MBA 640, Prof. Tai
MBA 640
Chapter 2
Financial
Statement
Analysis
• 3 Types of Financial Statements
• Balance Sheet
• Income Statement
• Statement of Cash Flows
• Taxes
• Net Working Capital
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Why Do We Want to Study Financial
Statements?
• Why to study?
• Managers need financial
information about the current
state as well as the future of the
company to make the effective
decision
• Lenders and investors need the
same information to make their
decision to lend/invest their
money in the company.
• How to get it?
• SEC
• EDGAR (10K and 10Q
reports)
• Company web sites
• Home Depot
• Capital IQ
• Google finance / Yahoo
finance
MBA 640, Prof. Tai
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Abbreviations
MBA 640, Prof. Tai
3
Financial Statements and Cash Flow
 Balance Sheet
• A snapshot of firm’s accounting value in specific point in time
• Total Assets = Total Liabilities + Stockholders’ Equity
 Income Statement
• Measures financial performance of a firm in a specific period of
time
• Income = Revenue - Expenses
 Cash Flows Identity
• The most important thing extracted from financial statements
• CF from Assets = CF to Creditors + CF to Stockholders
MBA 640, Prof. Tai
4
Balance Sheet
We should pay attention to:
 Liquidity
• How easily and quickly assets can be
converted into cash
• It is a measure of short-term health of
companies
 Debt vs. equity financing
• Tax benefit of debt
• Ownership of the company
 Market value vs. book value
• GAAP dictates that all assets have to be
recorded at historical cost
MBA 640, Prof. Tai
Q1. Liquidity
All assets are liquid at some price.
True or False? Explain.
Q2. Market Vs Book Value
Under standard accounting rules,
it is possible for a company’s
liabilities to exceed its assets.
When this occurs, the owner’s
equity is negative. Can this
happen with market values? Why
or why not?
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Net Working Capital (NWC)
 NWC = Current Assets – Current Liabilities
o CA = Cash + Accounts Receivable + Inventories
o CL = Accounts Payable + Notes Payable + Accruals
 NWC and growth involves
o Cash management
o Credit and inventory management
o Short-term financing and planning
MBA 640, Prof. Tai
6
Income Statement
 GAAP
• Revenues have to be matched
with expenses
o Income is reported when it is
earned
 Non-cash items
• Depreciation
• Deferred taxes
• Net income is not cash!
MBA 640, Prof. Tai
Q3. Accounting & CFs
Why might the revenue and
cost figures shown on a
standard income statement not
represent the actual cash
inflows that occurred during a
period?
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CFFA Q5 OCF
Cash Flows (CF) of the Firm (Ch. 2.5) Q4
Why is it not necessarily

Earnings can be manipulated

CF from assets (CFFA or FCF) is more objective

(CF Identity): CFFA  CF to Creditors + CF to Shareholders

CFFA (CFFA = OCF + NCS + NWC) has 3 components:
• Operating Cash Flow (OCF) = EBIT + Depreciation - Taxes
• Net Capital Spending (CapEx) = NFAEND – NFABEG + Depreciation
•  NWC = NWCEND – NWCBEG
 CF to Creditors = Interest paid – Net New Borrowing
• Where Net New Borrowing = LTDEND - LTDBEG
 CF to Shareholders = Dividends – Net New Equity Raise
• Where Net New Equity Raised = Stock Sold – Stock Buyback
MBA 640, Prof. Tai
bad for the CFFA and OCF
to be negative for a
particular period? What
about OCF?
Q6 NCS,  NWC
A company’s NCS and NWC
could be negative in a given
year. How could this
happen?
Q7 CF to Creditors & CF
Stockholders
A company’s CF to creditors
and CF to shareholders could
be negative in a given year.
How could this happen? 8
Accounting Statement of Cash Flows (Ch. 2.6)
 Statement of CFs has three components:
• CF from Operating (Ops.) Activities = Net Income + Noncash
expenses +  CA &  CL (excluding cash and notes payable)
• CF from Investing Activities = Acquisitions of Fixed Assets and
Sale of Fixed Assets
• CF from Financing Activities = CF to and from Creditors include
Changes in Debt and Equity
 Net  in Cash = CF Ops. + CF Investing + CF Financing
MBA 640, Prof. Tai
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Taxes
 Marginal Tax Rate
o
% paid on the next dollar earned
 Average Tax Rate (Effective Tax Rate)
o
Taxes / Taxable income
MBA 640, Prof. Tai
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