ACC323B - FINANCIAL MANAGEMENT

S.Y. ‘24 - ‘23 | PAGE 64-96 CHAPTER 3: FINANCIAL STATEMENT, CASH FLOW, & TAXES

OVERVIEW: STOCKHOLDERS’S EQUITY

Key Financial Statements It represents the amount that stockholders paid the
Balance Sheet company when shares were purchased and the
amount of earnings the company has retained since
Income Statement
its origination.
Statement of Stockholders’ Equity
Statement of Cash Flows Stockholders’ Eq = Paid-in capital + Retained
Free Cash Flow earnings
Federal Tax System Stockholders’ Eq = Total assets + Total liabilities

1.0 FINANCIAL STATEMENTS AND RETAINED EARNINGS

REPORTS They represent the cumulative total of all earnings
kept by the company during its life.

A manager’s primary goal is to maximize shareholder Points about Balance Sheet:

value, which is based on the firm’s future cash flows 1. Cash Vs. Other Asset
2. Working Capital
ANNUAL REPORT ➢ Asset turnover (current asset)
A report issued annually by a corporation to its ➢ Net working capital = CA - CL
stockholders. It contains basic financial statements ➢ Net Operating Working Capital (NOWC) =
as well as management’s analysis of the firm’s past Operating CA - Operating CL
operations and future prospects.
NET OPERATING WORKING CAPITAL
Provides these four basic financial statements: ➔ distinction between cash that is used for
1. The balance sheet - shows what assets the operating purposes and “excess” cash that is
company owns and who has claims on those being held for other purposes
assets as of a given date (December 31, ➔ make an estimate of excess cash and
2021) subtract this from the company’s current
2. The income statement - shows the firm’s assets to get the company’s operating current
sales and costs (and thus profits) during assets
some past period—for example, 2021. ➔ distinguish between its “free” liabilities
3. The statement of cash flows - shows how (accruals and accounts payable) and its
much cash the firm began the year with, how interest-bearing notes payable. These
much cash it ended up with, and what it did to interest-bearing liabilities are typically treated
increase or decrease its cash. as a financing cost, rather than an operating
4. The statement of stockholders’ equity - cost, which explains why they are not included
shows the amount of equity the stockholders as part of the company’s operating current
had at the start of the year, the items that liabilities.
increased or decreased equity, and the equity
at the end of the year. Table 3.1

1.1 THE BALANCE SHEET

➔ a “snapshot” of a firm’s position at a specific
point in time

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S.Y. ‘24 - ‘23 | PAGE 64-96 CHAPTER 3: FINANCIAL STATEMENT, CASH FLOW, & TAXES

give the bondholder an option to

exchange their bonds for shares of
common stock
➢ In the event of bankruptcy, debt is paid off
first, and then preferred stock. Common
stock is last, receiving a payment only
when something remains after the debt
and preferred stock are paid off

5. Depreciation
➢ Internal Revenue Service (IRS) rules and is
used to calculate taxes
➢ GAAP and is used for reporting to
investors
➢ Firms often use straight-line depreciation
for stockholder reporting while IRS
depreciation method for taxes

6. Market values vs. Book Values

➢ use GAAP to determine the values
reported on their balance sheets

7. Time Dimension
➢ snapshot of the firm’s financial position at
a point in time—for example, on
December 31, 2021.
3. Total Debt vs. Total Liabilities
➢ A company’s total debt includes both its 1.2 THE INCOME STATEMENT
short term and long-term interest-bearing
liabilities ➔ Reports summarizing a firm’s revenues,
➢ Total Lia = Debt + Company’s “free” expenses, and profits during a reporting
(non-interest bearing) Liabilities period, generally a quarter or a year.
➔ Net sales are shown at the top of the
statement; then operating costs, interest, and
taxes are subtracted to obtain the net income
available to common shareholders.

EARNINGS PER SHARE (EPS)

the bottom line, denoting that of all items on the
income statement
➔ Operating Income
◆ Earnings from operations before
interest and taxes (i.e., EBIT)
◆ Derived from the firm’s regular core
business

4. Other sources of funds

➢ Companies finance their assets with a
combination of short-term debt, long-term
debt, and common equity
➢ Some companies also use “hybrid”
securities such as preferred stock,
convertible bonds, and long-term leases.
➢ Preferred stock is a hybrid between
common stock and debt, while
convertible bonds are debt securities that

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S.Y. ‘24 - ‘23 | PAGE 64-96 CHAPTER 3: FINANCIAL STATEMENT, CASH FLOW, & TAXES

B. Net Income
Table 3.2 - first operating activity
C. Depreciation and Amortization
- depreciation must be added back to net
income when cash flow is determined
D. Increase in Inventories
- To make or buy inventory items, the firm must
use cash.
E. Increase in Account Receivable
- To stay in business, it must replace the
inventory that it sold on credit, but it won’t yet
have received cash from the credit sale.
F. Increase in Account Payable
- represent a loan from suppliers
G. Increase in accrued wages and taxes
- Increase in accruals is an increase in the cash
inflow
H. Net cash provided by operating activities
- All of the previous items are part of normal
➔ Non Operating Income
operations—they arise as a result of doing
business. When we sum them, we obtain the
net cash flow from operations.
I. Investing activities.
- Long-term assets; includes the purchase and
sale of short-term investments, other than
trading securities, and lending and collecting
on notes receivables.
J. Additions to property, plant, and equipment
DEPRECIATION - Spent money on fixed assets during the
The charge to reflect the cost of assets depleted in current year is a cash outflow (if sold = cash
the production process. Depreciation is not a cash inflow)
outlay. K. Net cash used in investing activities
L. Financing activities
AMORTIZATION M. Increase in notes payable
A noncash charge similar to depreciation except that N. Increase in bonds (long-term debt)
it represents a decline in value of intangible assets O. Payment of dividends to stockholders.
P. Net cash provided by financing activities
EBITDA Q. Summary
Earnings before interest, taxes, depreciation, and R. Net decrease in cash.
amortization S. Cash and equivalents at the beginning of the year
T. Cash and equivalents at the end of the year
** Income statement is tied to the balance sheet
through the retained earnings account on the balance
sheet. 2.0 STATEMENT OF STOCKHOLDERS’
EQUITY

1.3 STATEMENT OF CASH FLOW ➔ Changes in stockholders’ equity during the

accounting period are reported in the
➔ A report that shows how items that affect the
statement of stockholders’ equity
balance sheet and income statement affect
the firm’s cash flows
➔ how much cash the firm is generating

A. Operating Activities
- items that occur as part of normal ongoing
operations

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3.0 USES AND LIMITATIONS OF

FINANCIAL STATEMENTS

➔ Although companies are required to follow

GAAP, managers still have a lot of discretion
in deciding how and when to report certain
transactions.

4.0 FREE CASH FLOW

FREE CASH FLOW (FCF)

➔ The amount of cash that could be withdrawn
without harming a firm’s ability to operate and
to produce future cash flows

NET OPERATING PROFIT AFTER TAXES (NOPAT)

EBIT (1 - T)
➔ The profit a company would generate if it had
no debt and held only operating assets.

**Depreciation and amortization are added back

because these are noncash expenses that reduce
EBIT but do not reduce the amount of cash the 5.0 MVA AND EVA
company has available to pay its investors.
2 Financial Performance Measures:
A positive level of FCF indicates that the firm is
generating more than enough cash to finance current MARKET VALUE ADDED (MVA)
investments in fixed assets and working capital. By ➔ The excess of the market value of equity over
contrast, negative free cash flow means that the its book value
company does not have sufficient internal funds to ➔ simply the difference between the market
finance investments in fixed assets and working value of a firm’s equity and the book value as
capital, and that it will have to raise new money in the shown on the balance sheet, with market
capital markets in order to pay for these investments. value found by multiplying the stock price by
the number of shares outstanding
➔ The higher its MVA, the better the job
management is doing for the firm’s
shareholders.
➔ Boards of directors often look at MVA when
deciding on the compensation a firm’s
managers deserve

EXCESS VALUE ADDED (EVA)

➔ Economic profit
➔ Excess of NOPAT over capital costs
➔ Realize positive EVA if the benefits of their
investments exceed the cost of raising the
necessary capital
➔ Estimate of a business’s true economic profit
for a given year, and it often differs sharply
from accounting net income

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6.0 INCOME TAXES

➔ Individuals and corporations pay out a

significant portion of their income as taxes, so
taxes are important in both personal and
corporate decisions

6.1 INDIVIDUAL TAXES

➔ The tax rates are progressive—that is, the
higher one’s income, the larger the percentage
paid in taxes

TAXABLE INCOME
gross income less a set of exemptions and
deductions

MARGINAL TAX RATE

The tax rate applicable to the last unit of a person’s
income

AVERAGE TAX RATE

Taxes paid divided by taxable income

CAPITAL GAIN
The profit from the sale of a capital asset for more
than its purchase price.

CAPITAL LOSS
The loss from the sale of a capital asset for less than
its purchase price

SAMPLE TEST

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