FIN 365 Business Finance

Topic 3: Financial Statements,

Cash Flow, and Taxes
Larry Schrenk, Instructor

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Todays Outline
1. Project and CengageNOW
2. Financial Statements

Balance Sheet
Income Statement
Statement of Cash Flows

3. Free Cash Flow

4. Taxes
.Website: EDGAR
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1. Course Project
Financial Statements
Download your Firm's
Most Recent 10Q from
EDGAR
Extract
i.
ii.

Quarterly Income
Statement
Balance Sheet

Put these on one Excel

Worksheet like
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EDGAR 1
Click on Interactive Data

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EDGAR 2
Click on View Excel Document

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CengageNOW Hints
Check Precision Requested
11.20 11.2

Rounding (1.10 1.09, 1.11)

Review Similar EoC Problem
EoC Problem Solutions in Blackboard

Do the Problem Using Excel

Email me with
Details of the Specific Problem
All of your Calculations
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2. Financial Statements

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Three Financial
Statements
1. Income Statement
2. Balance Sheet

Flow
Stock

3. Statement of Cash Flows Flow

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Stock versus Flow

Statements
Stock Statements
Value at One Point in Time
Snapshot
Time Unit: One Date
Example: Volume of Water in a Lake on a Specific
Date

Flow Statements
Value over a Period of Time
Time Unit: Quarter, Year
Example: Flow/Increase of Water into a Lake over
some Period of Time
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Annualization
Data: Annual Assumption. We assume
annualization. Remember interest.
Annualizing
Annual Equivalent of Non-Annual
Quarterly x4, Semi-Annual x2

WARNING: Only Annualize Flow

Statements! Income statement and cash
flow statements.
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Balance Sheet
Accounting Value at a Specific Point
in Time. Stock statement.
Identity:
Assets = Liabilities + Equity
or better

Equity = Assets Liabilities

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Balance Sheet Analysis

Assets (LHS)
Firm Value
Allocation of
Investments
Organized by
Receivable Liquidity
Assets Portfolio
Cash Equivalents:
Treasury securities,
investments highly
liquid!
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Liabilities (RHS)
Claims on Firm Value.
Claims on the firms
value as a whole, not
specific assets.
Allocation of Securities
Issued
Organized by Payable
Liquidity. Current vs.
non current
Claims Portfolio
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Balance Sheet Issues

A. Accounting Liquidity
B. Debt versus Equity
C. Market Value versus Historical
Cost

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A. Accounting Liquidity
Liquidity
Time in which Assets can be Converted to
Cashwithout a Significant Loss in Value.
Without a significant loss in value : fair
market value. Not sell 10000 dollar
factory for 100 dollars for example

Liquidity Risk-Return Trade-Off. The

less liquid the more return.
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Accounting Liquidity
Time Horizons for liquidity (turning into
cash)
Cash and Cash Equivalents??? Instantly
Accounts Receivable??? Needs a ratio. Turnover
ratio. Accounts receivable or Inventory Turnover.
Roughly between a year but with ratios more
specific
Inventory???

Working Capital. Current assets

current liabilities.
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B. Debt versus Equity

Equity holders also called Residual
Claimants. Get the money thats left over
after everything else is payed of (interest)
THINK OF FINANCIAL STATEMETNS.
Retained earnings.
Solvent Cash Flows
Bankruptcy (AbsolutePriorityRule)

Two Concerns
Total Amount of Debt
Ability to Service Debt
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C. Value versus Cost

Market Value versus Historical
Cost.
Non-Real Cash Flows. No transfer
of cash
Goodwill. The extra between
market value and historical cost
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T-P-S
What is the effect on the level of
current assets of collecting more
accounts receivable?
1.
2.
3.
4.
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Increases
Decreases
Stays the Same
Cannot Determine
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Income Statement
Measures financial performance
over a specific period of time.
Accounting Definition of Income:
Income = Revenue Cost
Organization: Levels of Earnings
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Income Statement Organization

Sales
Variable Costs
Gross Costs
Fixed Costs
EBIT
Interest
EBT
Taxes
Net Income
Dividends
Additions to Retained
Earnings
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Earnings
From Unit Production
From Total Production
After Financing Included
After Taxes Included
Retained by the Firm
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Income Statement Issues

A. Non-Cash Items
B. Annualization (above)

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A. GAAP & B. Non-Cash

Items
A. GAAP
Accrual Accounting Principle
Match Revenue with Expenses
Not Real Cash Flows

B. Non-Cash Items
Depreciation. Not a cash flow.
Differed Taxes
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T-P-S
How do changes in the balance
sheet alter the income statement?
Mainly through changes in
1.
2.
3.
4.

Current Assets
Current Liabilities
Debt
Equity

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3. Statement of Cash
Flows
Measures Generation of Cash over
a Specific Period of Time
Real Cash Flows (Almost)

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Cash Flow Organization

Sources (+)/Uses (-) of Cash
LHS
Short Term Investments (Operations)
Long Term Investments
RHS
Financing
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3. Free Cash Flow

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Free Cash Flow (FCF)

Cash Flow Potentially Payable to
Investors
Not Covered by GAAP

Contrast with Other Measures

Net Income
Dividends + Interest Payments
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Free Cash Flow (FCF)

Pro: Best Measurement of
Earnings.
Con: Possibly Subjective
Contrast with Income Statement

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Calculating Free Cash

Flows
EBIT. Income before interest
Taxes
+ Depreciation (not real cash flow)
Capital Expenditures
Working Capital
= Free Cash Flow (FCF). How much the
firm could pay out to investors. Amount
available to investors.
NOTE: , i.e., delta means change in
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FCF Example
A firm records an EBIT of $1,000 and its corporate
tax rate is 30%. Depreciation for this period is
$400, the firm has increased capital appreciation
by $200 and working capital by $50.
FCF Calculation
$1,000
-300
+400
-50
-200
$850
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EBIT
Taxes
Depreciation
Working Capital
Capital Appreciation
FCF
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4. Taxes

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Tax Issues
Corporate versus Personal
Double Taxation. Dividends and retained
earnings are taxed

Debt-Equity Asymmetry. Debt payments

are expensable , dividends are not.
Tax Shields: money through debt.
Anything that lowers your taxes because
it covers it like depreciation
Carry-Forward/Carry-Back
Expenses and Depreciation
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Tax Rates
Corporate
Progressive. The more income, the higher the
tax
Uniform Rate (Generally)

Personal
Progressive
Multiple Rates Possible
Dividends
Interest Payments
Capital Gains
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Marginal versus Average

Tax
Average Tax: Tax Payment/EBT
Marginal Tax: Tax Paid on next $1
Earned.
Incremental

When to Use Each

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Example
Current Tax Schedule
10% up to $100,000
20% over $100,000

Current Taxes on $500,000 income

10% of $100,000 = $10,000
20% of $400,000 = $80,000
Total $90,000

Average Tax Rate = $90,000/$500,000 = 18%

Marginal Tax Rate = 20%
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