CHAPTER 2 Financial Statements, Cash Flow, and Taxes

1
CHAPTER 2Financial Statements, Cash Flow, and
Taxes

• Balance sheet
• Income statement
• Statement of cash flows
• Accounting income vs. cash flow
• Federal tax system

2
Annual Report and Financial
Statements

• Information contained in the annual report is
  useful to investors in two major respects
• Analysis of past performance, and
• Form expectations about future performance

3
The Annual Report

• Balance sheet provides a snapshot of a firms
  financial position at one point in time.
• Income statement summarizes a firms revenues
  and expenses over a given period of time.
• Statement of retained earnings shows how much
  of the firms earnings were retained, rather than
  paid out as dividends.
• Statement of cash flows reports the impact of a
  firms activities on cash flows over a given
  period of time.

4
Balance Sheet

• Balance Sheet indicates the firms financial
  position at a specific point in time.
• Left-hand side Assets
• Listed in order of liquidity
• Right-hand side Liabilities and Equity
• Listed in order in which they must be paid

5
Balance Sheet Assets

• Cash
• A/R
• Inventories
• Total CA
• Gross FA
• Less Dep.
• Net FA
• Total Assets

6
Balance sheet Liabilities and Equity

• Accts payable
• Notes payable
• Accruals
• Total CL
• Long-term debt
• Common stock
• Retained earnings
• Total Equity
• Total L E

7
Income Statement

• Income statement shows the financial performance
  of the firm during a period of time.
• It is a summary of firms revenues and expenses
  over an accounting period.

8
Income statement

• Sales
• COGS
• Other expenses
• EBITDA
• Depr. Amort.
• EBIT
• Interest Exp.
• EBT
• Taxes
• Net income

2002 6,034,000 5,528,000
519,988 (13,988) 116,960 (130,948)
136,012 (266,960) (106,784) (160,176)
2001 3,432,000 2,864,000 358,672 209,328
18,900 190,428 43,828 146,600 58,640
87,960
9
Statement of Retained Earnings (2002)
203,768 (160,176) (11,000) 32,592

• Balance of retained
• earnings, 12/31/01
• Add Net income, 2002
• Less Dividends paid
• Balance of retained
• earnings, 12/31/02

10
Statement of Cash Flows

• A statement reporting the impact of a firms
  operating, investing, and financing activities on
  cash flows over an accounting period.
• It summarizes the changes in the firms cash
  position during an accounting period.
• Operating Activities
• Net Income
• Depreciation and amortization
• Decrease in current assets
• Increase in current liabilities
• - Increase in current assets
• - Decrease in current liabilities

11
Statement of Cash Flows

• Investing Activities
• Inflows
• Sales of fixed assets
• Sale of debt or equity securities of other
  entities
• Collecting on loans (principal)
• Outflows
• Acquisition of fixed assets
• Purchase of debt or equity securities of other
• entities
• Lending money (principal)
• Financing Activities
• Inflows
• Proceeds from borrowing
• Proceeds from issuing equity securities
• Outflows
• Repaying of debt (principal)
• Repurchase of firms own shares
• Payment of dividends

12
Statement of Cash Flows (2002)

• OPERATING ACTIVITIES
• Net income
• Add (Sources of cash)
• Depreciation
• Increase in A/P
• Increase in accruals
• Subtract (Uses of cash)
• Increase in A/R
• Increase in inventories
• Net cash provided by ops.

(160,176) 116,960 378,560 353,600 (280,960) (57
2,160) (164,176)
13
Statement of Cash Flows (2002)
(711,950) 436,808 400,000 (11,000) 825,808 (
50,318) 57,600 7,282

• L-T INVESTING ACTIVITIES
• Investment in fixed assets
• FINANCING ACTIVITIES
• Increase in notes payable
• Increase in long-term debt
• Payment of cash dividend
• Net cash from financing
• NET CHANGE IN CASH
• Plus Cash at beginning of year
• Cash at end of year

14
Net Cash Flow

• Net Cash Flow (NCF) is actual net cash generated
  by the firm during a specified period.
• NCF differs from Net Income or the Accounting
  Profit.
• Accounting Profit is calculated on accrual
  basis (revenues earned and expenses incurred)
  rather than on cash basis (revenues received
  and expenses paid).

15
Net cash flow

• NCF02 NI Dep
• (160,176) 116,960
• -43,216
• NCF01 87,960 18,900 106,860

16
Corporate and Personal Taxes

• Both have a progressive structure (the higher the
  income, the higher the marginal tax rate).
• Corporations
• Rates begin at 15 and rise to 35 for
  corporations with income over 10 million.
• Also subject to state tax (around 5).
• Individuals
• Rates begin at 10 and rise to 38.6 for
  individuals with income over 307,050.
• May be subject to state tax.

17
Tax treatment of various uses and sources of funds

• Interest paid tax deductible for corporations
  (paid out of pre-tax income), but usually not for
  individuals (interest on home loans being the
  exception).
• Interest earned usually fully taxable (an
  exception being interest from a (muni).
• Dividends paid paid out of after-tax income.
• Dividends received taxed as ordinary income for
  individuals (double taxation). A portion of
  dividends received by corporations is tax
  excludable, in order to avoid triple taxation.

18
More tax issues

• Tax Loss Carry-Back and Carry-Forward since
  corporate incomes can fluctuate widely, the tax
  code allows firms to carry losses back to offset
  profits in previous years or forward to offset
  profits in the future.
• Capital gains defined as the profits from the
  sale of assets not normally transacted in the
  normal course of business, capital gains for
  individuals are generally taxed as ordinary
  income if held for less than a year, and at the
  capital gains rate if held for more than a year.
  Corporations face somewhat different rules.