Financial StatementsFinancial Statements

Income StatementsIncome Statements RevenuesRevenues Expenses (expired costs)Expenses (expired costs) Timing of recordingTiming of recording

at time of saleat time of sale

at time of useat time of use

fixed and variablefixed and variable Non Cash ItemsNon Cash Items

Financial Statements Financial Statements

Prepare an Income StatementPrepare an Income Statement RevenuesRevenues

Sales Sales CostsCosts

OperatingOperatingNon Cash (Depreciation)Non Cash (Depreciation)Interest (Finance Charge)Interest (Finance Charge)TaxesTaxes

Net IncomeNet IncomeThe bottom line…but we want cash flow!The bottom line…but we want cash flow!

Financial StatementsFinancial Statements

The Balance SheetThe Balance Sheet AssetsAssets LiabilitiesLiabilities Owner’s EquityOwner’s Equity Assets Assets ≡≡ Liabilities + Owner’s Equity Liabilities + Owner’s Equity

This is an identityThis is an identity

It always holds and is a check on the It always holds and is a check on the fundamental nature of who owns the fundamental nature of who owns the business (assets)business (assets)

Financial StatementsFinancial Statements

Portions of the Balance SheetPortions of the Balance Sheet

Net Working CapitalNet Working Capital Current AssetsCurrent Assets Current LiabilitiesCurrent Liabilities LiquidityLiquidity NWC = Current Assets - Current LiabilitiesNWC = Current Assets - Current Liabilities

Debt versus EquityDebt versus Equity fixed claimsfixed claims residual claimsresidual claims

Financial StatementsFinancial Statements

Market Value versus Book ValueMarket Value versus Book Value

Financial StatementsFinancial Statements

Build from Current Assets and ClaimsBuild from Current Assets and Claims Current Assets (In order of conversion to Current Assets (In order of conversion to

cash)cash) Long-term Assets Long-term Assets Current Liabilities (In order of anticipated Current Liabilities (In order of anticipated

payment of claim)payment of claim) Long-term LiabilitiesLong-term Liabilities Owner’s EquityOwner’s Equity Identity CheckIdentity Check

Assets = Liabilities + Owner’s EquityAssets = Liabilities + Owner’s Equity

Financial StatementsFinancial Statements

Cash FlowCash Flow the difference between accounting cash flow the difference between accounting cash flow

and financial cash flowand financial cash flow segments of cash flowsegments of cash flow

operationsoperations

capital spendingcapital spending

working capitalworking capital

shareholders/bondholdersshareholders/bondholders Importance of taxes and depreciationImportance of taxes and depreciation

Cash Flow From OperationsCash Flow From Operations

Textbook usesTextbook uses

Net Profit + Net Profit + DepreciationDepreciation

This is a special case This is a special case when you have no when you have no interest expenseinterest expense

This later is wrong if This later is wrong if you want to do Cash you want to do Cash Flow StatementsFlow Statements

Correct ApproachCorrect Approach

EBIT + Depreciation – EBIT + Depreciation – Taxes = Cash Flow Taxes = Cash Flow from Operationsfrom Operations

Then to get Cash Then to get Cash Flow Statement Flow Statement Correct you put Correct you put Interest Expense with Interest Expense with Cash Flow From Cash Flow From Financing ActivitiesFinancing Activities

Statement of Cash FlowsStatement of Cash Flows

Cash Flow Statement in three partsCash Flow Statement in three partsCash Flow from Operating Activities:Cash Flow from Operating Activities:

Cash Flow from Operations Cash Flow from Operations (EBIT + Depreciation – Taxes)(EBIT + Depreciation – Taxes)Changes in Net Working CapitalChanges in Net Working Capital

Cash Flow from Investing Activities:Cash Flow from Investing Activities:Net Change in Gross Fixed Assets (Purchases and Sales)Net Change in Gross Fixed Assets (Purchases and Sales)

Cash Flow from Financing ActivitiesCash Flow from Financing Activities::Net Change in Debt (Sales and Retirements)Net Change in Debt (Sales and Retirements)Net Change in Common Stock (Sales and Purchases)Net Change in Common Stock (Sales and Purchases)Net Change in Preferred Stock (Sales and Purchases)Net Change in Preferred Stock (Sales and Purchases)Dividends PaidDividends PaidInterest ExpenseInterest Expense

Depreciation and Salvage CFDepreciation and Salvage CF

Depreciation using MACRSDepreciation using MACRS Life of AssetLife of Asset Depreciation Schedule (page 89)Depreciation Schedule (page 89) Assumption: No Salvage ValueAssumption: No Salvage Value

Disposal of Asset – Cash FlowDisposal of Asset – Cash Flow Full Depreciated AssetFull Depreciated Asset Partially Depreciated AssetPartially Depreciated Asset Short-cut…book value or basis for gain/lossShort-cut…book value or basis for gain/loss

Financial StatementsFinancial Statements

TaxesTaxes Corporate TaxesCorporate Taxes Personal TaxesPersonal Taxes User TaxesUser Taxes Sales TaxesSales Taxes Property TaxesProperty Taxes

Average Tax versus Marginal TaxAverage Tax versus Marginal Tax tax total divided by taxable incometax total divided by taxable income tax on the next dollar of earningstax on the next dollar of earnings