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Week 18

ABCs of Accounting, Periodic Table of Financial Metrics, and The Auditors Handbook

Josh Aharonoff

Jul 6, 2023

Welcome to a knowledge-packed edition of Legit Numbers!


Whether you're a Finance & Accounting professional, a business owner, or a fractional CFO...there's something here for everyone


This week, I show you how Finance & Accounting can be art by walking you through my famous Periodic Table of Financial Metrics, and ABCs of Accounting.


We'll then end with a deep dive into the popular world of Auditing.



What we’ll be covering in this edition:

  • The ABCs of Accounting

  • The Periodic Table of Financial Metrics

  • The Auditors Handbook 📔


Let's dive in...




Won’t you sing along with me?


A

Assets

Items of Economic Value that you own / substantially control



B

Balance sheet

Snapshot of the business showing the Assets, Liabilities, and Owners Equity



C

Cash flow

The total cash entering & leaving your bank account



D

Depreciation


The wear and tear on the fixed assets in our business



E

EBITDA


Earnings Before Interest Taxes Depreciation & Amortization



F

Financial statements


The Income Statement, Balance Sheet, and Cash Flows



G

GAAP


Generally Accepted Accounting Principles



H

Historical cost


The cost to acquire an asset



I

Income statement


Show’s you the income & expenses of your business, and various levels of profitability



J

Journal entries


Your Debits & Credits



K

KPIs


Key Performance Indicators



L

Liabilities


Obligations & amounts owed to creditors of the business



M

Matching principle


An accounting principle that requires you to match the timing of income with the timing of expenses



N

Net income


Revenue - COGS - Operating Expenses + Other Income - Other Expenses



O

Owners Equity


Amounts contributed by owners + prior earnings



P

Profit


What you earn after costs



Q

Quick ratio


(Current Assets - Inventory) / Current Liabilities



R

Revenue


Your income



S

Shareholders


The owners of the company



T

Taxes


Amounts owed to the government



U

Unearned revenue


The amount of revenue collected / due, but not yet earned



V

Valuation


How much a company is worth



W

Working capital

Current Assets - Current Liabilities



X

X-Axis

The horizontal axis on your graph, typically for a timeline series



Y

Yield

The return on an investment



Z

Zero-based budgeting

A method of budgeting where you start from 0 and justify every financial activity



Any other examples you’d add?








Where chemistry meets profitability...



  1. 1️⃣ OCF Operating Cash Flow


    Net Income + Other Non-Cash Items - Changes in Working Capital

  2. 2️⃣ FCF Free Cash Flow


    Operating Cash Flow - Capital Expenditures

  3. 3️⃣ CCC Cash Conversion Cycle


    Days of Inventory Outstanding + Days of Sales Outstanding - Days of Payables Outstanding

  4. 4️⃣ NCF Net Cash Flow


    Operating Cash Flow + Investing Cash Flow + Financing Cash Flow

  5. 5️⃣ DCF Discounted Cash Flow


    CF1 / (1+r)1 + CF2 / (1+r)2 + ... + CFn / (1+r)n, where CF is cash flow, r is the discount rate, and n is the number of periods.

  6. 6️⃣ PV Present Value


    CF / (1+r)^t, where CF is cash flow, r is the discount rate, and t is the number of periods.

  7. 7️⃣ FV Future Value


    CF x (1+r)^t, where CF is cash flow, r is the interest rate, and t is the number of periods.

  8. 8️⃣ PP Payback Period


    Initial Investment / Annual Cash Flow

  9. 9️⃣CR Cash Ratio


    (Cash + Marketable Securities) / Current Liabilities

  10. 🔟 CB Cash Burn


    Cash from Operating Activities + Cash from Investing Activities

  11. 1️⃣1️⃣ UFCF Unlevered Free Cash Flow:


    EBIT x (1 - Tax Rate) + Depr & Amort - CapEx - Incr in Net Working Capital

  12. 1️⃣2️⃣ LFCF Levered Free Cash Flow:


    EBITDA - Taxes - Capital Expenditures - Changes in Net Working Capital - Interest Expense

  13. 1️⃣3️⃣ GP Gross Profit


    Total Revenue - Cost of Goods Sold (COGS)

  14. 1️⃣4️⃣ EBITDA Earnings Before Interest Taxes Depr and Amort


    Net Income + Int Expense - Int Income + Taxes + Depr + Amort

  15. 1️⃣5️⃣ EBITDA (M) EBITDA Margin


    EBITDA / Revenue

  16. 1️⃣6️⃣ OI Net Operating income


    Gross Profit - Operating Expenses

  17. 1️⃣7️⃣ NI Net Income


    Total Revenue - Total Expenses

  18. 1️⃣8️⃣ NIM Net Income Margin


    Net Profit / Revenue

  19. 1️⃣9️⃣ GPM Gross Profit Margin


    Gross Profit / Revenue

  20. 2️⃣0️⃣ ROI Return on Investment


    Net Profit / Total Investment

  21. 2️⃣1️⃣ ROE Return on Equity


    Net Profit / Shareholders Equity

  22. 2️⃣2️⃣ ROA Return on Assets


    Net Profit / Total Assets

  23. 2️⃣3️⃣ NOI Net Other Income


    Other Income - Other Expense

  24. 2️⃣4️⃣ EPS Earnings per Share (EPS)


    Net Profit / Total Shares Outstanding

  25. 2️⃣5️⃣ OM Operating Margin


    Operating Income / Revenue

  26. 2️⃣6️⃣ PE Price-to-Earnings


    Price per Share / EPS

  27. 2️⃣7️⃣ ROCE Return on Capital Employed


    Operating Profit / Capital Employed


…and many more!



⬇️ Download this in high resolution via the link in the infographic







Auditing is a BIG field in Accounting


Here’s a summary of what you need to know:


➡️ What is Auditing?


Think of an auditor as an impartial party whose job is to provide assurance that your financial information is being presented fairly and in accordance with the appropriate accounting standards.



➡️ What do Auditors do?


Auditors assess the internal controls and risk management systems being used in an organization to identify any potential weaknesses


That typically involves preparing an audit based off of one of 2 standards:



➡️ Auditing Standards


  1. SEC Compliant

    • Conducted by Securities and Exchange Commission (SEC)



    • It’s less stringent than PCAOB

  2. PCAOB • Established by the Public Company Accounting Oversight Board (PCAOB)



    • Required for public companies



➡️ Internal Controls & Risk Assessment


These are important to identify, analyze, and mitigate certain risks such as fraud, errors, and issues with compliance


Auditors will analyze both the existence of these controls, as well as the effectiveness of these controls


areas include:


  1. Segregation of duties → here auditors assess whether there is a clear separation of responsibilities to present fraud or errors

  2. Access Controls → here auditors evaluate the controls to ensure that sensitive information is being access only by authorized individuals ex: passwords, databases, or files

  3. Going Concern → this is when an auditor assesses the likelihood of a company going out of business for the foreseeable future

  4. Management Oversight → auditors assess whether management has been regularly reviewing financial transactions to ensure accuracy and to identify potential issues

  5. Internal Audits → these are independent assessments conducted by internal auditors to ensure that everything is running efficiently and in line with regulations

  6. Reconciliations → this is where auditors will evaluate whether information shown on the financial statements matches to different sets of financial records ex: bank reconciliations



➡️ How do Auditor do their job?


Here are a few common techniques


  1. Statistical Sampling → using statistical principles

  2. Judgmental Sampling → relies on an auditors professional judgement

  3. Materiality assessment



➡️ What are the Audit Opinions?


These are opinions on the ultimate conclusion of the audit, and include:


  1. Unqualified Opinion → All is good 😎

  2. Qualified Opinion → Good, but there can be a specific area of concern 🤔

  3. Adverse Opinion → You got problems 😱

  4. Disclaimer of Opinion → When you're unable to conclude 🤷‍♂



PS: This is an excerpt from my Intro to Accounting course



You can take the course, or grab the e-book right here: https://bit.ly/3CN8Ny0





I hope you enjoyed this week's edition of Legit Numbers!


If you haven't already replied to say hello, please do and let me know how I can help - I reply to all of my emails personally :)


Till next time!

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