the challenges with workflow in spreadsheets is that:
•
Select the best answer from the options below.
A. Implementing an automated or controlled workflow in a spreadsheet environment is
easy with macros and preset security in excel
B. One person controls the data and this is the best practice
C. Governance becomes complex and time consuming with minimal auditability.
Check your understanding
•One of the challenges with workflow in spreadsheets is that:
A. Implementing an automated or controlled workflow in a spreadsheet environment is
easy with macros and preset security in excel
B. One person controls the data and this is the best practice
C. Governance becomes complex and time consuming with minimal auditability.
Lesson
Outline
Lesson 1:
Introduction
to Planning,
Budgeting,
and
Forecasting
Lesson 2:
Strategic
Planning and
Budgeting
Lesson 3:
Performance
Target
Setting
Lesson 4:
Forecasting
Financial
Indicators
Lesson 5:
Evolution of
Budgeting
Lesson 6:
Integrated
Financials
Introduction to Lesson 3
Welcome to Lesson 3: Performance Target Setting and Reporting
•
This lesson will introduce you to the target setting process and the key components
that make up the process.
•
You will also learn how the application of analytics can improve an organization’s
revenue and sales planning, and performance reporting capabilities.
Target Setting Process
Here is a depiction of the target setting process
Target Setting Inputs
• External peer Benchmarks
• Strategic Vision
• Current Valuation
• Historical Performance
• Internal Benchmark
• Model by business unit
Target Setting
process
Target Setting Outputs
Corp
Targets
Business Unit
Targets
Functional Targets
Target Setting Process
Target setting process defined and key questions to think about along the way:
•
External Peer Benchmarks: To establish an external peer benchmark, ask the question:
➔ How does my performance compare with peers at a corporate, business unit, and functional level?
•
Strategic Vision: To formulate a strategy vision, ask questions like:
➔ What is the long term vision for overall company and Business Unit?
➔ Where are we on the path to value?
•
Current Valuation: To assess current valuation, ask the question:
➔ What are the owners expectations on financial returns and tolerance for risk?
•
Historical Performance: To measure historical performance, ask the question:
➔ How effective has the company's strategies been in achieving financial returns and operational improvements?
•
Internal Benchmark: To devise an internal benchmark, ask the question:
➔ How have the different Business Units' been contributing to performance?
•
Business Model of Business Unit: To measure a business model of a Business Unit, ask the question:
➔ What is the risk and return profile of the BU’s?
Target Setting Process
Target setting process defined and key questions to think about
•
Key Design Principles: Let us look at the key design principles used in the target setting process.
➔ Targets defined need to be linked directly to value creation and need to be quantifiable and measurable
➔ The target settings process is iterative and must include both top-down target settings from corporate to
Business Units (BUs) and functions as well as bottom-up analysis to ensure feasibility
•
Business Unit Targets:
➔ Business Unit targets are set based on corporate targets and inputs from the target setting process
➔ These targets allow BU’s to track performance and corporate goals
➔ Examples include revenue growth, operating margins, asset efficiency
•
Functional Targets:
➔ Functional targets are set based on BU targets and internal and external benchmarks
➔ These targets tend to be operational in nature and are used to measure functional performance and efficiency
➔ Examples include reduction in customer churn or increase manufacturing throughout
•
Corporate Targets:
➔ Corporate targets are defined directly out of the target setting process
➔ Targets are strategic in nature and are linked to value creation.
➔ Examples include EM, Enterprise Value and warranted share price
Target Setting – Leading practices integrated
Target setting is an integral process as part of the entire forecasting picture. The Leading practice is to differentiate between
each process; the base Forecast (Operational), Strategic Plan and Annual Budget and unique, with target setting key to begin
the cycle
Enterprise Level Planning
Finalize changes
and approve base
model
Finalize changes and
approve base model
Start planning cycle
bottoms up
detailed plan development
Systemically create
detailed plan
(e.g. BU level planning,
departmental plans etc.)
Model scenarios as
required by the
business
Leverage inputs into strategic plan
(FP&A reviews consolidated results)
Validate Plans
(e.g. Dept. leads, verify plan
assumptions and check results
for reasonableness)
Publish
results
(guidance, management
reports, adhoc analysis)
End Planning Cycle
BU and Dept Level
Targets provided for
operational/ base forecast
Check your
understanding
Lesson
Outline
Lesson 1:
Introduction
to Planning,
Budgeting,
and
Forecasting
Lesson 2:
Strategic
Planning and
Budgeting
Lesson 3:
Performance
Target
Setting
Lesson 4:
Forecasting
Financial
Indicators
Lesson 5:
Evolution of
Budgeting
Lesson 6:
Integrated
Financials
Introduction to Lesson 4
Welcome to Lesson 4: Forecasting Financial Indicators
•
In this lesson, you will become familiar with concepts of Forecasting, its role in
decision-making, and essential elements to implement effective forecasting system.
•
You will also learn about the significant role that Rolling Forecasts play in predicting
relevant financial indicators and the challenges faced while implementing this system.
•
With the aid of examples, you will see the implication of analytics in the Forecasting
process and the significance of identifying key drivers in the Forecasting process.
Lesson 4 Objectives
•
Upon completing this lesson, you will be able to:
➔ Describe the significance of Rolling Forecasts
➔ Recognize the challenges to implementing Rolling Forecasts
➔ Understand the role of key drivers in a Forecasting system
Rolling Forecast
Traditional annual budget cycles are typically a time-consuming and detailed activity that is largely focused on financials and
results in a plan, both which tend to become outdated due to new developments in the market. Such sluggish planning process
makes businesses unsustainable in the volatile markets. It is in this context that organizations are increasingly adopting rolling
forecasts to predict relevant financial indicators.
Rolling forecasts are primarily financial forecasts, including metrics like sales, costs and cash-flows that are updated on a rolling
basis. Typical rolling forecasts are not tied to a particular fiscal year and are prepared each quarter to cover the upcoming five
quarters.
Track
Performance
Triggers
Re-forecast
Re-allocate
Scenarios
Evaluate
Scenarios
Barriers to implementing rolling forecasts
It is difficult to implement a well-functioning rolling forecasting system in a large organization. The main challenges faced by
organizations are listed below.
Challenge 1
Challenge 2
Challenge 3
•Dispersed
operations,
customers, and
suppliers across
several geographical
area complicates
the effort required
to produce,
consolidate, review
and approve a reforecast on a
regular basis.
•It is necessary to
develop effective
capabilities and
implement
supporting
technologies to
disseminate and
consolidate planning
information rapidly.
•For rolling forecasts
to be effective, it
has to be owned by
the points which are
closest to the
customersㅡ i.e.,
decentralization to
local levels so that
fact-based decisions
can be made
quickly.
Analytics in the Forecasting Process
To bring together both these concepts, Here is an example to show how analytics can help in driving the forecasting process
•
While analyzing the Budget-vs-Actual report, Rachel, a Budget Manager, notices
that the Hotel expenses of the firm are higher than the budgeted amount.
•
Rachel drills-down to the actual figures to see the underlying transactions
and observes that the staff has been traveling more than planned. She also
discovers that the hotel-and-travel expenses per trip was higher than budgeted
expense.
•
Travel cost-cutting plan is formulated and re-forecast is performed.
•
After discussing options with the staff, it is decided to conduct more remote
meetings instead of travelling.
Check your
understanding
Lesson
Outline
Lesson 1:
Introduction
to Planning,
Budgeting,
and
Forecasting
Lesson 2:
Strategic
Planning and
Budgeting
Lesson 3:
Performance
Target
Setting
Lesson 4:
Forecasting
Financial
Indicators
Lesson 5:
Evolution of
Budgeting
Lesson 6:
Integrated
Financials
Introduction to Lesson 5
Welcome to Lesson 5: Evolution of Budgeting
•
This lesson will provide you with an overview of different budgeting processes
•
After you have gained a conceptual understanding of these processes, you should be
able to understand the evolution of various budgeting models
•
In addition, You will learn about the key benefits each process represents and where
they add the most value
Lesson 5: Evolution of Budgeting
In order to understand traditional budgeting and financial planning, lets take a look at the evolution of budgeting models. These
concepts and processes have evolved to instill increased flexibility while maintaining control
“TOP DOWN”
CENTRALIZED
PLANNING




Traditional financial
management system
Inductive process
Centralized Strategic
Planning or senior
executives (“top down”)
determine BU’s,
departments and project
budgets
ZERO BASE
BUDGETING
ORGANIC
PLANNING




“Top down” goals


Still most used
management system


Deductive process
Budgets are prepared by
each department
(“bottom up”) deriving a
consolidated budget
Negotiation — “top down”
directives vs. “bottom up”
requests
Many “rounds” to
equilibrium
This can be time
consuming in nature if
extremely detailed, but
can be perceived as more
accurate




1970’s; 1980’s
Separation between CAPEX
and OPEX
“Blank page” — questioning
all budget lines, eliminates
the historical biases
High impact on first
implementation,
bureaucratic in regime
Most applicable in industries
with large discretionary
accounts
Great for when you need to
make reductions, or when
you have significant and rapid
technological change
ROLLING
BUDGETS








Eliminates budgeting formal
cycles
Fosters continuous
improvement and high
performance
Emphasis on what is ahead, not
past performance
Dynamic resource allocation
Fosters agility and value
creating decisions
Hard to integrate with reward
system (due to moving targets)
Reduces uncertainty & allows
flexibility where long-term costs
and/or activities cannot be
forecast accurately.
Hypergrowth is a great place for
this.
Check your
understanding
Lesson
Outline
Lesson 1:
Introduction
to Planning,
Budgeting,
and
Forecasting
Lesson 2:
Strategic
Planning and
Budgeting
Lesson 3:
Performance
Target
Setting
Lesson 4:
Forecasting
Financial
Indicators
Lesson 5:
Evolution of
Budgeting
Lesson 6:
Integrated
Financials
Introduction to Lesson 6
Welcome to Lesson 6: Integrated Financials Explained
•
This lesson will provide you with an overview of different financial reference
materials to understand basics of the income statement, balance sheet, cash flow and
how they operate together.
•
Provides a glossary to explain used terminology and explain key concepts or principles
•
Offers a way for consultants to understand and use key Income statement / Balance
Sheet / Cash Flow Forecasting concepts in practice
Lesson 6:
The Income Statement shows how a company has performed over a given accounting period in terms of
profit generated from sales less costs and expenses
Cost of
Goods
Sold
 Cash-based Accounting: Expenses recorded
when cash paid; revenue is recorded when
cash is received; generally used for tax
purposes or other special situations.
Expense
Sales
Gross
Profit
Interest
& Tax
Operating
Profit
(PBIT)
Reflects results of managing
the operations aspect of the
business
Net
Profit
After
Tax
(NPAT)
Dividend
Retained
Earnings
Retained for
further growth of
the company
 Accrual-based Accounting: Revenue recorded
when earned; expenses recorded when
incurred.
 The Income Statement records current
period wear and tear of business’ assets by
subtracting Depreciation and Amortization
from Revenues as operating expenses.
Lesson x:
Understanding the Income Statement: Reflects financial results of an entity for a period of time, often
one year. Lets take a snapshot of a company and dive into each aspect
Revenues: The earnings of a company before
any costs or expenses are deducted. Includes
all net sales plus any other revenue associated
with the main operations of the business.
Costs and Expenses: Includes the cost of goods
sold (COGS); and salaries, commissions, and
travel expenses for executives and
salespeople, advertising costs, and payroll
expenses (SG&A).
Operating Profit: Earnings before interest and
taxes (EBIT). Measures a company’s earning
power from ongoing operations.
Interest expense: The expense incurred to
cover the interest on loans.
Net Income: Sales minus taxes, interest,
depreciation, and other expenses. Also called
net earnings, net profit, or bottom line.
Always read the notes!!
Integrated Financials
As PBF processes translate an organization’s strategic objectives into measurable financial terms, a set of financial statements are
generated. These statements together with PBF processes define the targets that our customers should aim for, future
looking.
The major components which build an organization’s integrated financials are as follows:
Allocations
•Allocations utilize drivers to manage allocations of costs and revenue across
departments. Once modeled, allocations are dynamically recalculated as
underlying drivers (such as costs and headcount) change.
Capital Assets
•Drivers or metrics like headcount, production units, expansion, acquisition,
and many more such metrics can be used to plan new capital expenditures.
Interest expense, depreciation, gain or loss from disposal or sale of assets can
be modeled to analyze impact on financial statements.
Expenses
•Expenses can be tracked across dimensions like cost center, geography,
project, fund, program and many other dimensions. Drivers such as number of
trips, cost per trip and many such drivers can help plan spending.
Revenues
•Integrate actual sales data-units and pricing, sliced by various dimensions,
from a CRM or other enterprise systems to plan revenue over life of contracts
and other drivers.
Lesson 6:
The Balance Sheet: The Balance Sheet presents a financial “snapshot.” It details where the company’s
money came from and where it is deployed at the end of the accounting period
Assets = Liabilities + Shareholder Equity
 Generally, money to be allocated
can come from three sources:
– Loans
– The sale of stocks
 The balance sheet consists of
Assets, Liabilities, and Equity
– Assets always equal liabilities
plus equity
Current Assets
Where the
money is
going to
Fixed Assets
Intangible
Assets
Liquidity
– Profits in the form of
Retained Earnings
Current
Liabilities
Long-term
Liabilities
Shareholder’s
Equity &
Retained
Earnings
Off-Balance Sheet Items
Where the
money is
coming from
Lesson 6:
Understanding the Balance Sheet: The Balance Sheet provides a snapshot of assets and liabilities at a
point in time
Current Assets: The sum of cash and cash equivalents,
accounts receivable, inventory, marketable securities,
prepaid expenses, and other assets that could be
converted to cash in less than one year.
Property, plant, and equipment (PP&E)
Other: Includes other assets such as Intangibles.
Current Liabilities: The sum of all obligations owed by a
company and due within one year.
Noncurrent Liabilities: Debt not due to be paid within
the next year.
Stock
Retained Earnings: Earnings not paid out as dividends but
instead reinvested in the core business or used to pay off
debt.
Lesson 6:
The Cash Flow Statement used in financial analysis to provide more detail around information contained
in the Income Statement as well as changes in the Balance Sheet.
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The Cash Flow Statement identifies principal inflows (receipts) and outflows
(disbursements) of cash from three primary categories of business activities:
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The Cash Flow Statement is intrinsically linked to the Balance Sheet and Income
Statement:
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Operating Activities, e.g., the selling of and payment for goods and services
Investing Activities, e.g., the purchase of non-current assets such as property and equipment
Financing Activities, e.g., the borrowing of funds (short- or long-term) and sale of stock
Revenues recorded on the Income Statement would appear as cash inflows
Changes in debt levels on the Balance sheet would appear as inflows/outflows
For valuation purposes, we are interested in the timing as well as the amount of cash
flows (time value of money).
For performance measurement purposes, we often try to ignore the timing of specific
items and are therefore happy to rely on the other financial statements, which attempt
to smooth out peaks and troughs in the flow of funds through a business.
Lesson 6:
The Interconnectivity between the three financial statements is the most critical in understanding.
Lesson 6:
Financial statement connectivity: How changes to the balance sheet impact the cash flow statement
Change in Balance Sheet Item
Impact on Cash Flow Item
Accounts Receivable
Cash Flow from Operations
Accounts Payable
Cash Flow from Operations
Inventory
Cash Flow from Operations
Prepaid Expenses
Cash Flow from Operations
PP&E
Cash Flow from Investments
Issuance of Debt
Cash Flow from Financing
Issuance of Stock
Cash Flow from Financing
Lesson 6:
Financial statement connectivity: How changes to the income statement impact the cash flow
statement
Change in Balance Sheet Item
Net Sales
1.
2.
3.
Impact on Cash Flow Item
Depends
Cash Flow from Operations1
Cost of Goods Sold
Cash Flow from Operations
G&A Expenses
Cash Flow from Operations
Depreciation & Amortization
Cash Flow from Operations2
Interest Expense
Cash Flow from Operations
Income Tax
Cash Flow from Operations
Other Income
Cash Flow from Operations or
Cash Flow from Investments3
Net impact on Cash Flow from Operations depends on whether sales made were actually collected in cash for the accounting period being examined
Impact on cash flow is due only to the tax effects of depreciation and amortization
Other income can be linked either to Stock-Based Compensation in Cash Flow from Operations or Proceeds from Sale of Securities in Cash Flow from Investments