Chapter 2 financial statement, taxes, and cash flow

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Chapter 2 financial statement, taxes, and cash flow

  1. 1. Chapter 2 Understanding Financial Statements, Taxes, and Cash FlowsCopyright © 2011 Pearson Prentice Hall. All rights reserved. 3-1
  2. 2. Learning Objectives1. To discuss about the user and needs of financial statement2. To explain the components in the income statement, balance sheet, cash flow statement and statement of shareholders’ equity3. To explain the calculation of tax and depreciation.Copyright © 2011 Pearson Prentice Hall. All rights reserved. 3-2
  3. 3. Basic Financial Statements• Following four types of financial statements are mandated by the accounting and financial regulatory authorities: 1. Income statement 2. Balance sheet 3. Cash flow statement 4. Statement of shareholder’s equityCopyright © 2011 Pearson Prentice Hall. All rights reserved. 3-3
  4. 4. Basic Financial Statements (cont.)• 1. Income Statement: – An income statement provides the following information for a specific period of time (for example, a year or 6 months or 3 months): • Revenue, • Expenses, and • Profit.Copyright © 2011 Pearson Prentice Hall. All rights reserved. 3-4
  5. 5. Basic Financial Statements (cont.)• 2. Balance sheet: – Balance sheet provides a snap shot of the following on a specific date (for example, as of December 31, 2010) • Assets (value of what the firm owns), • Liabilities (value of firm’s debts), and • Shareholder’s equity (the money invested by the company owners).Copyright © 2011 Pearson Prentice Hall. All rights reserved. 3-5
  6. 6. Basic Financial Statements (cont.)• 3. Cash flow statement: – It reports cash received and cash spent by the firm over a period of time (for example, over the last 6 months).Copyright © 2011 Pearson Prentice Hall. All rights reserved. 3-6
  7. 7. Basic Financial Statements (cont.)• 4. Statement of shareholder’s equity: – It provides a detailed account of the firm’s activities in the following accounts over a period of time (for example, last six months): • Common stock account, • Preferred stock account, • Retained earnings account, and • Changes to owner’s equity.Copyright © 2011 Pearson Prentice Hall. All rights reserved. 3-7
  8. 8. Why Study Financial Statements? 1. Assess current performance through financial statement analysis (Financial statement analysis allows us to assess the present financial condition of a firm), 2. Monitor and control operations, and 3. Forecast future performance.Copyright © 2011 Pearson Prentice Hall. All rights reserved. 3-8
  9. 9. An Income Statement• An income statement is also called a profit and loss statement.• An income statement measures the amount of profits generated by a firm over a given time period (usually a year or a quarter).Copyright © 2011 Pearson Prentice Hall. All rights reserved. 3-9
  10. 10. An Income Statement (cont.)• Income statement can be expressed as follows: – Revenues (or Sales) – Expenses = ProfitsCopyright © 2011 Pearson Prentice Hall. All rights reserved. 3-10
  11. 11. An Income Statement (cont.)• An income statement will contain the following basic elements: 1. Revenues 2. Expenses • Cost of goods sold, Interest expenses, SGA (selling, general and administrative) expense, depreciation expense, Income tax expense 1. Profits • Gross profit, net operating income (also known as EBIT), earnings before taxes (EBT), and net incomeCopyright © 2011 Pearson Prentice Hall. All rights reserved. 3-11
  12. 12. An Income Statement (cont.)• Sales – Minus Cost of Goods Sold• = Gross Profit• Minus Operating Expenses – Selling expenses – General and Administrative expenses – Depreciation and Amortization Expense• = Operating income (EBIT)• Minus Interest Expense• = Earnings before taxes (EBT)• Minus Income taxes• = Net income (EAT) – EBIT = Earnings before interest and taxes; EBT = Earnings before taxes; EAT = Earnings after taxesCopyright © 2011 Pearson Prentice Hall. All rights reserved. 3-12
  13. 13. Sample Income StatementCopyright © 2011 Pearson Prentice Hall. All rights reserved. 3-13
  14. 14. Evaluating a Firm’s EPS andDividends• We can use the income statement to determine the earnings per share (EPS) and dividends.• EPS = Net income÷ Number of shares outstandingCopyright © 2011 Pearson Prentice Hall. All rights reserved. 3-14
  15. 15. Connecting the Income Statementand the Balance Sheet• What can the firm do with the net income?: 1. Pay dividends to shareholders, and/or 2. Reinvest in the firmCopyright © 2011 Pearson Prentice Hall. All rights reserved. 3-15
  16. 16. The Balance Sheet• The balance sheet provides a snapshot of the firm’s financial position on a specific date.• The balance sheet is defined by the following equation: Total Assets = Total Liabilities + Total Shareholder’s EquityCopyright © 2011 Pearson Prentice Hall. All rights reserved. 3-16
  17. 17. The Balance Sheet (cont.)• Total assets represents the resources owned by the firm.• Total liabilities represent the total amount of money the firm owes its creditors• Total shareholders’ equity refers to the difference in the value of the firm’s total assets and the firm’s total liabilities.Copyright © 2011 Pearson Prentice Hall. All rights reserved. 3-17
  18. 18. The BalanceSheet (cont.)Copyright © 2011 Pearson Prentice Hall. All rights reserved. 3-18
  19. 19. The Balance Sheet (cont.) • The balance sheet includes the following main components: 1.Assets – Found on the left-hand side of the balance sheet. It includes current assets and fixed assets. 2.Sources of financing – Found on the right-hand side of the balance sheet. It includes current liabilities, long-term liabilities, and owner’s equity.Copyright © 2011 Pearson Prentice Hall. All rights reserved. 3-19
  20. 20. The Balance Sheet (cont.)• Current assets consists of firm’s cash plus other assets the firm expects to convert to cash within 12 months or less, such as receivables and inventory.• Fixed assets are assets that the firm does not expect to sell within one year. For example, plant and equipment, land.Copyright © 2011 Pearson Prentice Hall. All rights reserved. 3-20
  21. 21. The Balance Sheet (cont.)• Current liabilities represent the amount that the firm owes to creditors that must be repaid within a period of 12 months or less such as accounts payable, notes payable.• Long-term liabilities refer to debt with maturities longer than a year such as bank loans, bonds.Copyright © 2011 Pearson Prentice Hall. All rights reserved. 3-21
  22. 22. The Balance Sheet (cont.)• The stockholder’s equity is broken down into two components:(1) The amount the company received from selling stock to investors. It may be shown as common stock in the balance sheet or it may be divided into two components: par value and additional paid in capital above par. Par value is the stated or face value a firm puts on each share of stock. Paid in capital is the additional amount the firm raised when it sold the shares.Copyright © 2011 Pearson Prentice Hall. All rights reserved. 3-22
  23. 23. The Balance Sheet (cont.)• For example, DLK corporation’s par value per share is $2.00 and the firm has 30 million shares outstanding such that the par value of the firm’s common equity is $60 million. If the stocks were issued to investors for $240 million, $180 million represents paid in capital.Copyright © 2011 Pearson Prentice Hall. All rights reserved. 3-23
  24. 24. The Balance Sheet (cont.)• (2) The amount of the firm’s retained earnings. Retained earnings are the portion of net income that has been retained (i.e. not paid in dividends) from prior years operations.• Thus stockholder’s equity = Par value of common stock + Paid in Capital + Retained EarningsCopyright © 2011 Pearson Prentice Hall. All rights reserved. 3-24
  25. 25. The Balance Sheet (cont.)• We can also express stockholders’ equity as follows: Shareholders equity = Total Assets – Total LiabilitiesCopyright © 2011 Pearson Prentice Hall. All rights reserved. 3-25
  26. 26. The Cash Flow Statement• The Cash Flow Statement is used by firms to explain changes in their cash balances over a period of time by identifying all of the sources and uses of cash.Copyright © 2011 Pearson Prentice Hall. All rights reserved. 3-26
  27. 27. Sources and Uses of Cash• Source of cash is any activity that brings cash into the firm. For example, sale of equipment.• Use of cash is any activity that causes cash to leave the firm. For example, payment of taxes.Copyright © 2011 Pearson Prentice Hall. All rights reserved. 3-27
  28. 28. Balance Sheet forH.J. Boswell, Inc.Copyright © 2011 Pearson Prentice Hall. All rights reserved. 3-28
  29. 29. Cash Flow Analysis• Why did the cash balance decline by $4.5 million from 2009 to 2010?1.Accounts receivable increased by $22.5 million representing an increase in uncollected cash from credit sales. Thus it represents $22.5m of use of cash to invest in accounts receivable.Copyright © 2011 Pearson Prentice Hall. All rights reserved. 3-29
  30. 30. Cash Flow Analysis (cont.)2. Inventory increased by $148.50 million indicating use of cash to procure inventory.3. Equipment increased by $175.50 million indicating use of cash to invest in equipment.In general, – an increase in an asset account = use of cash – a decrease in an asset account = source of cashCopyright © 2011 Pearson Prentice Hall. All rights reserved. 3-30
  31. 31. Cash Flow Analysis (cont.)4. Accounts Payable, credit extended to the firm, increased by $4.5million. Thus source of cash increased by $4.5million due to accounts payable.5. Long-term debt increased by $51.75 million indicating a source of cash.6. Short-term debt decreased by $9 million indicating use of cash to pay off the debt.Copyright © 2011 Pearson Prentice Hall. All rights reserved. 3-31
  32. 32. Cash Flow Analysis (cont.)7. Retained earnings increased by $159.75 million representing a source of cash to the firm from the firm’s operations.In general, – An increase in a liability account = source of cash – A decrease in a liability account = use of cashCopyright © 2011 Pearson Prentice Hall. All rights reserved. 3-32
  33. 33. Cash Flow Analysis (cont.)• Change in cash balance = Sources of cash – Use of Cash = $216 - $220.50 = -$4.50 Sources of Cash Uses of Cash Increase in Accounts Payable Increase in Accounts = $4.50 Receivable $22.50 Increase in long-term debt Increase in inventory = $148.50 =$51.75 Increase in retained earnings = Increase in net plant and $159.75 equipment = $40.50 Decrease in short-term notes = $9 Total Sources of cash = Total Uses of cash = $220.50 $216.00Copyright © 2011 Pearson Prentice Hall. All rights reserved. 3-33
  34. 34. Cash Flow Analysis Summary Sources of Cash Uses of CashDecrease in an asset Increase in an assetaccount accountIncrease in a liability Decrease in a liabilityaccount accountIncrease in an owner’s Decrease in an owners’equity account equity accountCopyright © 2011 Pearson Prentice Hall. All rights reserved. 3-34
  35. 35. Cash Flow Statement• The format for a traditional cash flow statement is as follows:Beginning Cash Balance Plus: Cash Flow from Operating Activities Plus: Cash Flow from Investing Activities Plus: Cash Flow from Financing Activities Equals: Ending Cash BalanceCopyright © 2011 Pearson Prentice Hall. All rights reserved. 3-35
  36. 36. Cash Flow Statement (cont.)• Operating activities represent the company’s core business including sales and expenses. Basically any activity that affects net income for the period.• Investing activities include the cash flows that arise out of the purchase and sale of long-term assets such as plant and equipment.Copyright © 2011 Pearson Prentice Hall. All rights reserved. 3-36
  37. 37. Cash Flow Statement (cont.)• Financing activities represent changes in the firm’s use of debt and equity such as issue of new shares, payment of dividends.Copyright © 2011 Pearson Prentice Hall. All rights reserved. 3-37
  38. 38. H.J. Boswell,Inc.Statement ofCash FlowsCopyright © 2011 Pearson Prentice Hall. All rights reserved. 3-38

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