Valuation course · Lesson 1 of 10
Three statements tell one story.
The income statement says what the company earned. The cash flow statement says where the cash went. The balance sheet says what is left. Each one checks the other two.
Where the numbers come from
A public company in the United States files an annual report, the Form 10-K. It contains audited financial statements: the income statement, the balance sheets and the statement of cash flows. This course uses the same three statements for Example Co. All figures are in $ millions.
The income statement
| Line | $ millions |
|---|---|
| Revenue | 1,000.0 |
| Cost of goods sold | (550.0) |
| Gross profit | 450.0 |
| Selling, general and administrative, with stock pay | (230.0) |
| Depreciation and amortization | (40.0) |
| Operating income | 180.0 |
| Interest expense | (12.0) |
| Interest income | 6.0 |
| Pretax income | 174.0 |
| Tax at 21% | (36.5) |
| Net income | 137.5 |
Example Co. sold $1,000 million of goods last year. After all costs, operating income was $180 million, a margin of 18%. After interest and tax, net income was $137.5 million, or $1.37 a share on 100 million shares.
Stock pay of $15 million is inside the SG&A line, with the other overhead costs. It is a real cost, but no cash leaves the company for it. Lesson 2 shows why that matters.
The cash flow statement
| Line | $ millions |
|---|---|
| Net income | 137.5 |
| Add depreciation and amortization | 40.0 |
| Add stock pay | 15.0 |
| Less the increase in working capital | (7.4) |
| Cash from operations | 185.1 |
| Less capital expenditure | (80.0) |
| Free cash flow | 105.1 |
| Less dividends | (40.0) |
| Less buybacks | (30.0) |
| Change in cash | 35.1 |
The statement starts with net income and adds back the costs that use no cash. Then it subtracts the cash that went into working capital and equipment. What is left is free cash flow, $105.1 million. The company paid out $70 million of that to its shareholders.
The balance sheet
| Line | Start of year | End of year |
|---|---|---|
| Cash | 114.9 | 150.0 |
| Working capital | 92.6 | 100.0 |
| Property and equipment | 360.0 | 400.0 |
| Total assets | 567.5 | 650.0 |
| Debt | 250.0 | 250.0 |
| Shareholders' equity | 317.5 | 400.0 |
The balance sheet is a list of what the company owns and what it owes, at one date. Assets less debt is shareholders' equity.
Three links
- The change in cash on the cash flow statement, $35.1 million, is the change in cash on the balance sheet.
- Property and equipment grew by capital expenditure, less depreciation: $360 million plus $80 million less $40 million is $400 million.
- Equity grew by net income and stock pay, less dividends and buybacks. That is $82.5 million.
If one of these links does not tie, a number is wrong. Our model checks all three before it prints a figure.
Key points
- The income statement shows the profit. The cash flow statement shows the cash.
- The balance sheet shows what is left at one date.
- The three statements must tie. Use the links to check your numbers.
Sources
- SEC, How to Read a 10-K, for the three financial statements in the annual report.