I’m trying to learn financial investment, so I will first attempt to read financial reports to understand the business activities happening in the world.

Here are some fundamentals to get know about a company:

• Income Statement (Profit & Loss): Shows the company’s revenues, expenses, and profits over a specific period. Key metrics to focus on: revenue, gross profit, operating profit, net income. It’s kind of a video shows the activity of the company in a past period.
• Balance Sheet: Provides a snapshot of the company’s assets, liabilities, and equity at a specific point in time. It gives insight into the company’s financial health and how it’s funded. It’s like a snapshot.
• Cash Flow Statement: Highlights the company’s cash inflows and outflows over a period. It focuses on operating, investing, and financing activities. A key metric here is free cash flow, which indicates the amount of cash a company has left after capital expenditures.
• Statement of Shareholders’ Equity: Explains changes in equity from the previous period.

Difference of Income Statement and Cash Flow Statement

1. Income Statement (Profit & Loss Statement)

What it focuses on:
The Income Statement shows a company’s revenues and expenses over a specific period (e.g., a quarter or a year), and ultimately calculates the net income (profit or loss). It focuses on accrual accounting, which means it records revenues when earned and expenses when incurred, regardless of when the actual cash is received or paid.

• Key Metric: Net Income

Main Focus: It is focused on profitability and financial performance over a period.

• What is included:
  • Revenues (or sales): Money earned from selling goods or services.
  • Cost of Goods Sold (COGS): Direct costs of producing goods or services sold.
  • Operating Expenses: Indirect costs such as R&D, marketing, and administrative expenses.
  • Interest and Taxes: Other costs related to financing and taxation.

Example: Let’s assume a company (Company X) sells products and reports the following in its income statement for the year:

• Revenue: $100,000
• COGS: $40,000
• Operating Expenses: $30,000
• Interest Expense: $5,000
• Taxes: $5,000

The net income would be calculated as:

\[ \text{Net Income} = \text{Revenue} - \text{COGS} - \text{Operating Expenses} - \text{Interest} - \text{Taxes} \]\[ \text{Net Income} = 100,000 - 40,000 - 30,000 - 5,000 - 5,000 = 20,000 \]

So, the company made a profit of $20,000 for the year, according to its income statement. This profit is earned, but may or may not have been paid out in cash.

2. Cash Flow Statement

What it focuses on:
The Cash Flow Statement shows the actual inflows and outflows of cash during a specific period. It reflects the company’s liquidity—how much cash it has on hand to pay its bills, invest, and operate. The cash flow statement breaks down cash flows into three categories:

• Operating Activities: Cash generated or used by the company’s core business activities (similar to net income, but adjusted for non-cash items).
• Investing Activities: Cash used for buying or selling assets (like property, equipment, or investments).
• Financing Activities: Cash received or paid related to borrowing, issuing or repurchasing stock, or paying dividends.

Key Metric: Cash Flow (especially free cash flow, which is cash left after capital expenditures).

Main Focus: It shows liquidity and cash availability, indicating whether the company has enough cash to sustain its operations and growth.

• What is included:
  • Cash from Operating Activities: Adjustments to net income for items like depreciation, changes in working capital, and non-cash expenses.
  • Cash from Investing Activities: Cash used to buy or sell long-term assets (e.g., property, equipment, or investments).
  • Cash from Financing Activities: Cash received from issuing debt or equity, or cash used to pay dividends or repay debt.

Example: Let’s take the same company, Company X, and assume the following for its cash flow statement:

• Net Income (from the Income Statement): $20,000
• Depreciation (non-cash expense): $5,000
• Increase in Accounts Receivable (cash not received yet): -$3,000
• Capital Expenditures (purchases of property, plant, or equipment): -$10,000
• Issuing new debt (received cash from borrowing): $8,000

Here’s how the cash flow would be calculated:

1. Cash Flow from Operating Activities:
   

   \[ \text{Net Income} + \text{Depreciation} - \text{Increase in Accounts Receivable} = 20,000 + 5,000 - 3,000 = 22,000 \]

2. Cash Flow from Investing Activities:
   

   \[ \text{Capital Expenditures} = -10,000 \text{ (outflow of cash for buying assets)} \]

3. Cash Flow from Financing Activities:
   

   \[ \text{Issuing New Debt} = 8,000 \text{ (inflow of cash from borrowing)} \]

Now, the Net Cash Flow for the period would be:

\[ \text{Net Cash Flow} = 22,000 + (-10,000) + 8,000 = 20,000 \]

So, the company’s cash increased by $20,000 during the period, even though its net income was also $20,000.

A Simple Example to Show the Difference:

Imagine a company sells a product for $1,000 and records this as revenue on the income statement. However, the customer will pay later, so $1,000 is not immediately cash in the bank.

• Income Statement: The company records $1,000 in revenue and the associated $500 COGS to show a net income of $500 for that transaction.

• Cash Flow Statement: However, no cash was received yet, so the cash flow from operating activities would be negative (due to the increase in accounts receivable). The company also might have spent cash on equipment or repaid debt, affecting its cash flow.

This illustrates how net income (from the income statement) can be quite different from the actual cash flow (from the cash flow statement), especially when a company has non-cash activities like credit sales or depreciation.

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Conclusion:

• Income Statement: Shows how much profit or loss the company made, based on the revenues and expenses it recognizes, even if cash hasn’t changed hands yet.
• Cash Flow Statement: Shows how much actual cash the company generated or spent, regardless of whether those revenues or expenses are realized in cash.

Case Study: NVIDIA

Income Statement

Revenue

• The total income generated from the company’s core business activities, such as selling products or services. It’s the top-line number and represents the starting point for understanding a company’s performance.

Cost of Revenue

• The direct costs associated with producing or delivering the products or services sold by the company. These are essential for calculating gross profit, which reflects production efficiency.

Gross Profit

• Formula: Revenue - Cost of Revenue
• This represents the profit the company makes after covering its direct costs. It’s a key indicator of the company’s ability to efficiently produce its products or deliver services.

Operating Expenses

• The costs incurred to run the business that are not directly tied to production. It includes:
  • Research and Development (R&D): Costs for innovation, developing new products, or improving existing products.
  • Sales, General, and Administrative (SG&A): Costs related to running the company, including marketing, sales, and administrative salaries.

Total Operating Expenses

• The sum of all operating costs incurred by the company. It reflects the expense required to sustain the company’s day-to-day operations.

Operating Income

• Formula: Gross Profit - Total Operating Expenses
• Also known as operating profit or EBIT (Earnings Before Interest and Taxes), it reflects the profit generated from the company’s core operations before accounting for interest and taxes.

Other Income (Expense), Net

• A category that includes non-operating items such as:
  • Interest Income: Income earned from investments or cash reserves.
  • Interest Expense: Costs incurred for borrowing money.
  • Miscellaneous gains or losses that are not part of the company’s core operations.

Income Before Income Tax

• Formula: Operating Income + Other Income (Expense), Net
• This is the company’s total income from all activities (operating and non-operating) before taxes are deducted.

Income Tax Expense

• The amount of taxes the company owes based on its taxable income. It’s important because it affects the bottom line directly.

Net Income

• Formula: Income Before Income Tax - Income Tax Expense
• This is the company’s final profit (or loss) after accounting for all expenses, including taxes. It’s often called the bottom line and is a key metric for assessing a company’s overall profitability.

Net Income Per Share (EPS - Basic and Diluted)

• Basic EPS: The portion of net income attributable to each outstanding share of stock.
• Diluted EPS: Adjusts for the impact of convertible securities (e.g., stock options) that could increase the number of shares outstanding.
• Importance: EPS is a critical measure of profitability on a per-share basis and is closely watched by investors.

Weighted Average Shares Outstanding

• This represents the average number of shares outstanding during the reporting period, used to calculate EPS. It’s important because it ensures EPS reflects the actual share structure of the company.

Summary

• Revenue shows the company’s ability to generate sales.
• Gross Profit and Operating Income reflect operational efficiency.
• Net Income indicates overall profitability, which is critical for assessing financial health.
• EPS connects net income to shareholders, providing a per-share measure of profitability.

Cash Flow Statement

1. Cash Flows from Operating Activities

This section shows the cash generated or used by the company’s core business operations. It starts with net income (from the income statement) and adjusts it for non-cash items and changes in working capital.

• Net Income:

  • The company’s profit (or loss) from its income statement. Since this is based on accrual accounting, it includes non-cash items (e.g., depreciation) and is adjusted here.

• Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities:

  • Adjustments are made to net income to remove non-cash items and account for changes in working capital. Common adjustments include:
    • Stock-Based Compensation Expense: Non-cash expense related to employee stock awards.
    • Depreciation and Amortization: Non-cash costs that spread the expense of tangible and intangible assets over their useful lives.
    • Deferred Income Taxes: Adjustments for differences between taxes reported on the income statement and actual cash taxes paid.
    • Gains or Losses on Investments: Non-cash gains or losses from investments in other entities.
    • Acquisition Termination Costs: A one-time cost, adjusted here as it doesn’t involve cash.

• Changes in Operating Assets and Liabilities:

  • This reflects how working capital (e.g., accounts receivable, inventory, accounts payable) affects cash flow:
    • Accounts Receivable: If customers owe the company money, it decreases cash flow.
    • Inventories: An increase in inventory ties up cash; a decrease releases cash.
    • Accounts Payable: An increase means the company delayed paying bills, which improves cash flow.
    • Other Liabilities: Changes in other short-term liabilities that impact cash flow.

• Net Cash Provided by Operating Activities:

  • This is the total cash generated (or used) by the company’s day-to-day business operations after adjustments.

2. Cash Flows from Investing Activities

This section shows cash used for or generated by investing activities, typically related to buying or selling assets.

• Proceeds from Maturities or Sales of Marketable Securities:

  • Cash inflows from selling investments like bonds or short-term securities.

• Purchases of Marketable Securities:

  • Cash outflows for buying investments such as stocks or bonds.

• Purchases Related to Property and Equipment (CapEx):

  • Cash spent on long-term investments like buildings, machinery, or equipment. A higher CapEx may indicate the company is investing in growth but reduces cash in the short term.

• Acquisitions, Net of Cash Acquired:

  • The cash paid (net of any cash acquired) to buy other companies or businesses.

• Net Cash Provided by (Used in) Investing Activities:

  • The total impact of the company’s investment activities on cash. A negative number indicates more cash was spent on investments than was received.

3. Cash Flows from Financing Activities

This section shows cash inflows and outflows related to funding the company, including borrowing, repaying debt, issuing stock, or paying dividends.

• Proceeds Related to Employee Stock Plans:

  • Cash inflows from employees purchasing stock through company stock plans.

• Repurchases of Common Stock:

  • Cash spent by the company to buy back its own shares, often to return value to shareholders.

• Dividends Paid:

  • Cash paid to shareholders as a return on their investment.

• Repayment of Debt:

  • Cash used to repay borrowed funds.

• Principal Payments on Property and Equipment:

  • Payments toward debt secured by property or equipment.

• Net Cash Provided by (Used in) Financing Activities:

  • The net impact of financing activities on the company’s cash. Positive numbers indicate cash inflows (e.g., from issuing debt), while negative numbers indicate outflows (e.g., repaying debt or dividends).

4. Change in Cash and Cash Equivalents

• Formula:
  \[ \text{Net Change in Cash} = \text{Net Cash from Operating Activities} + \text{Net Cash from Investing Activities} + \text{Net Cash from Financing Activities} \]
• This shows how the company’s cash position has changed during the period.

5. Cash and Cash Equivalents at Beginning and End of Period

• Beginning of Period: The company’s cash position at the start of the fiscal year.
• End of Period: The company’s cash position at the end of the fiscal year.
• Formula:
  \[ \text{Ending Cash} = \text{Beginning Cash} + \text{Net Change in Cash} \]

6. Supplemental Disclosures

• Cash Paid for Income Taxes and Interest:
  • These details are additional cash-related disclosures. They show how much actual cash was spent on taxes and interest during the period, regardless of what is recorded on the income statement.

Summary

1. Operating Activities: Indicates how well the company’s core business generates cash. Positive cash flow from operations is critical for sustaining the business.
2. Investing Activities: Reflects the company’s strategy for growth and asset management. A lot of spending here could indicate expansion, but persistent negative cash flow may also signal over-investment.
3. Financing Activities: Shows how the company raises or returns money to investors and lenders. Large outflows may indicate shareholder rewards (like dividends), while inflows may suggest borrowing or issuing stock to fund operations.
4. Net Change in Cash: Summarizes how cash availability has shifted, which directly affects the company’s ability to meet short-term obligations.

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We will leave Statement of Shareholders’ Equity and Balance Sheet to the later posts. Let us see some more examples in the semiconductor design industry: Intel & AMD.

Case Study: Intel

Income Statement

Cash Flow Statement

Case Study: AMD

Income Statement

Cash Flow Statement

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Last modified on 2024-12-24