1. FINANCIAL STATEMENTS

2. Accounting and Finance
The Balance Sheet
The Income Statement
The Statement of Cash Flows
Accounting Practice & Malpractice
Taxes
Financial Statements reflect the financial resuts of the firm.

3. (from an accounting perspective).
The Balance Sheet
Definition
Financial statements that show the value of the firm’s assets and liabilities at a particular point in time
(from an accounting perspective). 3

4. The Main Balance Sheet Items
The Balance Sheet
The Main Balance Sheet Items
Current Assets
Cash & Securities
Receivables
Inventories +
Fixed Assets
Tangible Assets
Intangible Assets
Current Liabilities
Payables
Short-term Debt +
Long-term Liabilities
Shareholders’ Equity = 5

5. Market Value vs. Book Value
Book Values are determined by GAAP
Market Values are determined by current values
Equity and Asset “Market Values” are usually higher than their “Book Values” 6

6. Market Value vs. Book Value
Example
According to GAAP, your firm has equity worth $6 billion, debt worth $4 billion, assets worth $10 billion. The market values your firm’s 100 million shares at $75 per share and the debt at $4 billion.
Q: What is the market value of your assets?
A: Since (Assets=Liabilities + Equity), your assets must have a market value of $11.5 billion. 8

7. Market Value vs. Book Value
Example (continued)
Book Value Balance Sheet
Assets = $10 bil Debt = $4 bil
Equity = $6 bil
Market Value Balance Sheet
Assets = $11.5 bil Debt = $4 bil
Equity = $7.5 bil 10

8. (from an accounting perspective).
The Income Statement
Definition
Financial statement that shows the revenues, expenses, and net income of a firm over a period of time
(from an accounting perspective). 11

9. Earnings Before Income & Taxes (EBIT)
The Income Statement
Earnings Before Income & Taxes (EBIT)
EBIT =
Total Revenues - COGS - DEPRECATION 12

10. Pepsico Income Statement (year end 2001)
The Income Statement
Pepsico Income Statement (year end 2001)
Net Sales ,935
(-) Cost of Goods Sold (10,754)
Gross Profit ,181
(-) Selling, G&A expenses (10,918)
(-) Depreciation expense (1,082)
EBIT ,181
(-) Net interest expense (152)
Taxable Income ,029
(-) Income Taxes (1,367)
Net Income ,662 13

11. Profits vs. Cash Flows Differences
“Profits” subtract depreciation (a non-cash expense)
“Profits” ignore cash expenditures on new capital (the expense is capitalized)
“Profits” record income and expenses at the time of sales, not when the cash exchanges actually occur
“Profits” do not consider changes in working capital 14

12. The Statement of Cash Flows
Definition
Financial statement that shows the firm’s cash receipts and cash payments over a period of time. 15

13. The Statement of Cash Flows
Pepsico Statement of Cash Flows
(excerpt - year end 2001)
Net Income 2,662
Non-cash expenses
Depreciation 1,082
Changes in working capital (41)
A/R=(13) A/P=26 Inv=(118) other=64
Cash Flow from operations 3,703
Cash Flow from investments (1,784)
Cash provided by financing (1,775)
Net Change in Cash Position 18

14. Taxes Taxes have a major impact on financial decisions
Marginal Tax Rate is the tax that the individual pays on each extra dollar of income.
Average Tax Rate is the total tax bill divided by total income. 20

15. Taxes
Example - Taxes and Cash Flows can be changed by the use of debt. Firm A pays part of its profits as debt interest. Firm B does not.
Example - Taxes and Cash Flows can be changed by the use of debt. Firm A pays part of its profits as debt interest. Firm B does not.
Firm A Firm B
EBIT
Interest
Pretax Income
Taxes (35%)
Net Income 23

16. Taxes
FOOD FOR THOUGHT - If you were both the debt and equity holders of the firm, which would generate more cash flow to you? (assume Net Income = Cash Flow)
Firm A Firm B
EBIT
Interest
Pretax Income
Taxes (35%)
Net Income ? 24

17. Taxes
FOOD FOR THOUGHT - If you were both the debt and equity holders of the firm, which would generate more cash flow to you? (assume Net Income = Cash Flow)
Firm A Firm B
Net Income
+ Interest
Net Cash Flow ? 26

18. Corporate Tax Rates (2002)

19. Personal Tax Rates (2002)

20. FINANCIAL RATIOS Leverage Ratios:
Long Term Debt Ratio= LTD / (LTD+ Equity)
Debt/Equity = Total Debt / Total Equity
Times Interest Earnings: EBIT / Interest payments
Liquidity Ratios:
Current Ratio= Current Assets/ Current Liabilities
Cash Ratio = (Cash+ Marketable Securities) / Current Liabilities
Quick Ratio= (Cash+ Receivables) / Current Liabilities
Efficiency Ratios:
Inventory Turnover= COGS/ Inventory
Receivables Turnover= Net Sales/ Receivables

21. FINANCIAL RATIOS Profitability Ratios:
NPM (Net profit margin)= Net Income / Net Sales
ROE= Net income / Equity
Growth Ratios :
Payout Ratio= Dividends / Net income
Sustainable Growth= ROE/(1- Payout)