Finance Literacy Understanding Financial Statements
290 Hearst Mining, Memorial Building Nov 30th, 10:00 – 11:00am
Presenter: Adile Quennarouch, Director of Finance & Capital Asset Strategies
1 Below are of the topics we’ll cover during this session
. Why do our financial statements look the way they do? . Why are financial statements important? . How to crosswalk from CalPlanning to the Financial statements . How to simplify the statements to create custom views and derive insights
2 On the more technical side, at the end of this session, you should be comfortable with these concepts
. Accrual versus Cash . Gross Income versus Net Income . Performance metrics such as Margins, Free Cash Flow . Financial ratios including days cash on hand
3 1. Context (~ 10 mins)
2. Financial Statements – Overview (~ 30 mins)
3. Financial Statement Analysis (~15 mins)
4. Concluding thoughts (~ 5mins)
4 1. Context
2. Financial Statements - Overview
3. Financial Statement Analysis
4. Concluding thoughts
5 Remember the headlines?
6 Berkeley’s state support was cut by roughly half in nominal terms over a 10-year period
$900,000 State Appropriations
$800,000
$700,000
$600,000
$500,000
$400,000
$300,000
$200,000
$100,000
$0 12345678910111213141516177 Source: UC Berkeley Budget Office analysis. More importantly, our entire budget model has changed
State Appropriations in (000's) $900,000
Tuition & Fees $800,000
$700,000 Contacts & Grants
$600,000
$500,000
$400,000 State Support
$300,000 Educ & Auxiliary Philanthropy
$200,000
$100,000
$0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 8 Source: UC Berkeley Budget Office analysis. Competitive revenue streams now account for ~ 85% of our total revenue base
2,200
2,000
1,800
1,600
1,400
1,200
1,000 COMPETITIVE REVENUE STREAMS
800
600
400
200 NON‐COMPETITIVE REVENUE STREAMS 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
9 Source: UC Berkeley Budget Office analysis. This change in revenue model has an impact on how we operate as a university
QUASI ‐ GOVERMENTAL BUSINESS CHARTIY AGENCY
1010 This complex structure is reflected in our financial statements
FINANCIAL STATEMENTS
QUASI ‐ GOVERMENTAL BUSINESS CHARTIY AGENCY
1111 More specifically...
1. Fund accounting not every dollar is created equal
2. No Shareholder’s equity Net assets
3. No income tax Non‐profit
4. Everything else like a private company
1212 Key takeaways
1. Public universities have a complex financial structure
2. That complexity is reflected in our financial statements
1313 1. Context
2. Financial Statements - Overview
3. Financial Statement Analysis
4. Concluding thoughts
14 1. Context
2. Financial Statements – Overview a) Introduction b) Income Statement c) Cash Flow Statement d) Balance Sheet
3. Introduction Financial Statement Analysis
4. Concluding thoughts
15 16 Why do financial statements matter?
Is my university/organization financially Will my university/organization be healthy? financially healthy 5 years from now? 1 2
FINANCIAL HEALTH PROSPECTIVE ANALYSIS
Financial Statements
3 4
CAPITAL STRUCTURE & CASH MANAGEMENT INVESTMENTS
Do I have enough cash on hand to make Can I make the required investment to payroll or pay my suppliers? support the university’s mission? 17 Financial statements are the language of finance
18 Financial statements have been around for a long time…
Sumerian clay tablet. Summary account of silver for the governor 2,500 BC
19 There are various “levels” of statements ALL FUNDS
UC System ALL FUNDS
UC Berkeley CURRENT FUNDS
CalPlanning
20 Where we are going to spend most of our time today ALL FUNDS
UC System ALL FUNDS
UC Berkeley CURRENT FUNDS
21 The 3 financial statements
INCOME STATEMENT CASH FLOW STATEMENT BALANCE SHEET
Operating Revenues Cash Flow from Operations Current Assets
Operating Expenses Cash Flow from Financing Long‐term Assets
Non‐Operating Cash Flow from Current Liabilities Revenues/Expenses Investments
Changes in Net Assets Long‐term Liabilities
Equity/ Net Assets
22 The guiding principles
. Going concern . Time period . Objectivity and reliability . Relevance . Full disclosure . Materiality . Conservatism . Consistency/comparability
23 Accrual versus cash
1. Accrual 2. Cash 3. Hybrid . Income statement . Cash flow . Part of the statement statement is using accrual . In accrual accounting while the accounting, . Cash accounting rest is based on cash revenues are recognizes an event accounting recognized when when a cash they are earned, not transaction takes . This is a non- necessarily when place standard (i.e. non cash is received GAAP) view of an . Easy to understand organization’s . Provides a better as cash accounting finances. picture of the true mimics what economic status of happens in your a business checking account. Stay away from the hybrid
1. Accrual 2. Cash 3. Hybrid . Income statement . Cash Flow . Part of the statement statement is using accrual . In accrual accounting accounting while the revenues are . Cash accounting rest is based on cash recognized when recognizes an event accounting they are earned, not when a cash necessarily when transaction takes . This is a non- cash is received place standard (i.e non GAAP) view of an . Provides a better . Easy to understand organization’s picture of the true as cash accounting finances economic status of mimics what a business happens in your checking account. 1. Context
2. Financial Statements – Overview a) Introduction b) Income Statement c) Cash Flow Statement d) Balance Sheet
3. Introduction Financial Statement Analysis
4. Concluding thoughts
26 The income statement
1. Accrual 2. Cash 3. Hybrid . Income statement . Cash Flow statement . Part of the statement is using accrual . In accrual accounting . Cash accounting accounting while the revenues are recognizes an event rest is based on cash recognized when when a cash accounting they are earned, not transaction takes necessarily when place . This is a non- cash is received standard (i.e non . Easy to understand GAAP) view of an . Provides a better as cash accounting organization’s picture of the true mimics what finances economic status of happens in your a business checking account. Income statements are also called:
. SRECNA / SRECNP . Profit & Loss statement . P&L . Statement of operations . Statement of financial performance . Earnings statement The income statement is a construct Income statement: the basic equation Matching principle: the resource expenditures required to produce the revenues Revenues - Expenses = Net Income
Accrual Basis: recognized when “BOTTOM LINE” they are earned, not necessarily when cash is received Income statement: Revenues
Tuition and Fees
Contracts and Grants
OPERATING Educational Activities & Auxiliary
Other Revenues REVENUES
State appropriations
NON‐OPERATING Investment income
Private gifts Income statement: Expenses
Salaries and Wages
Benefits OPERATING Supplies & Materials
Utilities EXPENSES
Interest Expense
NON‐OPERATING Depreciation
Investment losses Simplify, simplify, simplify: creating a custom view
INCOME Simplify CUSTOM STATEMENT VIEW
33 A few guiding principles to remember when simplifying
. Simplifying usually means re‐organizing and/or excluding revenues/expenses.
. Simplifying almost never entails adding revenues/expenses not originally captured in the statement.
. You need a clear rationale as to why you exclude things.
. The end result should be easy to benchmark.
. The end result should be easier to explain than the original statement.
34 In practice, you may want to simplify things
Guiding principle: list revenues that are available to support operations in that year
Tuition and Fees
Contracts and Grants
OPERATING Educational Activities & Auxiliary
Other Revenues REVENUES
State appropriations
NON‐OPERATING Investment income
Private gifts In practice, you may want to simplify things
Guiding principle: list expenses that were incurred to support the operations in that year
Salaries and Wages
Benefits NON‐ OPERATING CAPITAL Supplies & Materials
Utilities EXPENSES
Interest Expense
NON‐CAPITALOPERATING Depreciation InvestmentX losses This is how I structure things in the model: MD&A
Revenues 1
2 Non‐Capital Expenses
Capital Expenses 3 noesaeetve Why Ilikethisview Income statementview– CAPITAL OPERATIONS Gross Net
Margin
Margin
A useful framework when using financial statements
DATA
INFORMATION
INSIGHTS
ACTION
39 A useful framework when using financial statements
We had access to data in the DATA income statement (IS)
INFORMATION We used that data in the IS to calculate Gross Margin
INSIGHT Our Gross Margin is too low
We need to either increase ACTION revenues and/or lower expenses
40 Watch your margins! “No Margin, No Mission”
41 Signal versus Noise – what this view does not include
1. Investment gains/losses
2. Unfunded pension liability Distorts the overall picture
42 How to go from CalPlanning to the model to the financial statements FINANCIAL INVESTMENT STATEMENTS GAINS/LOSSES PENSION LIABILITY CAMPUS MODEL All Funds NON‐CURRENT FUNDS
Current Funds CALPLANNING
Fiscal Year 43 Key takeaways about income statement
1. Shows activity throughout a fiscal year
2. It is a construct based on accrual Even though this bottom line reflects your true economic performance in the past year, it did not necessarily translate into a cash loss or profit
3. Simplify, simplify, simplify
4. Use your custom views to turn data into information into insights
44 Exercise How big is UCLA’s operating budget?
6,866
2,585
BERKELEY UCLA 4545 Stanford financial statements – Medical center
4646 1. Context
2. Financial Statements – Overview a) Introduction b) Income Statement c) Cash Flow Statement d) Balance Sheet
3. Introduction Financial Statement Analysis
4. Concluding thoughts
47 Introducing Cash Flow statements
1. Income Statement 2. Cash 3. Balance Sheet . Income statement . Cash Flow statement . In accrual accounting revenues are . Cash accounting recognized when recognizes an event service is rendered, when a cash not necessarily when transaction takes cash is received place
. Provides a better . Easy to understand picture of the true as cash accounting economic status of a mimics what business happens in your checking account.
48 Before we start…
49 Our cash balances are managed by UCOP
OFFICE OF THE PRESIDENT
CASH
STIP TRIP . Short Term Investment Pool . Total Return Investment (STIP) Pool (TRIP) . Established in 1976 . Established in 2008 . This is where our working . Allows campuses to capital is invested (operating maximize return on their expenses, payroll….) unused cash balances by investing in broad range of . Invested in cash-like asset classes instruments (money market) . Invested with a total return objective 50 How do we pay for things?
Guiding principle: We spend these resources in the order of lowest opportunity cost to ensure the highest returns on our financial assets.
Cash STIP TRIP
•Lowest return: •STIP returns 1‐ •TRIP returns 4‐ effectively zero. 2% 5% Pay with this •High liquidity, •Lower liquidity, first. low risks, low higher risk, •When returns higher returns. insufficient, •When •When receive transfer insufficient, insufficient, from… receive transfer receive transfer from… from…
51 Cash flow – The basic equation
Net Cash Flow from Operations
+ Net Cash Flow from Capital
+ Net Cash Flow from Investments BOTTOM LINE = Net Change in Cash Net Cash from Operations
SOURCES
USES Net Cash from Capital
SOURCES
USES Net Cash from Investing Activities Net Cash and Cash equivalent
“Cash in the bank” Bringing it all together $358,657
‐90,118 $268,539
2015 2016 Why cash flows matter?
When businesses fail, 42% of the time it’s because of poor cash flow management
US Bank ‐ 2017 In other words…
“Cash is king”
59 An interesting cash concept: Free cash flow
. Free cash flow (FCF) is calculated as operating cash flow minus net capital expenditures.
. FCF is the cash left after a company has covered its operating costs plus the investments in capital assets.
. It is a measure of financial performance/health.
. In the private sector, FCF represents the cash that is available for distribution to the shareholders (dividends).
. For us, it represents our ability to generate reserves. Key takeaways about cash flow statements
1. At a high level, it is easy to understand “Cash in the bank” 2. Can be difficult to explain in detail to non‐financially savvy audiences Lots of different pieces 3. This is just cash Endowment or TRIP balances are not included here
61 Exercise: the board/cabinet meeting
6262 Exercise: the board meeting
Income Statement Cash Flow KEY DRIVERS .The two views will rarely (if ever) have the same bottom line.
.Why? One is based on cash and the other is $‐90,118 based on accrual.
.However, the trend should be the same. $‐158,357 6363 1. Context
2. Financial Statements – Overview a) Introduction b) Income Statement c) Cash Flow Statement d) Balance Sheet
3. Introduction Financial Statement Analysis
4. Concluding thoughts
64 Balance sheet: the basic equation
Assets = Liabilities + Net Assets Balance sheet: Assets Balance sheet: Liabilities Off-balance sheet financing
. An off‐balance sheet refers to financing that is not reflected on a company’s balance sheet
. In other words, by using off balance sheet financing, an organization can keep large capital expenditures off their balance sheet, which is a way to keep the debt/equity ratio low
68 69 Off-balance sheet financing: a good example
Investors
1 Debt Service 2 Bond 5 Bowles Hall Proceeds Bonds (Net Student Housing Revenues)
Student Payments BHF Lease Payments UC Students (501c3) Berkeley 4 6
Payment for 3 construction
Developer
70 Balance sheet: Liabilities Key takeaways about balance sheet
1. The balance sheet contains information about wealth and liquidity (assets and liabilities) 2. The balance sheet presents the university’s financial position at a given point in time. 3. Things like off‐balance sheet debt are excluded from the view.
72 1. Context
2. Financial Statements – Overview a) Introduction b) Income Statement c) Cash Flow Statement d) Balance Sheet
3. Financial Statement Analysis
4. Concluding thoughts
73 Introducing Financial ratios
. Days Cash on . Gross Margin Hand . Net Margin . Current ratio . Pro‐forma Profitability Liquidity . Acid test ratio
Efficiency
. Return on Assets 74 Introducing Financial ratios
. Days Cash on Hand Liquidity
75 Example – Days Cash on Hand
Cash Days cash on hand = X 365 (Expenses – Depreciation)
76 Example – Days Cash on Hand
77 Calculation for Berkeley – Days Cash on Hand
Cash Days cash on hand = X 365 (Expenses – Depreciation)
Days cash on hand = $268,539/($2,744,595‐$218,932) x 365 = 38 days
78 Should we include TRIP in the calculation?
Cash STIP TRIP
•Lowest return: •STIP returns 1‐ •TRIP returns 4‐ effectively zero. 2% 5% Pay with this •High liquidity, •Lower liquidity, first. low risk, low higher risk, •When return higher return. insufficient, •When •When receive transfer insufficient, insufficient, from… receive transfer receive transfer from… from…
79 Example – Days Cash on Hand
80 Example – Days Cash on Hand - TRIP
The fair value of Berkeley’s investment in TRIP was $1,034.5 million and $1,033.0 million at June 30, 2016 and 2015, respectively.
UC Berkeley, Financial Statements, FY16, p13
81 Days Cash on Hand – Including TRIP
Cash + TRIP Days cash on hand = X 365 (Expenses – Depreciation)
Days cash on hand = $1,303,039/($2,744,595‐ $218,932) x 365 = 188 days
82 Days Cash on Hand - Benchmarks
83 Financial statement analysis – Art versus Science
ART SCIENCE
84 Days Cash on Hand – Including TRIP
Cash + TRIP Days cash on hand = X 365 (Expenses – Depreciation)
Days cash on hand = $1,303,039/($2,744,595‐ $218,932) x 365 = 188 days
85 Why do we care about ratings?
6.5% Interest Rate and Ratings
6.0% 5.9% 5.7% 5.5% 5.4%
AAA AA A+ A A‐ BBB
‐ DEFAULT RISK + 86 Key takeaways about financial ratios
1. Financial ratios use all 3 statements
2. Financial ratios are key to derive insights
3. Art versus science
87 So what’s the insight?
We had access to cash DATA data via the balance sheet
We calculated INFORMATION Days Cash on Hand
Our Days Cash on Hand INSIGHT is a lot lower than our peers ACTION To improve our rating, we should increase our Days Cash on Hand 88 Bringing it all back together
89 1. Context
2. Financial Statements – Overview
3. Financial Statement Analysis
4. Concluding thoughts
90 Concluding thoughts
1. Financial statements are the language of finance
2. Watch the margins! “No Margin, No Mission”
3. Simplify, simplify, simplify
4. Turn data into information and into insights into actions
5. Remember that financial statements have limitations and factor those in your analysis
91 Thanks! Go Bears!