Long Term Mindset

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FUNDAMENTALS OF ACCOUNTING ⚖ 
WHAT: Accounting is the procedure of data entry and recording, summarizing, analyzing, and reporting the financial data.

FIVE BASIC ACCOUNTING PRINCIPLES:

1: Revenue Recognition: 
→ Revenue is recorded at the time of the transaction.

2: Matching Principle: 
→ Assets are recorded at their acquisition cost.

3: Historical Cost: 
→ Fiscal Year Income is compared with Calendar Year Expense.

4: Full Disclosure: 
→ Full disclosure of all relevant info is made available.

5: Objectivity Principle: 
→ Information in books should be true, relevant, & accurate.

5 CATEGORIES OF ACCOUNTING:
1: Assets: → All Tangible & Intangible items owned by the company.

2: Liabilities: 
→ Amounts the company owes to others.

3: Equity: 
→ Net Worth of Entity: Assets - Liabilities

4: Expenses: 
→ Amount paid purchases made in business.

5: Income: 
→ Amount earned by the company from the sale of goods.

JOURNAL VS LEDGER:
→Journal Entries consist of Debits & Credits, the totals of which should be equal
→Journal are then transferred to the appropriate Ledger Accounts

FINANCIAL STATEMENTS: 
1: Income Statement:
→ Shows profit or loss during the period. 

2: Balance Sheet: 
→ A company's assets, liabilities, and equity at a point in time.

3: Statement of Cash Flow:
→ Shows the inflow and outflow of cash during the period.

DOUBLE ENTRY SYSTEM
→ Each Accounting Entry will have two sides - Debit and Credit. 
→ The accounts used will be from any of the five categories of accounting.

THREE FIELDS OF ACCOUNTING:
→ Financial Accounting: Preparing the Financial Statements. 
→ Managerial Accounting: Prepare reports for internal use. 
→ Cost Accounting: Measure the performance of resources.

TYPES OF ACCOUNTS:
→ Real: Consists of tangible and intangible assets. 
→ Personal: Accounts for individuals, groups, entities, banks, etc. 
→ Nominal: Accounts related to Gain, Loss, Expense & Income.

What did I miss? Let me know below!

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Margin vs. Markup
Knowing the difference can improve profits!

To calculate margin and markup, you need three numbers:

1: Revenue: Income earned from sales after discounts & rebates
2: Cost of Goods Sold (COGS): The cost to create the product/service
3: Gross Profit: Revenue - COGS

🔹 Margin is based on the selling price.

It shows the percentage of the selling price that becomes gross profit.

Formula: (Gross Profit / Reveue) x 100

🔹 Markup is calculated based on the cost.

It shows how much higher the selling price is than the item cost.

Formula: (Gross Profit / Cost of Goods Sold) x 100

Example!

You own a bike shop. You sell a bike for $200 that costs you $150.

 Margin: ($50 / $200) X 100 = 25%
Markup: ($50 / $150) x 100 = 33% 

Understanding the difference is crucial for pricing strategies, financial analysis, and overall business acumen.

More details are in the graphic below!

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How the Financial Statements connect 🔄

 Understanding how the three financial statements link is crucial to gaining a comprehensive view of a company's financial health.

📃 INCOME STATEMENT
Shows a company's revenue, expenses, and net income over a period of time (month, quarter, year).

📃 BALANCE SHEET
Shows a snapshot of a company's assets, liabilities, and equity at a point in time (Sept 30th, 2023).

📃 CASH FLOW STATEMENT 
Shows a company's cash movements over a period of time (month, quarter, year)

NET INCOME
→The bottom line of the Income Statement becomes the top line of the Cash Flow Statement.
→Net income is added to retained earnings on the Balance Sheet.

ENDING CASH BALANCE
→The bottom line of the Cash Flow Statement becomes the top line of the Balance Sheet

What questions do you have about the financial statements? Let me know below!

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How to analyze a Cash Flow Statement - FAST

Look for these 9 green flags:

1️⃣ Net Income Positive & Growing

Formula: Year 2 Net Income vs. Year 1 Net Income

What: Strong companies consistently grow their net income, even during recessions. 

2️⃣ Stock-Based Compensation < 10% of Net Income

Formula: Stock-Based Compensation / Net Income

What: Stock-based compensation can dilute shareholders when too much is issued. A rule of thumb is for this number to be under 10% of profits.

3️⃣ Operating Cash Flow > Net Income

Formula: Operating Cash Flow vs. Net Income

What: Operating Cash Flow adds back non-cash charges like Depreciation, Amortization, and Stock-Based Compensation. It should always be larger than Net Income. 

4️⃣ Free Cash Flow > Net Income

Formula: (Operating Cash Flow - Capital Expenditures) vs. Net Income

What: Free Cash Flow represents how much cash the business generated during the period. It's a great sign when Free Cash Flow is larger than Net Income. 

5️⃣ Capital Expenditures < 25% of Net Income

Formula: Capital Expenditures / Net Income

What: Great companies do not need to reinvest a lot of profit back into the business to grow. It's a great sign when Capital Expenditures are less than 25% of Net Income.

6️⃣ Debt Reduction

Formula: Debt issuance is negative 

What: Great companies do not need to rely on debt markets to fund themselves, especially in a high-interest-rate environment. It's a great sign when a company is reducing its debt load.

7️⃣ Stock Repurchase

Formula: Stock Issuance is a negative

What: Great companies return capital to shareholders. It's a positive sign if a company is buying back stock.

8️⃣ Dividends

Formula: Dividends paid is a negative

What: Great companies consistently pay a cash dividend to shareholders. It's a positive sign if a company returns capital to shareholders via a dividend.

9️⃣ Cash Balance Increases

Formula: Changes In Cash Balance During Period

What: It's a wonderful sign when a company pays for capital expenditures, reduces debt, buys back stock, pays a dividend, and its cash balance still increases.

What Green Flags did I miss? Let me know below!

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Financial Statements Green Flags 

INCOME STATEMENT 📜 
→Accelerating Revenue Growth
→Gross Margin Expansion
→Operating Expenses Growing Slower Than Revenue
→Operating Margin Expansion
→Interest Income Exceeds Interest Expense
→Pre-Tax Margin Expansion
→Income Tax Rate Near 21%
→Net Income Grows Faster Than Revenue
→Shares Outstanding Declines
→Earnings Per Share Consistently Grows

BALANCE SHEET 📜 
→More Cash Than Debt
→No Accounts Receivables
→No Inventory
→Goodwill Less Than 10% of Total Assets
→Current Liabilities Less Than Cash
→No Short-Term or Long Term Debt
→Deferred Revenue
→No Preferred Stock
→Retained Earnings Positive & Growing
→Treasury Stock

CASH FLOW STATEMENT 📜 
→Net Income Positive & Growing
→Stock-Based Compensation Less Than 10% of Net Income
→Operating Cash Flow Higher Than Net Income
→Capital Expenditures Less Than 10% of Net Income
→Free Cash Flow Higher Than Net Income
→Stock Repurchase
→Dividends Paid
→Cash Balance Increase

What "green flags" do you look for in financial statements? Let me know below!

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Balance Sheet 101

What is a balance sheet?

It's what a company owns and owes at a point in time.

A balance sheet is a snapshot of a company in that moment of time.

ASSETS = LIABILITIES + EQUITY

 What a company owns (assets) less what it owes (liabilities) is equal to its net worth (equity)

ASSETS

CURRENT ASSETS 
- Cash, inventory, accounts receivable, short-term investments, and pre-paid expenses.

FIXED ASSETS 
- Long-term assets such as property and equipment.

OTHER ASSETS 
- Intangibles such as patents or trademarks 

LIABILITIES AND OWNER'S EQUITYCURRENT LIABILITIES 
- Accounts payable, accrued wages, taxes, and interest due within a year

LONG-TERM LIABILITIES 
- Mortgages, band loans, and anything due in more than a year

OWNER'S EQUITY 

The money you have left over after selling everything in the company and paying off liabilities.

Why important? 
- Determine financial health 
- Help obtain loans 
- Value the company 
- Monitor changes over time

The real value of a balance sheet is in its consistent use and analysis. With it, you can transform expectations into real goals, set milestones and limits, and measure both short and long-term performance.

Enjoy this summary?

Income Statement 101
What is an income statement?

It's a financial statement that shows a company's revenues and expenses over a specific period, typically a fiscal quarter or year.

An income statement provides a snapshot of a company's financial performance during that period.

REVENUES - EXPENSES = NET INCOME

The income generated (revenues) minus the costs incurred (expenses) equals the company's net income or profit.

REVENUES

OPERATING REVENUES
Sales from the company's core business operations, such as product sales or service fees.

NON-OPERATING REVENUES
Income from sources outside the core business, like interest income or investment gains.

EXPENSES

OPERATING EXPENSES
Costs directly associated with running the business, including wages, rent, utilities, and raw materials.

NON-OPERATING EXPENSES
Costs unrelated to the core business, like interest payments on loans.

TAXES
Income taxes paid by the company.

NET INCOME
The remaining profit or loss after subtracting all expenses from revenues.

Why is it important?
- Measures financial performance.
- Provides insights into profitability.
- Helps with decision-making and budgeting.
- Demonstrates the ability to generate profit.

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