Every racer and team manager or owner quickly realizes the importance of money in a racing organization. Budgets, cash flow, and endorsement income rank right up there with elapsed times, lap speeds, RPM’s, chassis adjustments and horsepower.
This blog is designed to give you some insights into the reading of financial statements – that collection of numbers that your accountant or bookkeeper periodically gives you, with the expectation that you’ll understand their significance.
One of the difficulties of being a racing team manager owner is that many financial concerns ultimately come down to one or two questions, such as: ”How much is this going to cost?” and “Do we have enough cash for the next race?”
There are a few motorsports companies, such as Speedway Motorsports, Inc., or International Speedway Corporation, whose financial information in easily available. That’s because they’re public companies and their stock is bought and sold on stock exchanges. These companies are registered with the U.S. Securities and Exchange Commission, and by law anyone can look at their financial statements.
If you were to look up the numbers for any publicly held company, you’d soon be buried under an avalanche of numbers and footnotes. It’s not unusual for a publicly held company’s report to exceed 75 pages.
But, you’re a manager or owner of a small racing team and you’d like to get the most useful information in the least amount of time, hopefully, the following information will help.
For our purposes, there are three basic financial statements:
· The income statement, also known as the profit and loss sheet.
· The balance sheet, and
· The statement of cash flows.
Each of these statements focuses on a different financial aspect of the business operation and they’re integrated. The ending balance of one statement influences another, just as the pressure of a brake pedal is transmitted through the fluid in the brake lines to the brake caliper. Both the financial statements and the brakes form a complete system. Every component is essential.
Let’s take a look at each financial statement in some detail.
The Income Statement is the first statement prepared. It shows the profit or loss at the end of a time period. It does this by listing all the items of revenue and then subtracting from that total all the expenses. If the result if positive, the business has a profit. If it’s negative, the business has suffered a loss for that time period.
Some things to remember about the Income Statement:
· Not all money that comes into a business is revenue. If a business raises money through a sale of stock or a bank loan, the income statement isn’t affected.
· The profit amount will be the stepping-stone for determining the income taxes of a firm. There are adjustments to be made to convert that profit number to taxable income. This is a special area for accountants.
· Profit is not the same as cash. An increase is profit doesn’t always equal an increase in cash. It’s very possible for the cash balance to increase (say, through a loan) and the profit to decrease (because of the interest expense associated with the loan).
· Income statements cover a period of time – a month, quarter or a year.
The Balance Sheet is a listing of what the business owns (Assets), what it owes (Debts or Liabilities), and what’s left over (Equity). Putting it another way, if a business – any business – were to liquidate and sell all the assets, convert everything to cash, and pay off all debts, any amount left would go to the owner(s). The total amount of assets must always equal the amount of liabilities plus the equity amount.
Some additional items about a Balance Sheet include:
· Balance sheets are prepared as of a specific date, usually year-end or the end of a quarter or month.
· Assets include cash, accounts receivable (what others owe the business), prepaid rent and insurance, equipment (such as the equipment covered in a previous blog on depreciation), and inventory. (Unless a racing team purchases items for resale, it’s doubtful that there’s much if any inventory.)
· Liabilities are debts owed to other firms, such as for supplies, parts, taxes, payroll, and advertising – the list goes on and on as you well know.
· Equity is the owner’s financial interest is in the business. Any profit for the year is added to equity; any loss is subtracted from it. This is an example of the integrated nature of financial statements mentioned earlier.
· A well prepared Balance Sheet separates the assets and liabilities each into “current assets” and “current liabilities.” Current assets are cash and those items that will be converted into cash or used up in a year. Current liabilities are those debts that will be paid within a year. This distinction is important and has everything to do with “working capital.”
· Working capital is the result of subtracting current liabilities from current assets. If the result is positive, then the business can be viewed as being able to pay its bills on time. If the result is negative, the conclusion is the opposite and is a warning sign.
The Cash Flow Statement is a “diary” of cash ins and outs – inflows and outflows – organized into three categories or “activities.”
· Operating activities – the day-to-day operations of the business. For racing teams, this has everything to do with placing a car and driver in a race.
· Financing activities – the raising or money through sale of stock or borrowings. The three ways a business raises money are through profits, through sale of stock, or through loans. The last two items each have good and bad features; profits are always good. (Larger profits are even better.) You should also know that selling of stock of your racing team to anyone who’ll buy it may be illegal. You absolutely need to consult with an attorney on this.
· Investing activities – the spending of money on fixed assets, such as equipment, dynos, cars, etc. In this context, “investing” does not mean the buying of stocks and bonds with excess funds. (Frankly, for most racing activities, “excess funds” are non-existent.)
· The ending balance on the cash flow statement must equal the ending balance of cash on the balance sheet. (Another example of financial statement integration.)
A major focus of a Cash Flow statement is the amount of funds generated through operating activities: prizes, endorsements, contingencies, etc. If a business continually funds its operations through financing activities, that business has a difficult future.
Two absolutely vital financial characteristics of a business that need to be kept in mind at all times are profitability and solvency.
· Profitability – the ability of a business to consistently make a profit. By doing this, the survivability and long-run prosperity and success of the business are greatly increased. The key indicating number reflecting this is the profit or “net income” amount on the Income Statement.
· Solvency – the ability of a business to pay its bills. The prime indicators for this are the working capital numbers mentioned above and the analysis of the cash flow statement.
Profitability and solvency are not the same. It’s very possible for some businesses to have large amounts of profit in the beginning of their existence, but insufficient cash. Both are needed. A racing team needs to establish a pattern of profits to insure its survival and keep it solvent so it can pay its bills.
When I talk with my students or clients, I always mentioned “Schurrer’s Laws of Business Survival”
· There’s no such thing as excess profits, provided they were arrived at honestly
· The game is over when the money runs out.
· You can do many things with cash and no debt
· May your taxes double next year. This means that your net income (profit) will have risen by the same factor, all things being equal.
Profitability and solvency (as well as many other factors) can be determined by property understanding and using financial statements.
Remember, no one every bought a quarter-inch drill bit because he wanted a quarter-inch drill bit. He wanted a quarter inch hole. Financial statements, like drill bits, are tools. Use them well.
Let me know if you or your group would be interested in a presentation going into these topics or other tax and financial aspects of motor sports. I'd be interested in hearing from you.
Contact me at:
phil.schurrer.racingprof@gmail.com
Until next time …
Phil Schurrer, CPA
“This posting is intended to provide general information regarding the subject matter covered. It is provided with the understanding that the author is not engaged in rendering legal, accounting, or other professional services. This information should not be used as a substitute for professional advice in specific situations. If legal advice or other expert assistance is required, the services of a professional should be sought.”
- Adopted from a Declaration of Principles jointly adopted by a Committee of the American Bar Association and a Committee of Publishers.
Attorneys and other professionals dealing with specific matters and situations should also research original sources of authority.
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