Financial Statement and

Cash Flow Analysis

Chapter 2
Prepared by Dr. IKRAM UL HAQ
CHOUDHARY CPA, PhD
2009 Cengage Learning/SouthWestern

Financial Statements
Accrualbased
approach
Cash flow
approach

Revenues are recorded at the point

of sale and costs when they are
incurred, not necessarily when a
firm receives or pays out cash.
Used by financial professionals to
focus attention on current and
prospective inflows and outflows of
cash.

Financial Statements
Balance Sheet

Income Statement

Financial
Statemen
ts

Statement of
Retained Earnings
Statement of
Cash Flows

Notes to
Financial Statements

Balance Sheet
A firms balance sheet presents a
snapshot view of the companys financial
position at a specific point in time.

assets = liabilities + stockholders equity

Balance Sheet for Global Petroleum

Corporation

Income Statement
Income is also called profit, earnings, or margin.

Income = revenue expenses

Measures of
Income

Gross profit
Operating profit
Other income
Earnings before interest and taxes
Pretax income
Net income / net profit after taxes

Income Statement for Global Petroleum

Corporation

Statement of Retained Earnings

The statement of retained earnings
reconciles
the net income earned during a given
year, and any cash dividends paid,
with the change in retained earnings
between the start and end of that year.

Statement of Retained Earnings

for Global Petroleum Corporation

Financial Statements
Statement
of Cash
Flows

Notes to
Financial
Statements

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Reconciles
the firms operating, investment,
and financing cash flows
with changes in its cash and
marketable securities
during the year.

Explanatory notes
that provide detailed information
on the accounting policies,
calculations, and transactions
underlying entries in the
financial statements.

Cash Flow Analysis

Although financial managers are
interested in the information contained in
the firms accrual-based financial
statements, their primary focus is on cash
flows.
Without adequate cash to pay obligations
on time, to fund operations and growth,
and to compensate owners, the firm will
fail.
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The Firms Cash Flows

12

Free Cash Flow

Operating cash flow
= earnings before interest and taxes
taxes
+ depreciation
Free cash flow
= operating cash flow
change in gross fixed assets
change in current assets
+ change in account payables
+ change in accrued liabilities
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Inflows and Outflows of Cash

14

Statement of Cash Flows

for Global Petroleum Corporation

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Analyzing Financial Performance

Using Ratio Analysis
Liquidity
Ratios
Activity
Ratios

16

Measure a firms ability to satisfy its shortterm obligations as they come due.

Measure the speed at which a firm

converts various accounts into sales
or cash.

Debt Ratios

Measure the proportion of total assets

financed by a firms creditors.

Profitability
Ratios

Relate a firms earnings to its sales,

assets, or equity.

Market
Ratios

Relate a firms market value to

certain accounting values.

Using Financial Ratios

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Benchmar
k1

Analysts compare the current years

financial ratios with previous years ratios
to identify trends that help them evaluate
the firms prospects.

Benchmar
k2

Analysts compare the ratios of one

company with those of other firms in
the same industry.

Liquidity Ratios

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Activity Ratios

19

Debt Ratios

20

Profitability Ratios

21

Profitability Ratios

22

Profitability Ratios
DuPont System of Analysis

23

Market Ratios

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Corporate Taxes
Corporate taxes represent a significant cash
outflow.

Ordinary
corporate
income

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Corporate
capital
gains

Progressive tax rate schedule

Average tax rate: tax divided
by the pretax income
More relevant for financial
decision making: marginal tax
rate
Under existing tax laws,
ordinary income tax rates
apply

Financial Statement and Cash Flow

Analysis
Balance Sheet
Income Statement
Cash Flow Analysis
Liquidity Ratios
Activity Ratios
Debt Ratios
Profitability Ratios
Market Ratios
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