PowerPoint PresentationKey Concepts and SkillsChapter Outline2.1 The Balance SheetTake Notice! (on the following Balance Sheet)U.S. Composite Corporation Balance Sheet (in $ millions)Balance Sheet AnalysisAccounting LiquidityDebt versus EquityValue versus Cost2.2 The Income StatementU.S.C.C. Income Statement 2014 (in $ Millions)Slide 13Slide 14Income Statement AnalysisGAAPNoncash ItemsTime and CostsCosts and Purpose2.3 TaxesMarginal versus Average Tax Rates2.4 Net Working CapitalU.S.C.C. Balance Sheet2.5 Financial Cash FlowU.S.C.C. Financial Cash FlowSlide 26Slide 27Slide 28Slide 29Slide 302.5 The Statement of Cash FlowsU.S.C.C. Cash Flow from Operating ActivitiesU.S.C.C. Cash Flow from Investing activitiesU.S.C.C. Cash Flow from Financing activitiesU.S.C.C. Statement of Cash FlowsQuick QuizSources of Information2-1FINANCIAL STATEMENTS AND CASH FLOWChapter 2Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.2-2KEY CONCEPTS AND SKILLS•Understand the information provided by financial statements•Differentiate between book and market values•Know the difference between average and marginal tax rates•Grasp the difference between accounting income and cash flow•Calculate a firm’s cash flow2-3CHAPTER OUTLINE2.1 The Balance Sheet2.2 The Income Statement2.3 Taxes2.4 Net Working Capital2.5 Financial Cash Flow2.6 The Accounting Statement of Cash Flows2-42.1 THE BALANCE SHEETAn accountant’s snapshot of the firm’s accounting value at a specific point in timeThe Balance Sheet Identity is:Assets ≡ Liabilities + Stockholders’ Equity2-5TAKE NOTICE!(ON THE FOLLOWING BALANCE SHEET)•Assets exactly equal liabilities + equity•Assets are listed in order of liquidity•The amount of time it would take to convert them to cash in an operating business•Obviously cash and A/R are more liquid than property plant and equipment.•Liabilities are listed in the order in which they come due2-6U.S. COMPOSITE CORPORATION BALANCE SHEET (IN $ MILLIONS)2-7BALANCE SHEET ANALYSIS•When analyzing a balance sheet, the Finance Manager should be aware of three concerns:1. Accounting liquidity2. Debt versus equity3. Value versus cost2-8ACCOUNTING LIQUIDITY •Refers to the ease and quickness with which assets can be converted to cash—without a significant loss in value•Current assets are the most liquid.•Some fixed assets are intangible.•The more liquid a firm’s assets, the less likely the firm is to experience problems meeting short-term obligations.•Liquid assets frequently have lower rates of return than fixed assets.2-9DEBT VERSUS EQUITY•Creditors generally receive the first claim on the firm’s cash flow.•Shareholders’ equity is the residual difference between assets and liabilities.•Debt and equity have different costs; the relationship between them has an impact on the firm’s profitability2-10VALUE VERSUS COST•Under Generally Accepted Accounting Principles (GAAP), financial statements of firms in the U.S. carry assets at historical 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.2-112.2 THE INCOME STATEMENT•Measures financial performance over a specific period of time•The accounting definition of income is:Revenue – Expenses ≡ Income2-12U.S.C.C. INCOME STATEMENT 2014(IN $ MILLIONS)Total operating revenuesCost of goods soldSelling, general, and administrative expensesDepreciationOperating incomeOther incomeEarnings before interest and taxesInterest expensePretax incomeTaxes Current: $71 Deferred: $13Net income Addition to retained earnings $43 Dividends: $43The operations section of the income statement reports the firm’s revenues and expenses from principal operations.$2,262 1,655 327 90$190 29$219 49$170 84$862-13U.S.C.C. INCOME STATEMENT 2014(IN $ MILLIONS)Total operating revenues $2,262Cost of goods sold 1,655Selling, general, and administrative expenses 327Depreciation 90Operating income $190Other income29Earnings before interest and taxes $219Interest expense 49Pretax income $170Taxes 84 Current: $71 Deferred: $13Net income $86 Addition to retained earnings: $43 Dividends: $43The non-operating section of the income statement includes all financing costs, such as interest expense.2-14U.S.C.C. INCOME STATEMENT 2014(IN $ MILLIONS)Total operating revenuesCost of goods soldSelling, general, and administrative expensesDepreciationOperating incomeOther incomeEarnings before interest and taxesInterest expensePretax incomeTaxes Current: $71 Deferred: $13Net income Retained earnings: $43 Dividends: $43Net income is the “bottom line.”$2,262 1,655 327 90$19029$219 49$170 84$862-15INCOME STATEMENT ANALYSIS•There are three things to keep in mind when analyzing an income statement:1. Generally Accepted Accounting Principles (GAAP)2. Noncash Items3. Time and Costs2-16GAAP•The matching principal of GAAP dictates that revenues be matched with expenses. •Thus, income and expenses are reported when earned or incurred, even though no cash flow may have occurred.2-17NONCASH ITEMS•Depreciation is the most apparent non-cash item. No firm ever writes a check for “depreciation”•Other noncash accounts include uncollected sales on account, unpaid purchases on account and deferred taxes, none of which represent a cash flowThus, net income does not equal cash flow2-18TIME AND COSTS•Think of the future as having two parts: short run and long run•In the short run some costs are fixed and others variable:•In the short run equipment and commitments are fixed.•Production can only be varied by altering labor and materials•In the long run all costs are variable2-19COSTS AND PURPOSE•Financial accountants do not distinguish between variable costs and fixed costs•Accounting costs are usually treated as period or product costs•Product Costs: Total production costs•i.e., raw materials, direct labor, manufacturing overhead•Period Costs: Costs allocated to a time period•i.e., selling, general and administrative costs•Such as accountant salaries, office supplies2-202-202.3 TAXES•Taxes impact income; important to financial decisions•Taxes come from various sources:•Federal, state,