Financial Statements: An Interactive Learning Approach

Abstract

The often tedious but essential task of understanding financial statements and the inter-relationships among them can be enlivened by an interactive exercise with an unexpected and dramatic flair. I have used this approach for over ten years in both undergraduate and graduate finance and entrepreneurship classes, with entrepreneurs in Small Business Administration workshops, and with attendees at profit improvement planning workshops. The exercise begins with a four-quarter proforma income statement that shows a profitable, growing firm. Participants then create, with the instructor’s guidance, the company’s balance sheet that shows it unable to pay its bills by the end of the year. Then the participants discover for themselves how this seemingly contradictory situation can occur by developing, again with the instructor’s guidance, a proforma cash flow. This paper demonstrates how the approach works and provides the materials used in the interactive session.