1. Financial Statements, Cash Flow, and Taxes
CHAPTER 2
Financial Statements, Cash Flow, and Taxes

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

3. The Balance Sheet Cash Versus Other Assets
Inventory & Depreciation Accounting
Liabilities
Breakdown of the common equity account
Preferred versus common stock

4. Balance Sheet: Assets Cash A/R Inventories Total CA Gross FA
Less: Dep.
Net FA
Total Assets
2002
7,282
632,160
1,287,360
1,926,802
1,202,950
263,160
939,790
2,866,592
2001
57,600
351,200
715,200
1,124,000
491,000
146,200
344,800
1,468,800

5. Balance sheet: Liabilities and Equity
Accounts payable
Notes payable
Accruals
Total CL
Long-term debt
Common stock
Retained earnings
Total Equity
Total L & E
2002
524,160
636,808
489,600
1,650,568
723,432
460,000
32,592
492,592
2,866,592
2001
145,600
200,000
136,000
481,600
323,432
203,768
663,768
1,468,800

6. 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

7. Other data No. of shares EPS DPS Stock price Book Value Per Share
Cash Flow Per Share
2002
100,000
-$1.602
$0.11
$2.25
$4.93
-$0.43
2001
$0.88
$0.22
$8.50
$6.64
$1.07

8. 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
earnings, 12/31/02

9. 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)
(572,160)
(164,176)

10. 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

11. What can we conclude about the financial condition from the statement of CFs?
Net cash from operations = -$164,176, mainly because of negative NI.
The firm borrowed $825,808 to meet its cash requirements.
Even after borrowing, the cash account fell by $50,318.

12. What about net operating profit after taxes (NOPAT)?
NOPAT = EBIT (1 – Tax rate)
NOPAT02 = -$130,948(1 – 0.4)
= -$130,948(0.6)
= -$78,569
NOPAT01 = ?

13. What was the effect on net operating working capital?
NOWC = Current Non-interest
assets bearing CL
NOWC02 = ($7,282 + $632,160 + $1,287,360) – ( $524,160+$636,808 + $489,600)
= $276,234
NOWC01 = ?

14. What was the change in Net Cash Flow?
NCF02 = NI + Depreciation and Amortization
= ($160,176) + $116,960
= -$43,216
NCF01 = ?

15. Does the company pay its suppliers on time?
Probably not.
A/P increased 260%, over the past year, while sales increased by only 76%.
If this continues, suppliers may cut off the company’s trade credit.

16. How did the company finance its operation?
The company financed its operation with external capital.
It issued long-term debt

17. Federal Income Tax System

18. 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”).

19. 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.