| Excel is probably the most popular spreadsheet in | | | | generates before any financing decisions are |
| use today, and certainly a mainstay of investment | | | | taken into account. This number is also referred |
| banks, private equity firms and hedge funds. It | | | | to as EBIT (earnings before interest and taxes), |
| offers a tremendous amount of flexibility to | | | | and when you add back all depreciation, |
| develop a wide array of financial computations, | | | | amortization and other "non-cash" charges, you |
| ranging from simple, static calculations to complex, | | | | arrive at EBITDA (earnings before interest, taxes, |
| dynamic analysis. In order to effectively develop | | | | depreciation and amortization). EBITDA is and |
| financial models for use in valuation analyses or | | | | important calculation in the financial analysis world |
| forecasting, it is important to understand how | | | | because it represents the cash income earned for |
| companies show their information. This article is an | | | | running a business. This is the figure used in many |
| overview of the link between the basic | | | | industries to determine valuation, as well as how |
| components of a full financial spreadsheet: income | | | | much debt a company can handle. |
| statement, balance sheet and cash flow. Because | | | | After operating income, you will include items |
| these financial statements are based on | | | | involved in the financing of a company, like |
| accounting rules, there will be some accounting | | | | interest expense for a company who has debt. In |
| theory used in this article but only very high level, | | | | addition, you would include interest earned from |
| basic elements to allow the reader to follow along. | | | | excess cash balances or short-term and |
| The Income Statement | | | | long-term investments. If the company is a |
| The income statement includes items that give an | | | | financial institution, this interest expense and |
| indication of how much a company sells (called | | | | interest income lines are actually part of revenue |
| revenue, sales or net sales) and what it costs to | | | | and cost of revenue, so you would see that |
| run the business (cost of sales, operating | | | | information near the top, but for most other |
| expenses, taxes). If you took sales and | | | | industries, it constitutes a place below operating |
| subtracted all of the expenses, what is left is the | | | | income. Finally, if there are any other |
| net income of a company. An example income | | | | non-operating sources of income, like gains on |
| statement will look like the following: | | | | sales of assets, it would be included in this area, |
| Net Sales - Cost of Sales = Gross Profit | | | | too. The sum of all of these entries is normally |
| - Operating Expenses = Operating Profit | | | | called "Other Expenses, Net." |
| - Interest Expense + Interest Income +/- Other | | | | Once the other expenses are subtracted from |
| Expense/Income = Pretax Income | | | | operating income, a company has pretax income, |
| - Income Taxes = Net Income | | | | or income before income tax provision. This is the |
| Net sales represents what a company has sold, | | | | accounting figure used to determine how much |
| whether a physical product (box, toy, car, etc.) or | | | | tax an entity is required to pay to the |
| a service. The cost of sales represents what | | | | government. Normally, companies pay around a |
| expenses a company incurred to provide the | | | | 35% federal income tax, and they may have to |
| physical product or service. For example, if a | | | | pay a state and local tax amount based on |
| company sold $100 worth of shoes and the | | | | specific tax rules. There are also other items that |
| machine usage to make those shoes was $40, | | | | impact how much tax must be paid, including any |
| than $40 is your cost of sales, and thus, the | | | | operating losses from a prior year, tax credits |
| gross profit is $60. In general, a manufacturing | | | | used to offset taxable income, and certain |
| business has costs related to the running of | | | | accounting methods that can increase or |
| machinery to make a product plus a depreciation | | | | decrease the amounts owed during a particular |
| value associated with the economic wear and | | | | time period. Once the total tax is determined, the |
| tear, which is usually included in cost of sales. | | | | net income can then be calculated. |
| Operating expenses relate to items including the | | | | Without getting too much into accounting |
| administrative parts of running a business, including | | | | methods and tax law, the net income number is |
| payroll, rent or lease payments, advertising and | | | | merely the result of accounting methodologies and |
| marketing, depreciation and amortization on office | | | | does not necessarily reflect the cash generation |
| fixtures and other general and administrative | | | | of the firm. As stated earlier, EBITDA is a better |
| items. This category is usually reserved for the | | | | metric of a company's ability to generate cash. As |
| non-activity aspects of business. Some | | | | will be discussed later, there are certain items to |
| companies, like pharmaceutical or electronics | | | | be deducted from EBITDA to determine true |
| entities, will also have research and development | | | | free cash flow, but for now, just note that cash |
| expenses, and these are normally listed under this | | | | generation and accounting regulations create a |
| section of the income statement. After summing | | | | different set of results. It is important to keep |
| all of these expenses and subtracting from gross | | | | that in mind when you develop your financial |
| profit, you are left with operating income (or | | | | models because understanding the components of |
| operating loss). | | | | the income statement is the first step in putting it |
| Operating income is an important figure in | | | | all together. |
| business because that is what a company | | | | |