Hi everyone, welcome to business concepts for life scientists. Today, we're going to be talking about finance. My name is JeShaune Jackson and I'm the program manager of the Entrepreneurship Center here at UCSF's campus. I'll be initiating this today and then after Christine will followup with a few more topics that we'll discuss. So first, just some of the objectives by the end of the class, I promise that you'll be able to do the following: you'll be able to identify 3 different financial statements and how companies use them, read and identify parts of a P&L statement, calculate a burn rate, explain and apply concepts such as opportunity cost, cost of capital, and net present value, as well as apply these concepts in financial planning.
But first, let's define finance. So corporate finance deals with the sources of funding and the capital structure of corporations. Just a little step further, it's always important to remember that the purpose is always to increase the value of the firm to the shareholders. But within our context, let's think about biotechnology. So biotechnology defines finance as how the company will fund itself and allocate its financial resources.
In academia, where some of you may be a lot more familiar with, is how the lab will budget for its operations and manage expenses. So let's talk about 3 different categories today, the first category is Revenue and Costs, so within that we're going to talk about what the enterprise earns and spends. The second is Forecasting, and in Forecasting we're going to be estimating the funding of the enterprise. And then Cost of Capital is the required rate of return to make an investment. Sounds a little technically jargon-y right now, but I promise you're going to understand what we're talking about by the end of this. So first, let's just go in and talk about Revenue and Costs. So Revenue and Costs is how enterprises measure performance. So within this section we're going to talk about an overview of the financial statements and you'll be able to answer these 3 questions: How much revenue did Gilead earn in 2015? What was the annual burn rate for the company in 2015? And at the current burn rate, how many months of cash does this company have remaining left? But first, let's go into the types of financial statements.
So there are 3 financial statements you can find online at the SEC.gov. So public companies are required to file these financial statements so that shareholders have all the information that they need to make a decision on the company. These 3 statements are the income statement, the balance sheet, and the cash flow statement. The company we're going to be using is Gilead, which some of you are familiar with as a biotech company. If you look at the bottom, I put these three because there's really consolidated information, it's a lot more at a high level, some dashboards, instead of just diving directly into a 10K, which is just full of text. You may be lost. Some of you might want to start with Google Finance or Yahoo! Finance, because it's a lot more intuitive if you're just starting off. So first, we're going to talk about the income statement. So the income statement covers Revenue and Costs. It's also called a Profit and Loss statement. The income statement covers the net income over a period of time. So the period of time that we're going to be using is the year 2015.
So if you look at Gilead's income statement, you can see all the way up top, we have Revenues. Revenues is broken down into produce sales, which also has a line of royalty, contracts, as well as a few others. It's important to know that these are clumped together into total revenues and then we're going to subtract out some of the other expenses in the company.
Some of those expenses include cost of goods, which you can see here. Cost of goods for a biotech company is usually what goes into the direct cost, the raw materials, of developing a drug. So these are chemicals, raw goods such as pipetting materials, capsules, et cetera. For research and development, it's important to look at, in this expense, this is where your salary is going to come out of. As a scientist, as any technical person, research and development encompasses some of these laborers here. Selling, general, and administrative expenses, also called SG&A, here you can see where the marketing expenses are, where the sales team, the executive team, pretty much all of the business side of things is kind of pulled out of this side. So you can see what the total cost is in expenses are. Under it, you can see there are a few others, but it's not really — at this stage, I wouldn't dive too much into that.
Just know that there are taxes and other provisions that you kind of have to go through that you would subtract out. But right now, let's just keep it high level revenues minus expenses. And you can see at the bottom we have our net income to the company. The second statement we're going to talk about is the balance sheet. So the balance sheet pretty much encompasses the assets, liabilities, and equity. Different from the income statement because the balance sheet is just a snapshot at a period of time. So this can be any day. The day we're going to use is the same as our income statement, which is 12/31/15.
But just remember, it's a point in time. This is an overview of the balance sheet. You know, as scientists, we love equations so here's an equation. Assets always equals liabilities plus equity. So total assets we're going to go over, but liabilities just think of it as debt, and just know that these two have to balance out, no pun intended. So here's a consolidated balance sheet for Gilead. If you look at the top you can see cash and cash equivalents, if you look down another row item, you can see accounts receivable.
So accounts receivable is money that you're waiting to collect. So you already performed the service or you already sold the goods to the company, and if you think of it like on a credit card, you're just waiting to collect the cash from your customers. At the bottom you can see property, plant, and equipment, also called PP&E. Here are some of you're hard long-term assets, such as land or new manufacturing facility, or some other large asset that you want to just clump into this scenario. So you can see at the bottom what our total assets equates to. Next up, we're going to look at liabilities and equity. As I mentioned before, liabilities is just your debt, it's the debt of a company, it's what the company owes to any lenders. If you look down at the bottom you can see retained earnings, this is the company's stock.
So this is people who've purchase stock in the company and they have equity in it. So you can see what the retained earnings equals and that's your equity. So if you add these two up together, what do you get? Your total assets always equals your total liabilities plus equities. So you can see both of these equate to $51,839,000,000. The last statement we're going to talk about is the cash flow statement. The cash flow statement encompasses three different activities. So where's cash moving between these three? One of those is operating, the other is investing, and then finally, financing. And again, this is over a period of time. So we're going to use the year end of 2015. And so our snapshot is going to be coming from 12/31/15. So let's talk about the concept of cash burn. So cash burn at a high level is just how much is a the company churning through its cash, how much time do we have before we essentially run out of money and we have to close the doors.
So the formal definition we have here is that it's an approximation of how much money a biotech company or a project has and is using over a period of time. An example of that period of time can be monthly, quarterly, or annually for longer term strategies, And then it's important to remember in biotech one thing that we use is that we just use the operating loss as kind of a good benchmark for what our cash burn is. So we're not using Gilead for this, you can see the company name has changed to Portola Pharmaceuticals. And it's because Gilead is a really well-established, large, not burning out of any cash right now any time soon. So it's just not as good of an example as Portola, which as you can see has a operating loss of $227million. So let's just walk through the example of cash burn. So if you want to determine how many months of cash does this company have left. You use this simple equation, you take the current cash from the balance sheet and you then you divide it by the annual operating loss, you multiply it out by 12 months.
And you'll get the number of months that the company has left. So for this example, for Portola, we're going to look here we can see that the cash that we pulled from the balance sheet is $444million, you can see the operating loss as we previously mentioned is $227million. So if you divide those two out and you multiply by 12, you can see that the company has little under 2 years left before it essentially has to close its doors or raise additional funding, or increase revenue. Or decrease costs. So again, those financial statements as we mentioned, one is the balance sheet, which is a snapshot over a period of time, If you look at the two in the middle, remember that these are a summary of a period of time.
So we have our cash flow, which is where is cash moving between our operating and investing and financing activities. You have our income statement, also called a P&L, or profit and loss, and just remember, it's revenues minus expenses and it always equals the net income. Just to kind of put things into context, one of the things we like to use is operating evaluation metrics. Just because $20million doesn't mean much to a company like Apple, whereas $20million to a smaller company that's only doing, let's say $30million of revenue, the $20million means a lot more. So we like to create what are metrics or ratios, so you put that into a percentage so that it becomes a lot more relevant to the specific company that you kind of want to evaluate. One of those metrics is gross margin, also called profit, just to see you know, how profitable is this company. That's just revenues minus expenses equals gross profit. You convert that into percentages and you'll see in a relative context, how profitable is this company.
The next one is net income, this is just cash to the company. This is a simple equation, you really just want to see how much company is going to the company. And lastly, solvency, which is the ultimate financial health status of the company. So you use this metric as we used for Portola, just to see how many months does this company have left before it essentially has to close its doors or really do some hardcore capital restructuring. Next up, we're going to talk about parallels to academia. Please refer to Amy's video, and she'll give you a lot more examples of how do we use finance in academia and how she uses it in her lab, and how does it translate to some things that are similar to other small businesses. Alright, next up, we're going to talk about forecasting. So forecasting, as I mentioned before, is estimating the funding of the enterprise. Now, so in this segment, we're going to talk about what is forecasting, why companies do it, and we're going to predict the use of cash for activities that the company might use in the future.
But first, let's talk about why do companies forecast? The main reason, and the main goal, is to get a better grasp on cash management, where's our cash going? Where can we put cash today that can generate some more cash in the future? Remember, when it comes to companies in the finance side, cash is always king. You know, where is our money going right now? The second, as I kind of alluded to a little bit is strategy, so we can kind of strategize where do we put our money today, what activities do we invest in, what piece of equipment should we buy, how much money is this equipment going to give us in the future, or we can just determine some long-term short-term, and midterm strategies. It's also important to remember that as science as we are, and as technical we may be, forecasting really is an art and a science.
The science you might be a lot more familiar with, it's the math, the crunching equations, but there's also an art to it. It's always important to remember that the one thing that's true about forecasting is that it will always be 100% wrong. You know, it's really just about backing up your assumptions, coming up with really strong supported assumptions for what you have. Why are you forecasting out this? How'd you get there? And it just makes it a lot easier from a finance side to determine where the company's going to be going in the future. Alright, so let's talk about how we use forecasting with an organization. So usually we try to mesh this in with long-term, short-term, and mid-term strategies. So a long-term strategy usually is a much heavier of an investment. So long-term strategy are what are we going to finance, on an annual 3+ year type strategy. What are we going to invest in today that we're not going to see a return for a long period of time or over a lengthy period of time.
Whereas the short-term finance strategy would be a one year or one month, or just a really short-term budget. So what are we going to buy for office supplies? What are we going to buy this new machine for that we're only going to use for a year? Or really small, much smaller items. So here's an example that some of you may be familiar with. So this is just the different stages of drug development for a company. So the short-term strategy, as you can see, will be to just demonstrate proof of concept within just a few patients. We can see we budgeted out just how much it would cost, and we have a strategy map as to what we get out. On the long-term side, you can see the cumulative amount is roughly $240million total, but the long-term strategy is how do we get this drug to market commercial success, market this drug, whereas today, we're just mapping out for that proof of concept. So let's use an example that is a lot simpler to understand, just to kind of get your grasp around some of the concepts of forecasting. So here, we're going to use the very simple idea of, let's say your daughter.
Your daughter is entrepreneurial at heart, she really wants to work and earn her dollar. So she comes to you and says she wants to sell lemonade out of a lemonade stand. So for forecasting, you really want to predict what is this lemonade stand going to look like over the next 3 years? So we're going to forecast 2017, 2018, and 2019. But, you see the A next to 2015 and 2016 because these are our actuals. So these are actuals, also called historicals. So this is what we're going to base the foundation of our assumptions.
So you can see our assumptions column, some of the assumptions you can see here is, each year we're increasing by 50% the number of units sold as we went from 2016 to 2017, and that's based on the fact that your daughter sold 500 last year, she sold an additional 250 this year, so that's a 50% increase. So we're just using that as our base of assumption, it can be 50%, it can be 35%, it can be 100%, it can be 200%. In the end, it's just really about making sure that you have the credibility and validity to back up why you feel that percentage is going to be that number. So that's your assumption. So that's what you kind of manipulate in forecasting.
But you can see we're pretty much just forecasting out a traditional income statement. You're just doing a simple P&L forecast so you can see, is this going to be viable for your daughter to do in the future, how much is it going to cost you, is it going to be worth it? So you know, this is just a really simple example of a lemonade stand, but just wanted to get you guys a little more familiar with forecasting and financial statements. So next up, we're going to be going to Christine. Please check out her video, where she's going to finish off the finance section.