Financial Statements, Taxes, and
Cash Flow
Chapter 2
FIN311 – Financial Management
Instructor: Lin Tan
McGraw-Hill/Irwin
McGraw-Hill © 2004 The McGraw-Hill Companies, Inc. All rights reserved.
Key Concepts and Skills
Know the difference between book value and
market value
Know the difference between accounting income
and cash flow
Know the difference between average and
marginal tax rates
Know how to determine a firm’s cash flow from
its financial statements
2.2
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Chapter Outline
The Balance Sheet
The Income Statement
Taxes
Cash Flow
2.3
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The 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
2.4
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Figure 2.1
2.5
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US Corporation Balance Sheet –
Table 2.1
2.6
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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
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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
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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 say to show
revenue when it accrues and match the expenses
required to generate the revenue
2.9
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Table 2.2
2.10
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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
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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
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Example: Marginal Vs. Average
Rates
Suppose your firm earns $150,000 in taxable
income.
What is the firm’s tax liability?
What is the average tax rate?
What is the marginal tax rate?
2.13
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Example: Average and Marginal Tax
Rate
Example: Suppose taxable income is $150,000. What are the
average tax rate and the marginal tax rate?
.15(50,000) = 7,500
.25(25,000) = 6,250
.34(25,000) = 8,500
.39(50,000) = 19,500
Total 41,750
Average tax rate = 41,750 / 150,000 = 27.8%
Marginal tax rate = 39%
2.14
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The Concept of Cash Flow
Cash flow is the differnce between the number of
dollars that came in and the number that went out. It
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
2.15
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Table 2.5
2.16
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Example: US Corporation
OCF (I/S)—operating cash flow
= EBIT + depreciation – taxes
= 694 + 65 - 212
= $547 --- (1)
NCS ( B/S and I/S) –net capital spending
= ending net fixed assets – beginning net fixed assets + depreciation
= 1709 – 1644 + 65
= $130 ---(2)
Changes in NWC (B/S) –net working capital
= ending NWC – beginning NWC
= (1403 - 389) – (1112 - 428)
= $330 ---(3)
CFFA – cash flow from assets
= OCF – NCS - change in NWC
= (1) – (2) –(3)
= 547 – 130 – 330
= $87
CF to Creditors (B/S and I/S) = 70 – (454- 408) interest paid – net new borrowing = $24
CF to Stockholders (B/S and I/S) = dividends paid – net new equity raised = 103 –(640-600) =$63
CFFA = 24 + 63 = $87
2.17
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