Chapte r2 Financial Statements and Cash Flow 2 1 McGraw Hill Irwin Copyright 2013 by The McGraw Hill Companies Inc All rights reserved Chapter Outline The Balance Sheet The Income Statement Cash Flow 2 2 Balance Sheet of a Corporation Classification Assets Current Assets Liabilities and Equity Current liabilities Cash Payables Inventories expenses Fixed assets Property plant and equipment Intangible assets Other assets Long term debt Stockholders equity Stock Retained earnings Balance Sheet The most important relationship you can bring to this class from your accounting is the formula of the Balance Sheet Identity Total Assets Total Liabilities Stockholders Equity 2 4 Net Working Capital NWC Current Assets Current Liabilities Positive when the cash that will be received over the next 12 months exceeds the cash that will be paid out Usually positive in a financially healthy firm 2 5 US Corporation Balance Sheet Table 2 1 Place Table 2 1 US Corp Balance Sheet here 2 6 Balance Sheet Analysis When analyzing a balance sheet the Finance Manager should be aware of three concerns Liquidity Refers to the ease and quickness with which assets can be converted to cash without a significant loss in value Debt versus equity Creditors generally receive the first claim on the firm s cash flow Shareholder s equity assets liabilities Value versus cost Market value is the price at which the assets liabilities and equity could actually be bought or sold which is a completely different concept from historical cost Market Value 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 2 8 The Income Statement Measures financial performance over a specific period of time The accounting definition of income is Revenue Expenses Income US Corporation Income Statement Table 2 2 2 10 Income Statement Analysis When analyzing an income statement keep in mind 1 Generally Accepted Accounting Principles GAAP revenues be matched with expenses Thus income is reported when it is earned even though no cash flow may have occurred 2 Non Cash Items No firm ever writes a check for depreciation Time and Costs Short vs long run In the short run certain equipment resources and commitments of the firm are fixed but the firm can vary such inputs as labor and raw materials In the long run all inputs of production and hence costs are variable Financial accountants do not distinguish between variable costs and Financial Cash Flow The cash flow statement is concerned with the flow of cash in and cash out of the business shows how changes in balance sheet accounts and income affect cash The actual cash flow of the firm is the most important item in a financial statements The cash flow received from the firm s assets A must equal the cash flows to the firm s creditors B and stockholders Financial Cash Flow Cash flow from assets consists of Operating cash flows EBIT taxes Depreciation Where taxes EBT tax rate Capital spending ending net fixed assets beginning net fixed assets Dep n Financial Cash Flow Cash flows to Bondholders Net Interest in Debt Cash flows to stockholders dividends net new equity Cash Flow From Assets Operating Cash Flows Cash Flows to B H EBIT Taxes Net Interest Depreciation Net new Debt Capital Spending Cash Flows to S H Additions to NWC Dividends Net new equity The Concept of Cash Flow Cash flow is one of the most important pieces of information that a financial manager can derive from financial statements 2 17 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 Cash Flow Summary Table 2 6 2 18 Cash Flow From Assets Cash Flow From Assets CFFA Cash Flow to Creditors Cash Flow to Stockholders CFFA CF to creditors CF to Stockholders 2 19 Example of CCFA Part I CF to Creditors interest paid net new borrowing 24 CF to Stockholders dividends paid net new equity raised 63 CFFA CF to creditors CF to Stockholders 2 20 Cash Flow From Assets Cash Flow From Assets Operating Cash Flow Net Capital Spending Changes in NWC CFFA OCF NCS NWC 2 21 Example of CCFA Part II OCF EBIT depreciation taxes 547 NCS ending net fixed assets beginning net fixed assets depreciation 130 Changes in NWC ending NWC beginning NWC 330 CFFA OCF NCS NWC 2 22 CFFA 547 130 330 87 The Big Picture Problem Balance Sheet and Income Statement Information 2 23 Current Accounts 2009 CA 3625 CL 1787 2008 CA 3596 CL 2140 Fixed Assets and Depreciation 2009 NFA 2194 2008 NFA 2261 Depreciation Expense 500 Long term Debt and Equity 2009 LTD 538 Common stock APIC 462 2008 LTD 581 Common stock APIC 372 Income Statement EBIT 1014 Taxes 368 Interest Expense 93 Dividends Task use the information on the previous slide to compute the following 1 OCF 2 NCS 3 Changes in NWC 4 CFFA 5 CF to Creditors 6 CF to Stockholders 7 CFFA 8 Does the CF identity hold 2 24 Cash Flow Problem Answers OCF 1 014 500 368 1 146 NCS 2 194 2 261 500 433 Changes in NWC 3 625 1 787 2 25 3 596 2 140 382 CFFA 1 146 433 382 331 CF to Creditors 93 538 581 136 CF to Stockholders 285 462 372 195 CFFA 136 195 331 The CF identity holds Comprehensive Problem Current Accounts 2009 CA 4 400 CL 1 500 2008 CA 3 500 CL 1 200 Fixed Assets and Depreciation 2009 NFA 3 400 2008 NFA 3 100 Depreciation Expense 400 Long term Debt and Equity R E not given 2009 LTD 4 000 Common stock APIC 400 2008 LTD 3 950 Common stock APIC 400 Income Statement EBIT 2 000 Taxes 300 Interest Expense 350 Dividends 500 Task Compute the CFFA 2 26