1. FINANCIAL STATEMENTS Chapter 3 Balance Sheet Income Statement Statement of Cash Flows

2. All Rights ReservedChapter 3Page 2 Finance from a Personal Viewpoint A. All us own things and owe money B. If we own more than we owe – we are said to have a positive net worth. C. In Finance:  What we own are called Assets.  We we owe are called Liabilities.  If our Assets exceed our Liabilities then we have [positive] Equity.  Accordingly: Assets = Liabilities + Equity

3. All Rights ReservedChapter 3Page 3 Balance Sheet  The Balance Sheet answers two general questions:  How has the firm invested its capital (money)?  Current Assets (cash, receivables, inventory)  Fixed Assets (plant, property, equipment)  How has the firm financed its capital investment?  Borrowing: short-term (current liabilities) and long- term debt  Equity (stock) and Retained Earnings

4. All Rights ReservedChapter 3Page 4 INCOME STATEMENT A. The income statement gives information relating to the firm’s Revenues and Expenses for the last accounting (fiscal) period. B. The I/S is frequently called the P&L (Profit and Loss). C. The most important use is for determining how profitably a firm is operating.

5. All Rights ReservedChapter 3Page 5 STATEMENT OF CASH FLOWS  The statement of cash flows shows the financial analyst, stockholder, or other interested parties where the firm’s cash came from and how it was used.  The firm has 3 possible sources & Uses of cash:  Operating Activity (profits from sales)  Financing activity (borrowing or selling equity)  Investing activity (buying/selling assets)

6. All Rights ReservedChapter 3Page 6 Important Analytical Concepts A. Net Working Capital = CA – CL B. Operating Cash Flows = EBIT ( 1 – Tx) + Depreciation & Amortization C. Free Cash Flow = OCF – (Cap Exp +  NWC) D. MVA = MVF – BV (=TA – TL) E. EVA = NOPAT - $ Cost of Capital NOPAT = EBIT * (1 – Tax Rate)

7. All Rights ReservedChapter 3Page 7 Balance Sheet (Left hand side)  Current Assets  Cash  Marketable Securities  Accounts Receivable  Inventory  Prepaid expenses Total Current Assets (Right hand side)  Current Liabilities  Accounts payable  Notes payable (loans)  Accrued expenses  Current L-T Debt Total Current Liabilities

8. All Rights ReservedChapter 3Page 8 Balance Sheet  Long-Term assets  Gross Fixed Assets  -Accum. Depreciation  Net Fixed Assets  Other Assets  Patents, Copyrights  Goodwill  Investments in other companies (equity). Total Assets  Long-Term liabilities  Long Term Debt (bonds)  Deferred Taxes  Contingent Liability  Stockholder Equity  Preferred Stock  Common Stock  Paid in Capital  Retained Earnings Total Liabilities + Equity

9. All Rights ReservedChapter 3Page 9 INCOME STATEMENT  Net Sales (gross sales - allow for returns & adjust.)  - Cost of Goods Sold (direct labor, materials)  = Gross Profit (contribution to overhead expenses.)  - Sell, General & Administrative Expenses  = Operating Income before Depreciation / Amortization, Interest, and Taxes (also termed EBITDA)  EBITDA = Earnings Before Interest, Taxes, Depreciation, and Amortization.

10. All Rights ReservedChapter 3Page 10 INCOME STATEMENT  = Operating Income (EBITDA)  - Depreciation/Depletion/Amortization  = Net Operating Income ( EBIT)  EBIT = Earnings Before Interest and Taxes  - Interest Expense (cost of borrowed funds.)  + Interest Income (interest from s-t investments.)  = Earnings Before Taxes (EBT)

11. All Rights ReservedChapter 3Page 11 INCOME STATEMENT  = Earnings Before Taxes  - Taxes (includes federal, state, and foreign)  = Net Income before extraordinary items and discontinued operations (BEIDO)  ± Charges for Extraordinary Items, Discontinued Operations  (See Note 1 on page 8)  = Net Income Including EIDO (IEIDO)

12. All Rights ReservedChapter 3Page 12 INCOME STATEMENT  = Net Income including EIDO  - Preferred Stock Dividends (if issued).  = Earnings Available For Common Stockholders.  - Cash Dividends to Common Stockholders (if paid).  = Retained Earnings (reinvested in the business)  Net Cash Flow = NI + Deprec. & Amort.  Earnings per share (EPS) =Net Income (BEIDO)  Shares Issued & Outstanding  Primary, Fully Diluted

13. All Rights ReservedChapter 3Page 13 STATEMENT OF CASH FLOWS  Cash Flows from Operating Activities;  Net income; what's left after expenses and taxes.  Adjustments to determine operating cash flows;  + Depreciation expense; (a non-cash expense)  - Increases in current asset accounts.  + Decreases in current asset accounts.  + Increases in current liability accounts.  - Decreases in current liability accounts.  Net cash flows from operating activities.

14. All Rights ReservedChapter 3Page 14 STATEMENT OF CASH FLOWS  Cash Flows from Investing Activities;  - Increases in investments (buying securities).  + Decreases in investments (selling securities).  + Interest/dividends received from investments.  - Increases in plant, property, and equipment  + Decreases in plant, property, and equipment.  = Net cash flows from investing activities.

15. All Rights ReservedChapter 3Page 15 STATEMENT OF CASH FLOWS  Cash Flows from Financing Activities  + Increase in bonds outstanding (selling bonds).  - Decrease in bonds outstanding (retiring bonds).  - Payments of interest on bonds sold by the firm.  + Increases in stock (selling preferred or common shares).  - Decreases in stock (buying back shares)  - Payment of dividends on preferred and/or common stock.  Net cash flows from financing activities.  Cash and Equivalents EOY  (equals the change in Cash Balance from last year)

16. HOMEWORK CHAPTER 3  Self-Test: ST-1, c, h, g  Questions: 3-3, 3-5, 3-7, 3-10  Problems: 3-1, 3-3, 3-5