Josh Aharonoff
Sep 7, 2023
Welcome to Legit Numbers!
In this edition, we're simplifying complex financial concepts. We'll learn 12 creative ways to present your P&L, master the Financial Statements as a Piano player, and uncover the truth about EBITDA as a metric.
What we’ll be covering in this edition:
12 Ways to present a P&L
The Financial Statements Piano 🎹
Is EBITDA a good metric?
Let's dive in...
1. 📔 ACCRUAL basis
❔ What it is → showcases income when earned, expenses when incurred
💡 Why it’s valuable → gives you a more practical understanding of what’s actually happening
2. 🤑 CASH basis
❔ What it is → showcases income when cash is received, expenses when cash is paid
💡 Why it’s valuable → simple to prepare / understand
3. 📂By CLASS
❔ What it is → showcases your activity based off of tags
💡 Why it’s valuable → using tags, you can add a 3rd dimension to your data
4. 🗓️MONTHLY
❔ What it is → showcases your information on a month to month basis
💡 Why it’s valuable → allows you to understand what’s happening over a short time window
5. 🗓️ QUARTERLY
❔ What it is → showcase your information on a quarter by quarter basis
💡 Why it’s valuable → allows you to identify trends & seasonality across the year
6. 🗓️ ANNUALLY
❔ What it is → showcase your information on an annual basis
💡 Why it’s valuable → helpful in seeing where you’ve been, and where you’re going
7. % of REVENUE
❔ What it is → divide each section of your P&L by revenue
💡 Why it’s valuable → helps you understand what are the biggest drivers of your business activity
8. 📁 By CATEGORY
❔ What it is → showcase your P&L based off of cost type, or summary groupings
💡 Why it’s valuable → gives you a zoomed out view of what’s happening, allowing you to drill deeper
where necessary
9. 👥 By DEPARTMENT
❔ What it is → showcase your activity based off of each department’s activity
💡 Why it’s valuable → allows you to understand what area of your business is consuming your resources
10. 🕧 vs LAST PERIOD
❔ What it is → showcases your activity as compares to last period
💡 Why it’s valuable → understand how you are progressing each month
11. ❓ vs BUDGET
❔ What it is → show what happened vs what you thought would happen
💡 Why it’s valuable → gives you confidence & insights into where your assumptions are accurate vs need adjustment
12. 📅 vs LAST YEAR
❔ What it is → compare your results against the same time period last month
💡 Why it’s valuable → allows you to compare seasonality, and how much you’ve grown in 12 months
Those are my 12 ways to present a P&L!
What are some other ways that you present your P&L?
Learn about the Financial Statements…while learning to play Piano!
The Financial Statements are probably the most important concept to understand in Finance & Accounting
And with this piano, you can understand not only how they work…
but also how they are CONNECTED
Let’s do a deep dive:
🎹 PROFIT & LOSS
This section of the piano is reserved for telling you what you are generating in SALES…
and what you are consuming in EXPENSES
These chords will help you understand your PROFITABILITY at a number of different levels...
The major keys are:
🎵 Revenue → your income
🎵 Cost of Goods Sold → the cost to deliver your revenue
🎶 Gross Profit → Revenue - COGS
🎵 Operating Expenses → the cost to run your business
🎶 Net Operating Income → Gross Profit - Operating Expenses
🎵 Other Income / expense → income / expense amounts not related to your core business
🎶 Net Income → Net Operating Income + Net Other Income (can be before / after tax)
🎹 BALANCE SHEET
This section of the piano is reserved to help you understand a snapshot of the business
It in essence shows you the net worth of your company
The major keys are:
🎵 Assets → items of economic value that the business owns / substantially controls
🎵 Liabilities → amounts that are owed to creditors
🎵 Owners Equity → amounts that are owed to the owners of the business
The classic symphony that you’ll hear time and time again is…
🎼 ASSETS = LIABILITIES + OWNERS EQUITY
🎹 STATEMENT OF CASH FLOWS
This section of the piano is reserved for communicating where your cash is going from one period to the other
The major keys are:
🎵 Cash from Operating Activities → cash related to operating your business
🎵 Cash from Investing Activities → cash related to fixed / long term assets that you’ve invested in
🎵 Cash from Financing Activities → cash related to amounts contributed / withdrawn from the business
Now that you are a piano pro…did you know that certain keys play well with others?
That’s right…you’re financial statements are CONNECTED
And when these keys are played together…you have a beautiful sound 🎧
For example…
🎼 The Profit & loss ↔️ to the Balance Sheet via the NET INCOME key, and the RETAINED EARNINGS key
🎼 The Profit & loss ↔️ to the Statement of Cash Flows via NET INCOME key, and the DEPRECIATION & AMORTIZATION keys
🎼 The Balance Sheet ↔️ to the Statement of Cash Flows view MULTIPLE keys…such as:
🎼 ▲ in Current Assets / Current Liabilities → Cash from Operating Activities 🎶
🎼 ▲ in Fixed Assets / Long term Assets → Cash from Investing Activities 🎶
🎼 ▲ in Long Term Liabilities / Contributed Capital → Cash from Financing Activities 🎶
Now you are a pro at learning to play the Financial Statements piano 🎹
Check out the chords to the left to take your talent to the next level!
Got anything to add to the Financial Statements Piano?
That depends on who you ask…
and what you use it for.
First…
➡️ What is EBITDA?
EBITDA stands for Earning before Interest, Taxes, and Depreciation
It’s a very common term you’ll hear in Finance & Accounting
➡️ How do you calculate EBITDA?
Like the name suggests…
Start with Net Income
[+] add back your interest expense
[-] subtract out your interest income
[+] add back your taxes
[+] add back your depreciation
[+] add back your amortization
OK…now that we know what EBITDA is and how to calculate it…is it a good metric?
➡️ Pros to EBITDA
✅ Can be a good proxy for free cash flows → although not perfect, EBITDA can be a good measure of a companies free cash flows
✅ Simplifies Comparisons → EBITDA helps you compare businesses in a similar industries against one another
✅ Valuing a company - it’s common to use EBITDA as a multiple in order to get to a valuation
✅ Focuses on operating performance → EBITDA removes metrics that aren’t part of the normal course of business
✅ Widely accepted → everyone knows the term EBITDA
✅ Useful for high growth companies → since depreciation & amortization are not included, it tells more of a story related to profitability & growth
➡️ Cons to EBITDA
❌ Ignores changes in working capital → EBITDA doesn’t account for changes in items like inventory, accounts payable, or accounts receivable
❌ Is not a GAAP metric → EBITDA is not a metric that you’ll find in a Profit & Loss
❌ Vulnerable to Manipulation → you’ll often times hear of an alteration of EBITDA, that can be misleading
❌ Fails to consider capital structure - EBITDA won’t show you how the company is capitalized, and how much debt needs to be repaid
❌ Does not Represent cash flow → EBITDA can wildly differ from your actual cash flows
❌ Lacks industry specific considerations → your EBITDA won’t inform you of whether it’s a strong or weak indicator of performance in your industry
❌ Ignores the Quality of earnings → income from recurring sources are more attractive than non recurring sources, but EBITDA won’t inform you of this
❌ Excludes important expenses → Taxes, Interest, Depreciation, and Amortization can all be material expenses that the business faces
What do you think?
I hope you gained valuable insights into EBITDA, Month End Close processes, and Revenue Forecasting with this week's edition of Legit Numbers!
If you have any questions or need further assistance, feel free to reach out. I reply to all my emails personally :)
Till next Thursday!