Financial Statements

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as a current liability because it must be paid within the year. Because Under Armour is not required to pay all of its long-term debt immediately, it discloses exactly how much of it must be paid in the current year and reports that amount as a current liability. For UA, the investment in the business by its owners is denoted by the term stockholders’ equity.

The net working capital, or working capital, of any business is current assets less current liabilities. When net working capital is positive, the firm expects the cash paid out over the next year will be less than the cash that will become available over the next year. UA had positive net working capital of $1.279 billion in 2016 and $1.020 billion in 2015, representing an increase of $259 million in net working capital, indicating the company’s short-term assets have been exceeding the company’s short-term obligations. Positive net working capital is an indication of strong liquidity. Strong liquidity means that UA has the cash available to pay bills, expand operations, or sign endorsement deals with new athletes. A lack of liquidity is one of the most frequent causes for a sports organization to fail.

Income Statement The income statement measures a business’ profitability over a specific period—such as a year or a quarter—and is also called the profit and loss statement. Similarly, the income statement is a report card for a business as it is issued from time to time and gives an overview of how the business is doing for that time period. Since this statement reflects business activity over time (not like the balance sheet, which is a snapshot of a business for one segment in time), it is usually developed monthly, quarterly, and annually. Specifically, the income statement will show

if sales (revenues) are going up or down, the gross profit—how much money remains for the business after deducting what it costs to produce or purchase the product, all expenses for the time period covered, increases and decreases in net income, how much money is left to grow the business, and how much money is left for the owner(s).

Also, while the income statement does report income generated over a specific time period, the true earnings or profits reported can fluctuate, perhaps seasonally. A baseball team, for example, will typically have several months where income levels are much higher than months during the off season.

Income is defined as follows:

Income = Revenue − Expenses

Under Armour’s income statement is shown in appendix A. The income statement typically consists of three sections. The first section includes the revenues and expenses from the company’s

operations. Second, a nonoperating section of the income statement includes financing costs and any income earned by financial investments. For UA, the interest expense represents financing costs. Typically, the nonoperating section of the income statement includes all taxes paid by the enterprise. The third section of the income statement is the net income of the business.

Under GAAP, revenue is generated when an exchange of goods or services occurs. In addition, revenues and expenses are reported when they occur, although cash inflows or outflows may or may not have occurred. For example, when goods and services are sold for credit, associated sales and profits are reported even if payment has not yet been received. This system is known as accrual basis accounting as opposed to cash basis accounting, in which revenues and expenses are not recognized until actual cash inflows and outflows occur.

The value of a firm’s assets is linked to the future incremental cash flows that they will generate, but cash flows do not show up on the income statement. As a result, some expenses appearing on the income statement are not actual cash outlays. One such expense is depreciation. Depreciation represents an estimate by the firm’s accountants of the cost of equipment and property that are used up by the organization in the process of producing and distributing goods and services.

Companies report as the cost of goods sold those expenses that are directly related to the production and distribution of goods and services. Such costs include raw materials, direct labor, and manufacturing overhead. Other costs are allocated by the accountants preparing the financial statements to the period covered by the income statement. Such costs are reported separately as selling costs and as general and administrative costs. For example, a team with a call center to sell tickets might have additional selling costs while adding an extra secretary would be an administrative cost.

UA has a noncash expense related to the amortization of its property, plant, and equipment and intangible assets. Intangible assets are nonphysical fixed assets of the business that provide value, such as patents, licenses, trademarks, and copyrights (Investopedia, n.d.). Unless one is ready to assume an intangible asset has unlimited life for accounting purposes, amortization must be claimed over a reporting period because of either obsolescence or the wearing out of the intangible asset. As with depreciation, this amortization of intangible assets does not result in a cash outflow for UA. While the balance sheet and income statement are generally acknowledged to be the two most prominent financial statements, the statement of cash flows also plays an important role and will be discussed in the next section.

Statement of Cash Flows The statement of cash flows summarizes a firm’s cash flows resulting from operations, financing activity, and investment activity. Financial statements are important due to their ability to provide information about an organization’s cash flows. Cash flows for investors adds value to the firm. By cash flows, we are referring to cash flowing into the business as well as to cash flowing out of the business. As a reminder of the distinction between cash flows and accounting measures of income, income statements include noncash expenses such as depreciation.

The amount of depreciation reported on a business’ income statement has no effect whatsoever on the cash generated by the business. When the business reports depreciation, the dollar amount reported as depreciation is not directly paid to any vendors or employees, as would be the case with other operating expense categories. The statement of cash flows is a financial statement that reports changes in a company’s cash

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holdings over a particular period. Tracking cash for a business is an important part of the business operation particularly with newer companies. As an example, when a business has early success with a product it may hire more employees, expand too quickly, and purchase additional inventory. However, if the product’s demand begins to fade faster than expected, this can create financial stress on a company. Under Armour’s statement of cash flows is shown in appendix A.

Under Armour has three primary sources of cash flows as a result of business activities. These include cash flows from operating activities, cash flows from investing activities, and cash flows from financing activities. Cash flow refers to the difference between what a company brings in and what it pays out. Thus, cash flow from operating activities refers to both positive and negative cash flows resulting from the firm’s basic operating activities. These include operating revenues less all operating expenses other than noncash operating expenses, such as depreciation. When a firm earns revenue, positive cash flows occur, whereas cash expenses such as payments to a manufacturer are associated with negative cash flows. In addition, operating cash flows include the positive cash flows resulting from increasing current liabilities (other than short-term debt) and the negative cash flows associated with increases in current assets (other than cash).

The cash flows associated with financing activities are cash flows to and from creditors and owners. Such cash flows include changes in the firm’s debt and equity. When the firm increases its borrowings, it creates a positive cash flow. By comparison, paying off a loan results in negative cash flow. When dividends are paid out to stockholders, negative cash flow occurs, whereas proceeds from stock issues result in positive cash flow. When a sports team receives its share of a national television deal, a positive cash flow occurs.

Most companies choose to use the indirect method of cash accounting, and UA is no exception. Rather than add up every cash revenue and expense, the indirect method begins with the year’s net income, adds back noncash expenses, and deducts noncash revenues. This approach saves considerable time and effort because all the cash revenues and expenses are already accounted for in the net income figure.

UA reported positive cash flows from operating activities for the years ending December 31, 2015 and December 31, 2016. The cash flows from investing activities are associated with the business’ making additions to fixed assets. Purchases of current and fixed assets lead to negative cash flow resulting from the use of cash to purchase those assets. When current and fixed assets are reduced (e.g., sold) during the year, a positive cash flow occurs because of the cash generated by the sale of the assets. In addition, when current liabilities are increased, a positive cash flow occurs from investing activities because of the postponement of cash use.

In this section, we introduced the three primary financial statements including the balance sheet, income statement, and statement of cash flows. We discussed the elements of the balance sheet, which summarizes the firm’s financial condition at a particular point in time, and the contents of the income statement, used to measure the profitability of a business over a specified period. The balance sheet and the income statement provide a lead-in to explain changes in the cash position of a firm over a given period. Specifically, we described changes in cash flows resulting from operations, investing activity, and financing. The elements of the balance sheet and income statement are used to compute financial ratios summarizing the firm’s liquidity, activity, financial leverage, profitability, and market value.

Understanding the information contained in financial statements is critical to projecting future profits. When we forecast future sales and profits, we make various assumptions requiring extensive analysis of company financial statements, as well as knowledge of typical financials in the industry the company represents. This analysis is especially important because sales and profit forecasts are used in the planning process to determine capital needs and break-even sales.

FINANCIAL STATEMENT ANALYSIS Interpreting the key elements of financial statements allows management to evaluate areas of growth and opportunity while also identifying concerns about the overall future stability of the business. Financial statement analysis is an evaluative process used to estimate current and past financial positions and the subsequent results of an enterprise. Similarly, the primary objective is to determine the best possible predictions about the future. This is accomplished by the grouping and analysis of information provided by financial statements to establish relationships and identify strengths and weaknesses of a business. Additional implications complement the decision making involving comparison with other firms (cross-sectional analysis) and with a firm’s own performance over a time period (time series analysis).

Financial analysis is the selection, calculation, and understanding of financial data to help managers choose investments and guide decision making affecting their respective organizations. Specifically, financial analysis examines the relationship among data contained in several financial statements and the subsequent interpretation to gain insight into the profitability and operational efficiency of the firm. Likewise, financial analysis may also be used to evaluate employees, efficiency of operations, and external business operations such as borrowing money or interactions with creditors. In order to achieve success in their ventures, sports managers must know how to analyze financial statements and subsequently be able to tell a story. While seeing the different classifications of assets is important in terms of understanding what a company owns, examining the role these assets play in the company’s long-term financial position is possibly more important.

Interpreting Financial Statements Financial statements provide significant value to both internal and external stakeholder groups. Moreover, the ability to effectively communicate the information contained in these statements is an important skill, and organizations would be well served to ensure those individuals who are responsible for disseminating key financial information are adequately prepared to do so. Internal constituents include management, while external stakeholders include stockholders, analysts, customers, suppliers, and creditors. Internal uses might include planning, evaluating, and controlling company operations while external practices might include assessing past performance and current financial position, as well as subsequently making predictions about the future profitability and solvency of the com