Financial Statements

Core Concepts

The Three Statements and How They Articulate

• Income statement: revenue minus expenses over a period, on an accrual basis. Ends in net income.
• Balance sheet: assets = liabilities + equity at a point in time. Net income (less dividends) rolls into retained earnings, linking the two statements.
• Cash flow statement: reconciles net income to actual cash movement, split into operating (CFO), investing (CFI), and financing (CFF) activities. It starts from net income, adds back non-cash charges (D&A, stock-based compensation, impairments), and adjusts for working capital changes. The ending cash ties back to the balance sheet cash line.

Accrual accounting means reported earnings and cash generation can diverge for long stretches. Most analytical work is about measuring and interpreting that divergence.

EBITDA and Its Adjustments

EBITDA = EBIT + Depreciation & Amortization. It approximates pre-tax, pre-financing operating cash generation and is capital-structure neutral, which is why EV/EBITDA multiples use it. "Adjusted EBITDA" further strips items management deems non-recurring (restructuring, litigation, stock-based compensation). Scrutinize each add-back: recurring "one-time" charges and stock-based compensation are real economic costs. EBITDA ignores capex entirely, so it flatters capital-intensive businesses.

Free Cash Flow — FCFF and FCFE

FCFF (free cash flow to the firm) is cash available to all capital providers:

• From CFO: FCFF = CFO + Interest × (1 − τ) − Capex
• From EBITDA/EBIT: FCFF = EBIT × (1 − τ) + D&A − ΔNWC − Capex, where EBIT = EBITDA − D&A and EBIT × (1 − τ) is NOPAT