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Notes - Chapter 3 - Financial Statements

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23 views6 pages

Notes - Chapter 3 - Financial Statements

Uploaded by

Ms. Smith
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Chapter 3

Financial Statements

There are two types of assets:


Real assets
• Real assets include plant and equipment, land etc.
• It is these assets that make money for a firm.
Financial assets
• Financial assets are just sheets of paper that determine how the profits of a firm are
distributed among the beneficiaries of the firm.
• They include bonds, stocks, preferred stocks etc.

What are financial statements?


• They are merely pieces of papers with numbers written on them. These numbers
represent the real assets that underlie these numbers.
• Corporations also use these financial statements to convey their financial health to
their stockholders. Annual reports are one of them and they are also probably most
important.

Most prominent consolidation of financial statements: an annual report


• Verbal letter from the chairperson
• Balance sheet
• Income statement
• The statement of retained earnings
• Statement of cash flows

The balance sheet: Use the table on page 39


Things to remember:
• Cash vs. other assets
• Liabilities vs. owners’ equity – both are claims against assets
• Preferred vs. common stock
• Breakdown of common equity accounts
• Inventory accounting
• Depreciation methods
• The time dimension

Distinction between net income and net cash flows


Net cash flow = net income - non cash revenues + non cash charges
Usually net cash flows = net income + depreciation

Factors that affect the statement of cash flows:


Net cash flows are actually the cash flows generated in by the business in a given year.
Factors:
• More cash inflows is directly proportional to more cash in the bank
• Changes in working capital: Current assets-current liabilities = NWC.
➢  In current assets  cash inflows (inventories and accounts receivable)
➢  In current liabilities  cash inflows (payable)
• Fixed assets
• Security transactions (issuing of new securities)

The cash flow statement summarizes the companies


• Operating Activities
• Investing activities
• Financing activities

Modifying accounting data for Managerial decisions:


Managerial performance can be assessed through operating income and operating assets.
Assets can be tangible or intangible
Among tangible assts they can be operating or non operating
Current assets used in operations are known as net-operating working capital ( NOWC)
NOWC = current assets- current liabilities
Total operating capital = NOWC + Net fixed assets
Net operating profit after taxes (NOPAT) = EBIT (1-t)
Operating cash flow = NOPAT+ depreciation and amortization
Free cash flow = Operating cash flow - Investment in operating capital
Accounting numbers and data provide some useful information but accounting has
its own limitations. Some additional financial measures are:

Market value Added (MVA):


MVA = Market value of the equity- equity capital supplied by the investors
MVA = Stock price * no of shares outstanding - total common equity
Coke in 1995
69-8 =61
In contrast GM
69-87= -18

Economic Value Added:


EVA = after tax operating profit - after tax cost of capital (in dollars)
EVA = EBIT (1-corporate tax rate) - (Total capital)(after tax cost of capital)

EVA is different from the profits because it imposes a charge on the equity capital. You
can kind of imagine this to be an opportunity cost of funds. This is used to determine
executive compensation packages for the top management in the company and soon.
Income Taxes:
Individual income taxes:
Individuals pay taxes on wages and salaries and investment income and on profits from
proprietorship and partnership. Good feature about taxes: They are progressive.
• Taxable income: Gross income less a set of exemptions and deductions.
• Marginal tax rate: tax rate on the last unit of income.
• Remember that average tax rate is different from marginal tax rate
• Short term (less than one year) same as ordinary income but long term has a cap of
20%

Income Taxes for corporations:


• A tax return must be filed and the taxes paid by the corporation
• Taxable income is income less allowable exclusions and tax deductible expenses
• 70% of any dividends received from another corporation are tax exempt
• Dividend payments are not tax deductible
• Corporate capital gains are taxed the same as their operating income.
• If firm’s income originates in a foreign country, the tax rates and methods may vary.
• Net operating loss can be carried forward for 2 and 20 years
• Accumulated earnings tax is penalty surtax for discouraging corporations from
avoiding taxes.
• Consolidated corporate tax returns: if a firm owns 80% or more of another firm, they
can file together as one consolidated firm. The other rules apply as if they are one
entity.

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