Chapter 2
Financial Statement and Cash
Flow Analysis
1
Learning Objectives
Interpret information contained in the
balance sheet, income statement, and
statement of cash flows.
 Explain why income differs from cash flow.
 Measure and interpret financial ratios.
 Understand the essential features of the
taxation of corporate income.

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Topics Covered
The Balance Sheet
 The Income Statement
 Measuring Cash Flow & The Statement of
Cash Flows
 Corporate Taxes
 Financial Ratio Analysis

3
The Balance Sheet
Definition
 Financial statements that show the
value of the firm’s assets and
liabilities at a particular point in time
(from an accounting perspective).
 A “snapshot” of a company’s financial
position.
4

The Balance Sheet
The Main Balance Sheet Items
Current Liabilities
Payables
Short-term Debt
Current Assets
Cash & Securities
Receivables
Inventories
+
Fixed Assets
Tangible Assets
Intangible Assets
=
+
Long-term Liabilities
+
Shareholders’ Equity
5
Target Balance Sheet
($ Thousands)
PERIOD ENDING
29-Jan-05
31-Jan-04
Cash And Cash Equivalents
2,245,000
716,000
Net Receivables
5,069,000
5,776,000
Inventory
5,384,000
5,343,000
Other Current Assets
1,224,000
1,093,000
13,922,000
Empty
Empty
12,928,000
Gross Property Plant and Equipment
22,272,000
19,880,000
Accumulated Depreciation
-5,412,000
-4,727,000
Net Property Plant and Equipment
16,860,000
16,969,000
Current Assets
Total Current Assets
Empty
Empty
Fixed Assets
Goodwill
Intangible Assets
Other Assets
60,000
146,000
1,305,000
1,495,000
Total non-current assets
18,371,000
18,464,000
Total Assets
32,293,000
31,392,000
6
Target Liabilities & Stockholders’ Equity
($ Thousands)
PERIOD ENDING
29-Jan-05
31-Jan-04
7,716,000
7,448,000
504,000
866,000
Total Current Liabilities
8,220,000
8,314,000
Long Term Debt
9,034,000
10,217,000
Other Liabilities
1,037,000
Current Liabilities
Accounts Payable
Short/Current Long Term Debt
Deferred Long Term Liability Charges
973,000
1,796,000
19,264,000
20,327,000
74,000
76,000
11,148,000
9,645,000
1,810,000
1,341,000
-3,000
3,000
Total Stockholder Equity
13,029,000
11,065,000
Total Liabilities & Equity
32,293,000
31,392,000
Total Liabilities
Stockholders' Equity
Common Stock
Retained Earnings
Capital Surplus
Other Stockholder Equity
The Income Statement
Definition
Financial statement that shows
the revenues, expenses, and
net income of a firm over a
period of time (from an
accounting perspective).
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Target’s Income Statement (thousands
of $)
PERIOD ENDING
29-Jan-05
31-Jan-04
Total Revenue
46,839,000
48,163,000
Cost of Revenue
31,445,000
31,790,000
Gross Profit
15,394,000
16,373,000
Selling General and Administrative
10,534,000
11,534,000
Other Operating Expenses
1,259,000
1,320,000
Operating Income or Loss
3,601,000
3,519,000
Earnings Before Interest And Taxes
3,601,000
3,519,000
570,000
559,000
Income Before Tax
3,031,000
2,960,000
Income Tax Expense
1,146,000
1,119,000
Net Income From Continuing Ops
1,885,000
1,841,000
Discontinued Operations
1,313,000
-
Net Income
3,198,000
1,841,000
Interest Expense
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Accounting Income vs. Cash Flow
An Income Statement
 Sales
 Cost of Goods Sold
 Selling & Gen. Adm.
Exp
 Depreciation
 Interest Exp
 Taxable Income
 Taxes
 Net Income



Do all items reflect all
cash collected and
paid?
NO!!! Income
statement is on an
accrued basis.
What is and who is
depreciation?
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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
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Statement of Cash Flows
Shows how the firm used and raised cash
during the year.
 Reconciles the Income Statement by the
changes in the Balance Sheet from the
beginning of the year to the end of the
year

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Parts of Statement of Cash Flows



Cash Flow from Operations = net cash income
from income statement: net income,
Depreciation,change in A/R, Inv, Other CA, A/P,
Accruals (Wages & Taxes), Other CL
Cash Flow from Investments = Purchases and
Sales of long-term real assets & investments
and short-term investments
Cash Flow from Financing = issuances and
payments of debt and stock: L-T Debt, Common
and Preferred Stock, Notes Payable & Dividends
Paid
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Target’s Statement Of Cash Flows
($ Thousands)
PERIOD ENDING
29-Jan-05
31-Jan-04
Net Income
3,198,000
1,841,000
Depreciation
1,259,000
1,320,000
Adjustments To Net Income
-437,000
846,000
Changes In Accounts Receivables
-209,000
-744,000
1,064,000
912,000
Changes In Inventories
-853,000
-583,000
Changes In Other Operating Activities
-827,000
-432,000
3,195,000
3,160,000
-3,068,000
-3,004,000
Other Cashflows from Investing Activities
4,247,000
85,000
Total Cash Flows From Investing Activities
1,179,000
-2,919,000
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Changes In Liabilities
Total Cash Flow From Operating Activities
Investing Activities, Cash Flows Provided By or Used In
Capital Expenditures
Target’s Statement Of Cash Flows
($Thousands)
PERIOD ENDING
29-Jan-05
31-Jan-04
-272,000
-237,000
Financing Activities, Cash Flows Provided By or Used In
Dividends Paid
Sale Purchase of Stock
-1,144,000
Net Borrowings
-1,477,000
-72,000
56,000
26,000
Total Cash Flows From Financing Activities
-2,837,000
-283,000
Change In Cash and Cash Equivalents
$1,537,000
($42,000)
Other Cash Flows from Financing Activities
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Target’s Cash Flows Fiscal 2004-2005
($Thousands)
4000000
3000000
2000000
Operating
Investing
Financing
Change in Cash
1000000
0
-1000000
-2000000
-3000000
2004
2005
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Key Measures of Cash Flow
Cash Flow
from
Operations
• Total cash generated
Operating
Cash Flow
• Cash flow before repaying
lenders
Free Cash
Flow
• Cash flow that firm could
distribute to investors.
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Specific Cash Flow Definitions

Operating Cash Flow (OCF) = cash generated
from the firm’s operations



OCF = Earnings Before Interest and Taxes (EBIT) –
Taxes + Depreciation
Target 2005 OCF = 3,601,000 – 1,146,000 + 1,259,000
= 3,714,000
Free Cash Flow (FCF) = Cash available to the
firm’s investors after firm meets operating and
investment needs


FCF = OCF – DFA(gross) – (DCA – DA/P – DAccruals)
Target 2005 FCF = 3,714,000 – 2,408,000 – (994,000 –
268,000) = 580,000
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Corporate Income Taxes
Corporate deductions from income:
operating expenses, depreciation,
interest expense.
 Dividends paid are NOT deductible.
 Interest and capital gain income is fully
taxable.
 30% (in general) of Dividend income is
taxable.
 Losses can be carried back (for refund of
past taxes paid) and carried forward (to
reduce future taxable income & taxes).

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Corporate Tax Rates (2002)
Taxable Income over($)
0
50,000
75,000
100,000
335,000
10,000,000
15,000,000
18,333,333
Not over ($) Tax Rate (%)
50,000
15
75,000
25
100,000
34
335,000
39
10,000,000
34
15,000,000
35
18,333,333
38
35
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Corporate Tax Example

Kramerica has taxable income of $90,000.
What is their tax liability, marginal and
average tax rates?


Marginal tax rate = the tax rate on the next
dollar of income.
Average Tax Rate = taxes paid divided by
taxable income.
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