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Financial Statements, Taxes, and Cash Flows: Mcgraw-Hill/Irwin

The Balance Sheet is a snapshot of the firm's assets and liabilities at a given point in time. The income statement is a video of a firm's operations for a specified period of time. A company's net income is the amount of money it makes in a year.

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106 views21 pages

Financial Statements, Taxes, and Cash Flows: Mcgraw-Hill/Irwin

The Balance Sheet is a snapshot of the firm's assets and liabilities at a given point in time. The income statement is a video of a firm's operations for a specified period of time. A company's net income is the amount of money it makes in a year.

Uploaded by

MSA-ACCA
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
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Chapter 2

•Financial Statements, Taxes,


and Cash Flows

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
Chapter Outline

• The Balance Sheet


• The Income Statement
• Taxes
• Cash Flow

2-2
Balance Sheet

• The balance sheet is a snapshot of the


firm’s assets and liabilities at a given point
in time
• Assets are listed in order of liquidity
• Ease of conversion to cash
• Without significant loss of value
• Balance Sheet Identity
• Assets = Liabilities + Stockholders’ Equity

2-3
The Balance Sheet - Figure 2.1

2-4
Net Working Capital and
Liquidity
• Net Working Capital
• Current Assets – Current Liabilities
• Positive when the cash that will be received over the next 12
months exceeds the cash that will be paid out
• Usually positive in a healthy firm
• Liquidity
• Ability to convert to cash quickly without a significant loss in value
• Liquid firms are less likely to experience financial distress
• But liquid assets earn a lower return
• Trade-off to find balance between liquid and illiquid assets

2-5
US Corporation Balance Sheet –
Table 2.1

2-6
Market Vs. Book Value

• The balance sheet provides the book value


of the assets, liabilities and equity.
• Market value is the price at which the
assets, liabilities or equity can actually be
bought or sold.
• Market value and book value are often
very different. Why?
• Which is more important to the decision-
making process?
2-7
Example 2.2 Klingon
Corporation
KLINGON CORPORATION
Balance Sheets
Market Value versus Book Value
Book Market Book Market
Assets Liabilities and
Shareholders’ Equity
NWC $ 400 $ 600 LTD $ 500 $ 500
NFA 700 1,000 SE 600 1,100
1,100 1,600 1,100 1,600
2-8
Income Statement

• The income statement is more like a video


of the firm’s operations for a specified
period of time.
• You generally report revenues first and
then deduct any expenses for the period
• Matching principle – GAAP – ex: to show
revenue when it accrues and match the
expenses required to generate the
revenue
2-9
US Corporation Income Statement –
Table 2.2

2-10
Work the Web Example

• Publicly traded companies must file regular


reports with the Securities and Exchange
Commission
• These reports are usually filed
electronically and can be searched at the
SEC public site called EDGAR
• Click on the web surfer, pick a company
and see what you can find!

2-11
Taxes

• The one thing we can rely on with taxes is


that they are always changing
• Marginal vs. average tax rates
• Marginal – the percentage paid on the next
dollar earned
• Average – the tax bill / taxable income
• Other taxes

2-12
Example: Marginal Vs. Average
Rates
• Suppose your firm earns $4 million in
taxable income.
• What is the firm’s tax liability?
• What is the average tax rate?
• What is the marginal tax rate?
• If you are considering a project that will
increase the firm’s taxable income by $1
million, what tax rate should you use in
your analysis?
2-13
The Concept of Cash Flow

• Cash flow is one of the most important


pieces of information that a financial
manager can derive from financial
statements
• The statement of cash flows does not
provide us with the same information that
we are looking at here
• We will look at how cash is generated from
utilizing assets and how it is paid to those
that finance the purchase of the assets
2-14
Cash Flow From Assets

• Cash Flow From Assets (CFFA) = Cash


Flow to Creditors + Cash Flow to
Stockholders
• Cash Flow From Assets = Operating Cash
Flow – Net Capital Spending – Changes in
NWC

2-15
Example: US Corporation – Part I

• Operating Cash Flow (I/S) = EBIT + depreciation


– taxes = $547
• Net Cap.Spending ( B/S and I/S) = ending net
fixed assets – beginning net fixed assets +
depreciation = $130
• Changes in Net Working Cap. (B/S) = ending
NWC – beginning NWC = $330
• Cash Flow From Assets = 547 – 130 – 330 = $87

2-16
Example: US Corporation – Part II

• Cash Flow to Creditors (B/S and I/S) =


interest paid – net new borrowing = $24
• Cash Flow to Stockholders (B/S and I/S) =
dividends paid – net new equity raised = $63
• CFFA = 24 + 63 = $87

2-17
Cash Flow Summary Table 2.5

2-18
Example: Balance Sheet and
Income Statement Information
• Current Accounts
• 2004: CA = 3625; CL = 1787
• 2003: CA = 3596; CL = 2140
• Fixed Assets and Depreciation
• 2004: NFA = 2194; 2003: NFA = 2261
• Depreciation Expense = 500
• Long-term Debt and Equity
• 2004: LTD = 538; Common stock & APIC = 462
• 2003: LTD = 581; Common stock & APIC = 372
• Income Statement
• EBIT = 1014; Taxes = 368
• Interest Expense = 93; Dividends = 285

2-19
Example: Cash Flows

• OCF = 1014 + 500 – 368 = 1146


• NCS = 2194 – 2261 + 500 = 433
• Changes in NWC = (3625 – 1787) – (3596 –
2140) = 382
• CFFA = 1146 – 433 – 382 = 331
• CF to Creditors = 93 – (538 – 581) = 136
• CF to Stockholders = 285 – (462 – 372) = 195
• CFFA = 136 + 195 = 331
• The CF identity holds.
2-20
Chapter 2
•End of Chapter

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.

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