1. Chapter 2. Financial Statements And Cash Flow Analysis Professor Thomson Finance 3014

2. 2 Asset, Liability, Equity Asset – something that has value (typically can be sold for $). Why does it have value? It produces a benefit such as a cash flow. (Could be money in the bank, a house, car, college education) Liability – Something you have to pay for someone to take from you, like a loan (i.e. debt). It has negative value (to you). Equity – represents your ownership in something

3. 3 Balance Sheet Identity Assets = Liabilities + Equity This statement indicates that assets are financed either through borrowed money, or through ownership. Say your car is worth $10,000 and you have a 7,000 balance on your loan. You have $3000 of equity, or ownership in that car. Personal Finance Goal: –Increase your equity

4. 4 Balance Sheet Current AssetsCurrent Liabilities can easily be turned into cashwill be paid off within the year are "liquid" assets Long Term Debt primarily bonds often called "financial leverage" Fixed Assets Can be tangible (factory) Can be intangible (goodwill) Owners Equity Are "real" assets

5. 5 GAAP – Generally Accepted Accounting Principles Used to fairly portray the firm's past performance Accountants used an “accrual-based” approach. Revenue recorded at the point of sales and costs when they are incurred Finance professionals focus on the timing and size of the cash flows.

6. 6 Four Key Financial Statements 1.Balance sheet (A=L+E) – snapshot of assets, liabilities, equity 2. Income statement - Shows the flow of revenues and expenses over a period 3. Statement of retained earnings 4. Statement of cash flows

7. 7 Financial Statements Financial Managers and analysts use financial statements to conduct: -Cash Flow Analysis -Performance (Ratio) Analysis

8. 8 Staples (SPLS) Balance Sheet ($ Thousands)

9. 9 Staples Liabilities & Stockholders’ Equity ($ Thousands)

10. 10 Staples Income Statement ($ Thousands)

11. 11 Sources and Uses of Corporate Cash Sources Decrease in any asset Increase in any liability Net profits after taxes Depreciation and other non-cash charges Sale of stock Uses Increase in any asset Decrease in any liability Net loss Dividends paid Stock repurchase or retirement

12. 12 Staples Statement Of Cash Flows ($ Thousands)

13. 13 Staples Statement Of Cash Flows ($Thousands)

14. 14 Key Equation for Fin 3014 In this course we will study the cash flows that result from fixed investments An important cash flow item, derived from the Income Statement, is the Operating Cash Flow (OCF) from an investment We will compute: OCF = EBIT – taxes + depreciation EBIT is Earnings Before Interest and Taxes

15. 15 Current ratio Quick ratio Inventory turnover ratio Average collection period Debt-to-equity ratio Times interest earned ratio Gross margin EPS P/E ratio Market-to-book ratio Types Of Financial Ratios Activity Ratios Debt Ratios Profitability Ratios Market Ratios Liquidity Ratios

16. 16 Financial Ratios: Trends and Benchmarking Benchmarking: comparison of a company’s ratio values to industry competitors’ ratios Firms’ financial ratios compared at the same point in time Trend analysis - performance evaluation over time Developing trends can be seen using multi-year comparisons.

17. 17 Liquidity Ratios (short term obligations) note:NWC = CA - CL Staples (2004) Office Depot (2004)

18. 18 Activity Ratios Staples (2004) Office Depot (2004)

19. 19 Activity Ratios (Continued) Staples (2004) Office Depot (2004)

20. 20 Debt Ratios – relates to financial leverage Staples (2004) Office Depot (2004)

21. 21 Debt Ratios (Continued) Staples (2004) Office Depot (2004)

22. 22 Profitability Ratios Staples (2004) Office Depot (2004)

23. 23 Profitability Ratios (Continued) Staples (2004) Office Depot (2004)

24. 24 Net profit margin (2004 data) Consider two highly profitable companies: Wal-Mart: NPM = 3.3% Microsoft: NPM = 14.3% Which is the best company to invest in?

25. 25 Profitability Ratios - what if you have no liabilities? Staples (2004) Office Depot (2004)

26. 26 Market Ratios Staples (2004) Office Depot (2004)

27. 27 Market Ratios Staples (2004) Office Depot (2004)

28. 28 Corporate Taxes Significant cash outflow Ordinary income tax Progressive tax rate schedule Average tax rate: tax divided by the pretax income More relevant: marginal tax rate Capital gains tax Under existing tax laws, use ordinary income tax rates for capital gain taxes

29. Financial Statements and Financial Ratios r Balance Statement r Income Statement r Liquidity Ratios r Activity Ratios r Debt Ratios r Profitability Ratios r Market Ratios