Ch. 2: Financial Statements, Taxes, and Cash Flow

Balance Sheet

• Snapshot of the firm
• Balance Sheet Identity: Assets = Liabilities + Equity
• Piece by piece
  • Assets
    • Current Assets
      • < 1 year life
      • inventory, cash, accounts receivable
    • Fixed Assets
      • Tangible: plants, property, and equipment
      • Intangible: patents, trademarks, and intellectual property
  • Liabilities
    • Current liabilities
      • Due in < 1 year
      • Accounts payable
    • Long-term debt (bonds)
  • Equity (residual claim)
• Net Working Capital: Current Assets - Current Liabilities
• Evaluating a balance sheet
  • Liquidity
    • ease of conversion vs. loss of value
    • protection against financial distress vs. forgone potential profits
  • Leverage
    • debt vs. equity
    • serves to magnify gains and losses to equity
  • Market value vs. book value
    • Book value: historical cost (subject to GAAP)
    • Market value: price the market will bear
    • What drives the difference? (depreciated asset that still generates cash flows)

Income Statement

• See Table 2.2
• Cash flows over time: Revenues - Expenses = Income
• Evaluating a income statement
  • GAAP
    • Revenue - recognition (time of sale not collection)
    • Expenses - matched with revenue
    • Subject to managerial discretion?
  • Non-cash items (depreciation)
  • Time and costs
    • Finance: fixed and variable costs
    • Accounting: product and period costs

Taxes

• Marginal vs. average tax rates
• See Table 2.3 for tax schedule and Table 2.4 for example calculations

Cash Flow

• See Table 2.6 for formulas
• Cash flow from assets
  • Subject to our accounting identity
  • Consists of three parts:
    • Operating cash flow
      • day-to-day activities of producing and selling (no non-cash outflows or financing expenses)
      • Do inflows cover outflows?
    • Capital spending (CapEx): change in fixed assets not including depreciation
    • Change in net working capital (short-term assets less short-term liabilities)
• Cash flow to creditors: Interest paid - Net new borrowing
• Cash flow to stockholders: Dividends paid - Net new equity raised