Ch. 2


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Ch. 2

  1. 1. Financial Statement and Cash Flow Analysis Chapter 2
  2. 2. Financial Statements Accrual-based approach <ul><li>Revenues are recorded at the point of sale and costs when they are incurred, not necessarily when a firm receives or pays out cash. </li></ul>Cash flow approach <ul><li>Used by financial professionals to focus attention on current and prospective inflows and outflows of cash. </li></ul>
  3. 3. Financial Statements <ul><ul><li>Financial Statements </li></ul></ul>Statement of Retained Earnings Balance Sheet Income Statement Statement of Cash Flows Notes to Financial Statements
  4. 4. Balance Sheet <ul><li>A firm’s balance sheet presents a “snapshot” view of the company’s financial position at a specific point in time. </li></ul>assets = liabilities + stockholders’ equity
  5. 5. Balance Sheet for Global Petroleum Corporation
  6. 6. Income Statement <ul><li>Income is also called profit, earnings, or margin. </li></ul>Income = revenue  expenses Measures of Income <ul><li>Gross profit </li></ul><ul><li>Operating profit </li></ul><ul><li>Other income </li></ul><ul><li>Earnings before interest and taxes </li></ul><ul><li>Pretax income </li></ul><ul><li>Net income / net profit after taxes </li></ul>
  7. 7. Income Statement for Global Petroleum Corporation
  8. 8. Statement of Retained Earnings <ul><li>The statement of retained earnings reconciles </li></ul><ul><li>the net income earned during a given year, and any cash dividends paid, </li></ul><ul><li>with the change in retained earnings between the start and end of that year. </li></ul>
  9. 9. Statement of Retained Earnings for Global Petroleum Corporation
  10. 10. Financial Statements Statement of Cash Flows <ul><li>Reconciles </li></ul><ul><li>the firm’s operating, investment, and financing cash flows </li></ul><ul><li>with changes in its cash and marketable securities </li></ul><ul><li>during the year. </li></ul>Notes to Financial Statements <ul><li>Explanatory notes </li></ul><ul><li>that provide detailed information on the accounting policies, calculations, and transactions </li></ul><ul><li>underlying entries in the financial statements. </li></ul>
  11. 11. Cash Flow Analysis <ul><li>Although financial managers are interested in the information contained in the firm’s accrual-based financial statements, their primary focus is on cash flows. </li></ul><ul><li>Without adequate cash to pay obligations on time, to fund operations and growth, and to compensate owners, the firm will fail. </li></ul>
  12. 12. The Firm’s Cash Flows
  13. 13. Free Cash Flow <ul><li>Operating cash flow </li></ul><ul><ul><li>= earnings before interest and taxes </li></ul></ul><ul><ul><li> taxes </li></ul></ul><ul><ul><li>+ depreciation </li></ul></ul><ul><li>Free cash flow </li></ul><ul><ul><li>= operating cash flow </li></ul></ul><ul><ul><li> change in gross fixed assets </li></ul></ul><ul><ul><li> change in current assets </li></ul></ul><ul><ul><li>+ change in account payables </li></ul></ul><ul><ul><li>+ change in accrued liabilities </li></ul></ul>
  14. 14. Inflows and Outflows of Cash
  15. 15. Statement of Cash Flows for Global Petroleum Corporation
  16. 16. Analyzing Financial Performance Using Ratio Analysis Liquidity Ratios <ul><li>Measure a firm’s ability to satisfy its short-term obligations as they come due. </li></ul>Activity Ratios <ul><li>Measure the speed at which a firm converts various accounts into sales or cash. </li></ul>Debt Ratios <ul><li>Measure the proportion of total assets financed by a firm’s creditors. </li></ul>Profitability Ratios <ul><li>Relate a firm’s earnings to its sales, assets, or equity. </li></ul>Market Ratios <ul><li>Relate a firm’s market value to certain accounting values. </li></ul>
  17. 17. Using Financial Ratios Benchmark 1 <ul><li>Analysts compare the current year’s financial ratios with previous years’ ratios </li></ul><ul><li>to identify trends that help them evaluate the firm’s prospects. </li></ul>Benchmark 2 <ul><li>Analysts compare the ratios of one company with those of other firms in the same industry. </li></ul>
  18. 18. Liquidity Ratios
  19. 19. Activity Ratios
  20. 20. Debt Ratios
  21. 21. Profitability Ratios
  22. 22. Profitability Ratios
  23. 23. Profitability Ratios <ul><li>DuPont System of Analysis </li></ul>
  24. 24. Market Ratios
  25. 25. Corporate Taxes Corporate taxes represent a significant cash outflow. Ordinary corporate income <ul><li>Progressive tax rate schedule </li></ul><ul><li>Average tax rate: tax divided by the pretax income </li></ul><ul><li>More relevant for financial decision making: marginal tax rate </li></ul>Corporate capital gains <ul><li>Under existing tax laws, ordinary income tax rates apply </li></ul>
  26. 26. Financial Statement and Cash Flow Analysis <ul><li>Balance Sheet </li></ul><ul><li>Income Statement </li></ul><ul><li>Cash Flow Analysis </li></ul><ul><li>Liquidity Ratios </li></ul><ul><li>Activity Ratios </li></ul><ul><li>Debt Ratios </li></ul><ul><li>Profitability Ratios </li></ul><ul><li>Market Ratios </li></ul>