Chapter 2
Financial Statements, Cash Flow and Taxes
Financial Statements and Reports
You need to be familiar with the following statements:
Balance Sheet -- a statement of the firm’s financial position at a specific point in time
Statement of Retained Earnings -- a statement reporting changes in the firm’s retained
earnings as a result of the income generated and retained during the year. The balance sheet
figure for retained earnings is the sum of the earnings retained for each year the firm has been
in business
Statement of cash flows -- a statement reporting the impact of a firm’s operating, investing, and
financing activities on cash flows over an accounting period
Sources of cash:
Uses of cash:
Modifying accounting data for managerial decisions
Net Working Capital versus Net Operating Working Capital (NOWC)
Total Operating Capital
Net Operating Profit after Taxes
NOPAT = EBIT(1 – tax rate)
Operating cash flow = NOPAT + Depreciation and amortization
Gross investment in operating capital = Net investment in operating capital + Depreciation and
amortization
Free Cash Flow
Cash flow actually available for distribution to all investors after the company has made all
investment in fixed assets, new products, and working capital necessary to sustain ongoing
operations
FCF = operating cash flow – Gross investment in operating capital
(also FCF = NOPAT – Net investment in operating capital)
MVA and EVA
MVA is the difference between the market value of the firm’s stock and the amount of equity
capital investors have supplied
MVA = (shares outstanding)(stock price) – (total common equity)
EVA is the value added to shareholders by management during a given year
EVA = NOPAT – after-tax dollar cost of operating capital =
EBIT(1-T) – [(Total investor-supplied operating capital)(After-tax cost of capital)