This presentation aims at helping engineers, engineering managers and people in the delivery organization to understand how to interpret a customer's accounts, figure out the 'broad level' business drivers, create hypothesis about what might the customer value and then try to position ourselves accordingly. This presentation was delivered as part of our internal training program.

1. 12/28/2011
Understanding a Company’s
3 Vital Statistics
A Salesman’s Intro to Engineers
Interpreting Financial Statements
Presentation Delivered
at
My Company for Engineering Managers
27 Dec 2011
© Rajesh Sengamedu
Feedback from Participants
Technical Manager
Rating: 7
3 importance things I learnt:
Understood the actual P & L of a company or a personal account
Learnt and understood new terminologies in finance which is
important in my role
Understood the importance of AR and D/E ratio and how we can
make biz proposals with customer based on these figures.
Technical Lead
Thanks Rajesh for your valuable time
spent to educate us on financial
Technical Lead basics.
Content was simple and precise. Presentation was excellent.
3 ways this presentation will help me:
- Better understanding of our customers and their requirements.
- Some more better analysis of shares, market and companies.
- Partly better money management.
Project Manager
Thanks for the very informative
session Rajesh
1

2. 12/28/2011
Agenda
1. Introduction
2. Analysing P&L Statement
3. Analysing Balance Sheet Statement
4. Analysing Cash Flow Statement
5. Summary
Background
• I delivered this four hour training program to engineers &
engineering managers at my company.
• Objective of the training was to help the engineers understand how
a business person looks at an account and makes certain decisions
regarding how to engage with the account.
• This is useful for:
– Sales persons
– Marketing persons
– Engineering persons
• The examples taken are from the market segment that my company
supplies into.
• The recorded webinar is unfortunately not available for public as it
has discussions very relevant to my company, therefore
confidential.
2

3. 12/28/2011
Acknowledgements
• Material about Basware & Yell.Co.Uk obtained from the
published annual reports.
• Gratefully acknowledge material from “The Investing
Work Book Series” by www.morningstar.com
• Gratefully acknowledge material from “The Investors
Guide to Understanding Accounts” by Robert Leach
• Gratefully acknowledge the copyright owners of
pictures, cliparts that I liberally used from the web
directly.
• Thanks to all my engineering colleagues for giving this
opportunity to share.
1. Introduction
3

4. 12/28/2011
Understanding a Company’s
3 Vital Statistics
A Salesman’s Intro to Engineers
Interpreting Financial Statements
Introduction
What You Should Expect?
1. UNDERSTAND A LOT about your customers by looking at publicly
available documents (especially for listed company)
2. CREATE HYPOTHESIS about key drivers for the company, and test
them in your day-to-day dealings with customers
3. BECOME SENSITIVE to costs, revenue, profits
4. LEARN A NEW LANGUAGE – the language of numbers
4

5. 12/28/2011
Can You Understand Satyam Saga?
• Satyam inflated profits for many years!
• Accrued interest is non-existent
• Liability is understated
• Debtors position overstated
How many of such
statements have we read
in the press? We need to understand
Did we understand it all? the language!!
Financial Story of Mr. Ram, Tech Lead
(01 Jan 2010)
• Ram is a Tech Lead at XYZ co. His annual CTC is 12 Lakhs. As he
has already worked for several years and saved money, his total
savings is Rs. 45 Lakhs.
• Let us follow Ram’s finances in the year 2010 (Jan – Dec).
• He spends about Rs.60K annually on petrol to commute to work.
• He has a family – wife and two children and spends Rs. 4.8 Lakhs
per year on his household expenses. Ram is in 30% tax bracket
and pays tax on his CTC.
• Rest is his savings
• Ram falls in love with an apartment that costs him Rs.50 Lakhs.
He approaches HDFC Bank to take a loan for Rs. 15 Lakhs. He
decides to buy the house by putting Rs.35 Lakhs from his savings.
The bank’s EMI per year is Rs. 2 lakhs a year. The government
offers no tax benefits on home loans!!
5

6. 12/28/2011
Let’s draw up his “income –
expenses” statement & “Net
Worth” statement BEFORE & AFTER
he buys the house!!
(If something is not mentioned explicitly assume it is
not relevant – some details are deliberately omitted
to simplify this exercise)
Ram’s Income & Expense Statement –
BEFORE (on 31 Dec 2009)
• Gross Income (A) 1200
• Petrol Costs (B) 60
• A-B (C) 1140
• Household expenses (D) 480
• C-D (E) 660
• Tax (30% CTC) (F) 360
• Savings (E-F) (G) 300
6

7. 12/28/2011
Ram’s Assets & Loans Statements
BEFORE (31 Dec 2009)
• Assets • Liabilities
– Bank Balance(A) 4500 – No Liabilities 0
• Ram’s Net Worth 4500
Ram’s Income & Expense Statement –
AFTER (31 Dec 2010)
• Gross Income (A) 1200
• Petrol Costs (B) 60
• A-B (C) 1140
• Household expenses (D) 480
• Bank EMI (H) 200
• (D) + (H) (I) 680
• (C)-(I) (E) 460
• Tax (30% CTC) (F) 360
• Savings (E-F) (G) 100
7

8. 12/28/2011
Ram’s Assets & Loans Statements
AFTER (31 Dec 2010)
• Assets • Liabilities
– Bank Balance(A) 1100 – Bank Loan 1300
– House 5000
• Ram’s Net Worth 4800
Remember he pays Rs.2 Lakhs from his salary income to the bank!
Therefore his bank loan (15) reduces by that amount (2) at the end of the
year and becomes (15-2 =13)!!!
On 01 Jan 2010, Ram also buys a car for Rs. 3
Lakhs (and hopes to use this car for 3 years).
Assume that if he sells the car after using it
for a year, the car value is Rs. 2 Lakhs
Draw up his income & expenses
statement, assets & liabilities
statement now
8

9. 12/28/2011
Ram’s Income & Expense Statement –
AFTER buying car (31 Dec 2010)
• Gross Income (A) 1200
• Petrol Costs (B) 60
• A-B (C) 1140
• Household expenses (D) 480
• Bank EMI (H) 200
• One year cost of car (J) 100
• (D) + (H) + (J) (I) 780
• (C)-(I) (E) 360
• Tax (30% CTC) (F) 360
• Savings (E-F) (G) 0
Ram’s Assets & Loans Statements
AFTER buying car (01 Jan 2010)
• Assets • Liabilities
– Bank Balance(A) 700 – Bank Loan 1500
– House 5000
– Car 300 • Ram’s Net Worth 4500
9

10. 12/28/2011
Ram’s Assets & Loans Statements AFTER buying
car & using for one year (31 Dec 2010)
• Assets • Liabilities
– Bank Balance(A) 800 – Bank Loan 1300
– House 5000
– Car 300 • Ram’s Net Worth 4700
• Depreciation 100
On 31 Dec 2010, exactly one year after Ram
bought the house, he got an overseas offer
and decides to leave India permanently.
He has a buyer who buys his house, for Rs.60
Lakhs. He sells it and pays off the bank loan
completely
The buyer is ready to pay Rs. 2 Lakhs for the
car
Ram also needs to pay house sale gain tax of
30%
10

11. 12/28/2011
EXERCISE
Draw up his income statement
assets & loans statement now
(If something is not mentioned explicitly assume it is
not relevant – some details are deliberately omitted
to simplify this exercise)
Ram’s Income & Expense Statement –
AFTER selling house (31 Dec 2010)
• Gross Income (A) 1200
• Income from selling house (K) 6000
• Income from selling car (O) 200
• Total Income (A) +(K)+(O) (L) 7400
• Petrol Costs (B) 60
• House cost (M) 5000
• Cost of car (P) 200
• Total Direct Expenses (B) +(M) +(P) (N) 5260
• L-N (C) 2140
• Household expenses (D) 480
• Bank EMI (H) 200
• One year cost of car (J) 100
• (D) + (H) + (J) (I) 780
• (C)-(I) (E) 1360
• Tax (30% CTC + House gain) (F) 660
• Savings (E-F) (G) 700
11

12. 12/28/2011
Ram’s Assets & Loans Statements AFTER
selling house & car (31 Dec 2010)
• Assets • Liabilities
– Bank Balance(A) 5300 – Bank Loan 0
– House 0
– Car 0 • Ram’s Net Worth 5300
CALCULATIONS TO HELP YOU ARRIVE AT THE ABOVE NUMBERS
Current Bank Balance: 7
House: 57 (60 less 3 paid as tax)
Car: 2
Salary savings in 2010 0
Total increase in bank balance 59
Pending home loan liability -13
New bank balance 7+59-13= 53
Ram’s Cash Flow Statement (31 Dec
2010)
• Starting Cash Position 4500
• Savings from Income Statement 700
• Total cash flow in one year 5200
• Add One year usage cost of car 100
• Total Cash flow in one year 800
• Ending Cash Position 5300
4500+700 = 5200.
How does the Bank Balance in the Balance Sheet show 5300?
Any guesses?
12

13. 12/28/2011
You have Successfully Constructed 3
Main Financial Statements for Mr. Ram
1. The Income Statement (Profit & Loss)
2. The Balance Sheet
3. The Cash Flow Statement
2. The Profit & Loss Statement
13

14. 12/28/2011
Understanding a Company’s
3 Vital Statistics
A Salesman’s Intro to Engineers
Interpreting Financial Statements
1. The Income Statement (Profit & Loss)
2. The Balance 3. The Cash
Sheet Flow Statement
© Rajesh Sengamedu
The Income Statement (Profit & Loss)
1. Summarizes how the company’s operations
performed during a given period
2. Tells you how much money a company has
brought in (as revenues), how much it has
spent (as expenses) and the difference
between the two (its profit)
3. Revenues – Expenses = Profit (Loss)
14

15. 12/28/2011
Revenues (“Topline”)
• The amount of money the company makes by
selling its products or services
• Remember this !
– Different businesses have different ways of
‘recognizing’ revenue
Six Major Expenses
1. Cost of Sales (Cost of goods sold – COGS)
– Direct expenses incurred in creating the products or services
2. Selling, General and Administrative Expenses (SG&A)
– Sales & marketing costs, overhead costs like Finance, HR
departments, office building rental etc.
3. Depreciation and Amortization
– Tangible assets are ‘expensed’ as depreciation
– Intangible assets are ‘expensed’ as amortization, over a period of
time
4. Other Operating Expenses
– Can be any other expense!
5. Interest Income and Interest Expense
– Interest received on company’s deposits or interest paid to lenders
6. Taxes
– What the company owes to the Government on the profits made
15

16. 12/28/2011
Sample P&L Sheet – Yell.co.uk
Revenues
Revenues
Revenues
COGS
Revenues
Sales & Marketing Costs
Revenues
Administrative Costs
Revenues
Interest Costs
Revenues
Taxes
Sample P&L Sheet –
www.basware.com
Revenues
Revenues
Revenues
COGS
Revenues
Depreciation &Amortization
Finance costs
Revenues
Tax Expenses
Revenues
16

17. 12/28/2011
Some Key Terms in P&L
• Gross Profit • Gross Profit Margin
– Take Revenue & subtract – (Revenue –COGS)/ Revenue
COGS
• Operating Profit (or EBIT)
• Operating Profit (or EBIT)
Margin
– Take Revenue & subtract
ALL Costs, EXCEPT – (Revenue – All Costs except
Interest & Taxes Interest & Taxes)/ Revenue
• Net Profit (“Bottomline”) • Net Profit (“Bottomline”)
– What’s left over for a Margin
company after ALL – (Revenue – All Costs)/
expenses have been
accounted for Revenue
Remember to divide by REVENUES to arrive at margins, NOT costs
2 Ways Of Comparing Company
Performance
1. Across the financial periods
2. As a %age of a base value, say - Revenues,
across the financial periods
17

18. 12/28/2011
Comparision Across Financial Periods (Ex. 1)
YELL.CO.UK
M GBP 2011 2010
Increase Interpretation
Revenue decreased; Is there a problem in the
Revenue 1877.6 2122.7 -11.55% market situation? Competition? Downturn?
But cost of sales decreased more! Managing
Gross Profit 1056.9 1167.4 -9.47% their costs well, seems like!
Operating Higher SG&A expenses for the revenue
Profit 329.9 409.3 -19.40% earned! Too many ‘management guys’?
Paid lower interest & taxes. OK! Atleast the
management seems to be managing the
interest, taxes. Somehow they are producing
‘similar’ bottomline results for lower
PAT 46.7 46.8 -0.21% revenue, by cutting costs aggressively!!
Comparision as % of base value (1/2) Ex 1
YELL.CO.UK
M GBP 2011 2010 Interpretation
Revenues 1877.6 100.0% 2122.7 100.0%
Company reduced their cost of
COGS 820.7 43.7% 950.3 44.8% sales aggressively
Distribution But could not manage to reduce
Costs 76.6 4.1% 84.7 4.0% their sales costs
Neither could they manage their
admin costs!!!! They actually
Admin Costs 650.4 34.6% 673.4 31.7% increased it!!!
Hmm! The increased admin costs
Finance seems to have benefitted the
Costs 263.6 14.0% 339 16.0% company by reducing interest costs!
Tax 19.6 1.0% 23.5 1.1%And decreased their tax expenses!
18

19. 12/28/2011
Comparision as % of base value (2/2) Ex 1
YELL.CO.UK
M GBP 2011 2010 Interpretation
Revenue 1877.6 100% 2122.7 100%
Gross Profit 1056.9 56.3% 1167.4 55.0% COGS decreased aggressively
Could not reduce SG&A for the
Operating Profit 329.9 17.6% 409.3 19.3% revenue earned
Improved bottom line by
managing their COGS, interest &
PAT 46.7 2.5% 46.8 2.2% taxes.
Comparision Across Financial Periods (Ex. 2)
Basware.com
M€ 2010 2009 Increase Interpretation
Revenue 103283 92816 11.28% Revenue increased
Gross Profit 39551 34329 15.21% But cost of sales increased faster!
Lower depreciation, amortization &
Operating also lower overheads contributed to
Profit 13487 11825 14.05% higher operating profits
PAT 10333 9074 13.87% Improved bottom-line!!
19

20. 12/28/2011
Comparision as % of base value (1/2) Ex-2
Basware.com
M€ 2010 2009 Interpretation
Revenues 103283 100.0% 92816 100.0%
Basware reduced their cost of
goods sold & other direct
COGS 63732 61.7% 58487 63.0% expenses!! Good for them!
They even have lower depreciation
& amortization expenses (i.e they
Depreciation & are getting more from existing
Amortization 5117 5.0% 4456 4.8% assets than buying new assets)
Other Hmm…they have some other
Operating operating expenses that are
Expenses 20947 20.3% 18048 19.4% increasing…
Finance
Expenses 160 0.2% 234 0.3% Good, they have less loans!
Tax 2994 2.9% 2517 2.7% Reasonable level of taxes.
Comparision as % of base value (2/2) Ex 2
Basware.com
M€ 2010 2009 Interpretation
Revenue 103283 100% 98216
COGS and direct expenses are
lower, leading to higher gross
Gross Profit 39551 38.3% 34329 35.0% margins
Lower depreciation & amortization
Operating Profit 13487 13.1% 11825 12.0% leading to higher operating profits
Well managed company!
Improving sales and at the same
PAT 10333 10.0% 9074 8.8% time improving profit margins!!
20

21. 12/28/2011
Key Observations
• Revenues increase IF
– We sell more
• Profits increase IF
– We reduce our costs (for same revenue level)
– We sell more (for same cost levels)
– We sell more & reduce costs
3. The Balance Sheet
21

22. 12/28/2011
Understanding a Company’s
3 Vital Statistics
A Salesman’s Intro to Engineers
Interpreting Financial Statements
2. The Balance Sheet
1. The Income
3. The Cash
(Profit & Loss)
Flow Statement
Statement
© Rajesh Sengamedu
Assets, Liabilities, Owner Equity
1. What are Assets?
– That the company owns
2. What are Liabilities?
– That the company owes
3. What is Owner Equity?
– The money put in by shareholders
4. Balance Sheet Equation
– Assets = Liabilities + Owner Equity
5. Snapshot of assets, liabilities, owner equity are
“as of a specific date”
22

23. 12/28/2011
Assets (“What is owned?”)
• Current Assets
1. Cash & Cash Equivalents
2. Inventories
3. Money customers owe (“Accounts Receivable)
• Fixed Assets (Non-Current Assets)
1. Property, Plant & Equipment (“Tangible Assets”)
2. “Goodwill” & “Intangible Assets”
3. Investments made (“Financial Assets”)
Liabilities (“What is owed?”)
• Current Liabilities
– Money owed to suppliers (“Accounts Payable”)
– Short term Debt raised (from banks, issuing bonds etc)
• Non-Current Liabilities (“Long term liabilities)
– Long term debt
– Advances paid by customers (“Unearned revenues”)
– Tax liabilities
23

24. 12/28/2011
Owner Equity (“What the owners own!”)
• Money put in by owners (“share capital”)
• Cumulative excess money generated from operations (“Net Profits”)
Less dividends paid
Checklist for Balance Sheet
1. Balance sheet provides a snapshot of how much
a company owns (assets) and how much it owes
(liabilities) at a specific point in time.
2. The difference between what a firm owns and
what it owes is known as equity, the amount of
the company owned by shareholders.
3. Current assets are any assets expected to be
used up or converted into cash within one year.
4. Current liabilities are obligations expected to be
paid within a year.
24

25. 12/28/2011
Sample Balance Sheet – Yell.co.uk
Revenues
Fixed (“Non-Current”) Assets
Revenues
Current Assets
Revenues
Current Liabilities
Revenues
Non-Current Liabilities
Revenues
Owner’s Money
Sample Balance Sheet –
www.basware.com
25

26. 12/28/2011
Comparing BS Across Time Periods –
Yell.co.uk
2011 2010Change
Non Current Assets 4499 4718 -4.6%
Current Assets 1198 1319 -9.2%
Current Liabilities 734 772 -4.9%
Long Term liabilities 3450 3879 -11.1%
Equity 1514 1386 9.2%
Accounts & receivables 763 905 -15.7%
Cash & Equivalents 200 160 25.0%
Current Assets /Current Liabilities 1.63 1.71
Debt / Equity Ratio 2.28 2.80
Comparing BS Across Time Periods –
Basware.com
2010 2009Change
Non Current Assets 53.5 54.6 -2.0%
Current Assets 38 32.7 16.2%
Current Liabilities 21 22.9 -8.3%
Long Term liabilities 3.4 7.8 -56.4%
Equity 67.1 56.6 18.6%
Accounts & receivables 24 19.7 21.8%
Cash & Equivalents 13.8 12.2 13.1%
Current Assets /Current Liabilities 1.81 1.43
Debt / Equity Ratio 0.05 0.14
26

27. 12/28/2011
How Strong Is the Balance Sheet?
2011 2010
Yell Current Assets /Current Liabilities 1.63 1.71
Debt / Equity Ratio 2.28 2.80
2010 2009
Basware Current Assets /Current Liabilities 1.81 1.43
Debt / Equity Ratio 0.05 0.14
1. Both Basware & Yell have more current assets than current liabilities….so we
can assume they will pay off their current liabilities with these current assets
2. Basware has ‘almost’ no debt! Good for them. If the economy slows down,
they still will survive
3. Yell has more long-term debt than equity……so, if the lenders want their
money back, the company is in trouble
4. Good news is that Yell has reduced their debts from 2010 in 2011….they are
managing the company well.
Combining BS and P&L Statements
1. Check Account Receivables as a % of revenue
– If % has significantly increased => Company offering
better payment terms to customers
– If % has significantly decreased => Company
collecting money fast
– If % is around the same => OK, business as usual!
2. If Depreciation & Amortization is increasing as a
% of revenue
– Are they buying companies?
– Are they investing in property, plant & equipment?
27

28. 12/28/2011
How is Basware & Yell.co.uk doing in AR?
This Year Previous
year
Good, AR is
Yell.co.uk
AR / Revenue 40.6% 42.6% decreasing!!
Around the same levels, seems
Basware AR / Revenue 23% 21% like marginal increase
Key Observations
• A cause of worry is
– NOT too much debt in absolute terms
– BUT high debt to equity ratio
• A second cause of worry is
– IF Accounts Receivable (AR) is increasing
significantly compared to revenue growth
28

29. 12/28/2011
4. The Cash Flow Statement
Understanding a Company’s
3 Vital Statistics
A Salesman’s Intro to Engineers
Interpreting Financial Statements
3. The Cash Flow Statement
1. The Income
2. The Balance
(Profit & Loss)
Sheet
Statement
© Rajesh Sengamedu
29

30. 12/28/2011
What Does Cash Flow Statement
Show?
1. Cash flow statement tells you how much cash went into
and out of a company during a specific time frame
2. It shows how much cash a company is generating from
one period to next
3. Three Elements of cash flow statement
– Cash flows from operating activities
• How much cash the company generated from its core business
– Cash flows from investing activities
• How much cash is spent in capex, acquisitions, market investments
like shares, mutual funds, bonds etc.
– Cash flows from financing activities
• How much cash was spent /received from company’s shareholders
or creditors (banks etc).
• Example is repayment of debt, dividends paid etc., how much
money was raised by issuing new shares etc.
Sample CF Statement - Yell
30

31. 12/28/2011
Sample CF Statement - Basware
Basware – Sample CF Statement –
Operational Activities
2010 2009
Profit for the period 10331 9074
Total Adjustments 8508 7833
Following come from P&L
Employee benefits 235 625
Statement
Depreciation & Amortization 5117 4456 1. Profit OR the NET Profit
Finance &Interest Expenses 189 234 2. Depreciation &
Unrealized Profit & Loss -27 0 Amortization
Income taxes 2994 2517 3. Income taxes
Other Adj. 0 1
Total Working Capital Changes -3157 -137
Changes in inventories -23 15
Short term receivables -4668 1758
Changes in short term liabiliites 1534 -1910
Interest Paid -43 -192
Interest received 66 104
Other financial adjustments -98 -30
Income tax paid -3084 -1920
Net Cash Flow From Operating
Activities 12523 14732
31

32. 12/28/2011
Basware – Sample CF Statement –
Investing Activities
2010 2009 Good that the
Purchase of tangible/intangible assets -2722 -3135 company is investing
in buying some assets.
Sale of tangible /intangible assets 0 1 But they are actually
paying lesser in
Acquisition of subsidiaries -1732 -1835
2010…but generating
Total Cash flow from Investing activities -4454 -4969 higher revenues….
5. Summary
32

33. 12/28/2011
Understanding a Company’s
3 Vital Statistics
A Salesman’s Intro to Engineers
Interpreting Financial Statements
© Rajesh Sengamedu
Learnt That There are
3 Main Financial Statements
1. The Income Statement (Profit & Loss)
2. The Balance Sheet
3. The Cash Flow Statement
33

34. 12/28/2011
Linking Balance Sheet & Income Statements
Answer These Six Questions & Learn About a
Company in Under 10 Minutes
1. Are the revenues increasing year on year?
2. Are the profits increasing year on year?
3. Are the profits growing at a higher rate than the
revenues? (CAGR)
4. What is the % age of Capex to revenue? Is that
increasing? Or decreasing? Or Constant?
5. How much cash the company has in the bank?
6. What is the debt /equity ratio?
34

35. 12/28/2011
Feedback
• Pl. send your feedback to me on email
– Rajesh dot sengamedu at gmail dot com
• In your feedback, pl. include these:
– On a scale of 1 to 10 (10=highly useful),
• How much use was this training?
– What are the 3 learnings you have?
– What 3 things you would do to apply these
learnings?
35