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Financial Statements, Cash Flows, Taxes, and the Language of Finance
1.
Chapter Two Financial
Statements, Cash Flows, Taxes, and the Language of Finance Principles of Managerial Finance First Canadian Edition Lawrence J. Gitman and Sean Hennessey © 2004 Pearson 2-1
2.
Learning Goals LG1
– Review characteristics, format, key components, and relationships between Income Statement, Balance Sheet, Statement of Retained Earnings, and Statement of Cash Flows. LG2 – Analyze a firm’s cash flows; develop and interpret the statement of cash flows. © 2004 Pearson 2-2
3.
Learning Goals (continued)
LG3 – Introduce basics of corporate taxation in Canada. LG4 – Understand tax deductibility of expenses, how they reduce actual, after-tax costs to a profitable company. LG5 – Discuss and illustrate Capital Cost Allowance (CCA), the tax version of amortization, and how CCA increases cash flows. © 2004 Pearson 2-3
4.
Learning Goals (continued)
LG6 – Review the information provided in a publicly traded company’s annual report to shareholders. LG7 – Discuss some key concepts in finance and review the language of finance. © 2004 Pearson 2-4
5.
Four Principal Financial
Statements Developed by the Canadian Institute of Chartered Accountants: 1. Income Statement 2. Balance Sheet 3. Statement of Retained Earnings 4. Statement of Cash Flows © 2004 Pearson 2-5
6.
Income Statement •
Provides financial summary of operating results for a specified period. • Main operating results consist of: – Sales revenues, Cost of goods sold, Operating expenses, Interest expenses, Taxes, and Preferred share dividends. © 2004 Pearson 2-6
7.
Income Statement (continued)
• Important sub-totals of these operating results are: – Gross margin. – Operating earnings (EBIT). – Earnings before taxes (EBT). – Net Income after taxes (NIAT). – Earnings available for common shareholders (EAC). © 2004 Pearson 2-7
8.
Balance Sheet •
Presents summary of firm’s financial position at a given point in time. • Assets = Liabilities + Equity. • In the short term, working capital management focuses on current assets and current liabilities. © 2004 Pearson 2-8
9.
Balance Sheet (continued)
• Current Assets: – Cash, Marketable securities, Accounts receivable, Inventories • Gross Fixed Assets: – Land & Buildings, Machinery & equipment, Furniture, Vehicles, Others • Less: Accumulated amortization • Current Liabilities: – Accounts payable, Line of credit, Accruals • Long-term debt • Shareholder’s equity: – Preferred shares, Common shares, Retained earnings © 2004 Pearson 2-9
10.
Statement of Retained
Earnings • Details changes in Retained Earnings from the beginning to the end of the fiscal year. Retained Earning Balance (start of year) Plus: Net Income After Taxes Less: Cash Dividends Paid Retained Earning Balance (end of year) © 2004 Pearson 2-10
11.
Statement of Cash
Flows • Provides summary of all inflows and outflows of cash over the same period as the Balance Sheet. • Provides insights into the firm’s operating, investment, and financing cash flows. • Reconciles changes in cash and marketable securities. © 2004 Pearson 2-11
12.
The Firm’s Cash
Flows Operating Flows: • Payments: – Accruals, Credit purchases, Taxes, Overhead expenses • Receipts: – Cash sales, Collection of credit sales, Tax refunds Investment Flows: • Purchases & Sales: – Fixed assets, Business interests Financing Flows: • Increases in Debt or Equity • Reductions in Debt or Equity © 2004 Pearson 2-12
13.
Figure 2.2 Cash
Flows © 2004 Pearson 2-13
14.
Inflows vs. Outflows
1. Decrease in any asset. 2. Increase in any liability. 3. Net income after taxes. 4. Amortization and other non-cash expenses. 5. Sale of shares. 1. Increase in any asset. 2. Decrease in any liability. 3. Net loss. 4. Dividends paid. 5. Repurchase or retirement of shares. © 2004 Pearson 2-14
15.
Developing Cash Flow
Statement 1. Cash and marketable securities (start of year). 2. Calculate net cash from operations. 3. Determine total changes in non-cash working capital accounts. 4. Determine cash flows from investing activities. 5. Determine cash flows from financing activities. 6. Determine change in cash and marketable securities (end of year). © 2004 Pearson 2-15
16.
Taxation of Business
Income • Corporations can earn four types of income: – Active Business Income – Passive Income – Intercorporate Dividends – Capital Gains • Types of Corporations for tax purposes: – Non-Manufacturing – Manufacturing or Processing – Canadian-controlled private corporation (CCPC) © 2004 Pearson 2-16
17.
Deductions from Federal
Tax Rate • Federal Corporate Tax for general Non- Manufacturing is 29.12%. • Manufacturing and processing deduction (Federal Tax of 22.12% of earnings). • Small business deduction (Federal Tax of 13.12% on earnings up to $200,000). • CCPC rate reduction (Federal Tax of 22.12% on earnings between $200,000 and $300,000). © 2004 Pearson 2-17
18.
Tax-Deductible Expenses •
There are two main categories of deductible expenses for all types of Canadian Corporation: – Operating Expenses – Interest Expenses © 2004 Pearson 2-18
19.
CCA-Capital Cost Allowance
• Canadian Customs and Revenue Agency (CCRA) requires companies to use their schedule of Capital Cost Allowance (CCA) as a means of amortizing expenses of capital equipment for tax purposes. • Like the concept of amortization, CCA is a non-cash expense item that is deductible for tax purposes. © 2004 Pearson 2-19
20.
Company Annual Report
• Required for all publicly traded firms • Letter to Shareholders • Management’s Discussion and Analysis • Financial Statements: – Income statement, Balance Sheet, Statement of retained earnings, Statement of cash flows • Summary © 2004 Pearson 2-20
21.
Language of Finance
• Basic accounting • Financial forecasting • Financial markets • Cost of capital • Capital budgeting © 2004 Pearson 2-21
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