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Accounting Statements
The Balance Sheet
The Income Statement
Net Working Capital
Financial Cash Flow
The Statement of Cash Flows
Financial Ratios
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Balance Sheet
• An accountant’s snapshot of the firm’s
accounting value as of a particular date.
• The Balance Sheet Identity is:
Assets ≡ Liabilities + Stockholder’s Equity
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Balance Sheet Analysis
When analyzing a balance sheet, the financial
manager should be aware of three
concerns:
1. Accounting liquidity
2. Debt versus equity
3. Value versus costs
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Accounting Liquidity
• Refers to the ease and quickness with which assets
can be converted to cash.
• Current assets are the most liquid.
• Some fixed assets are intangible.
• The more liquid a firm’s assets, the less likely the
firm is to experience problems meeting short-term
obligations.
• Liquid assets frequently have lower rates of return
than fixed assets.
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Debt versus Equity
• Bondholders has the first claim on the
firm’s cash flow.
• Shareholder’s equity is the residual between
assets and liabilities.
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Value versus Cost
• Under GAAP audited financial statements
of firms in the U.S. carry assets at cost. I.e.,
book value refers to cost.
• Market value is a completely different
concept, referring to value.
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The Income Statement
• The income statement measures performance over
a specific period of time.
• The accounting definition of income is
Revenue – Expenses ≡ Income
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Income Statement Analysis
There are three things to keep in mind when
analyzing an income statement:
1. GAAP
2. Non Cash Items
3. Time and Costs
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Generally Accepted Accounting Principles
1. GAAP
The matching principal of GAAP dictates
that revenues be matched with expenses.
Thus, income is reported when it is earned,
even though no cash flow may have
occurred
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Income Statement Analysis
2. Non Cash Items
Depreciation is the most apparent. No firm
ever writes a check for “depreciation”.
Another noncash item is deferred taxes, which
does not represent a cash flow.
-- both of them are not cash expenses.
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Income Statement Analysis
3. Time and Costs
In the short run, certain equipment, resources, and
commitments of the firm are fixed, but the firm
can vary such inputs as labor and raw materials.
In the long run, all costs are variable.
Financial accountants do not distinguish between
variable costs and fixed costs.
-- product costs
-- period costs
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Net Working Capital
Net Working Capital ≡ Current Assets – Current Liabilities
• NWC is usually growing with the firm.
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U.S. COMPOSITE CORPORATION
Balance Sheet
20X2 and 20X1
(in $ millions)
Assets
Current assets:
Cash and equivalents
Accounts receivable
Inventories
Other
Total current assets
20X2
$140
294
269
58
$761
20X1
$107
270
280
50
$707
Fixed assets:
Property, plant, and equipment
$1,423 $1,274
Less accumulated depreciation
-550
-460
Net property, plant, and equipment
873
814
Intangible assets and other
245
221
Total fixed assets
$1,118 $1,035
Total assets
$1,879
$1,742
Liabilities (Debt)
and Stockholder's Equity
Current Liabilities:
Accounts payable
Notes payable
Accrued expenses
Total current liabilities
Long-term liabilities:
Deferred taxes
Long-term debt
Total long-term liabilities
20X2
20X1
$213
50
223
$486
$197
53
205
$455
$117
471
$588
$104
458
$562
Stockholder's equity:
Preferred stock
$39
$39
Common stock ($1 par value)
55
32
Capital surplus
347
327
Accumulated retained earnings
390
347
Less treasury stock
-26
-20
Total equity
$805
$725
Total liabilities and stockholder's equity $1,879 $1,742
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Financial Cash Flow
cash flow from received from the firm’s assets
must equal the cash flows to the firm’s
creditors and stockholders.
CF(A)≡ CF(B) + CF(S)
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Financial Cash Flow of the
U.S.C.C.
U.S. COMPOSITE CORPORATION
Financial Cash Flow
20X2
(in $ millions)
Cash Flow of the Firm
Operating cash flow
(Earnings before interest and taxes
plus depreciation minus taxes)
Capital spending
(Acquisitions of fixed assets
minus sales of fixed assets)
Additions to net working capital
Total
Cash Flow of Investors in the Firm
Debt
(Interest plus retirement of debt
minus long-term debt financing)
Equity
(Dividends plus repurchase of
equity minus new equity financing)
Total
$238
Operating Cash Flow:
EBIT
(173)
(23)
$42
Depreciation
$219
$90
Current Taxes ($71)
OCF
$238
$36
6
$42
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Financial Cash Flow of the
U.S.C.C.
U.S. COMPOSITE CORPORATION
Financial Cash Flow
20X2
(in $ millions)
Cash Flow of the Firm
Operating cash flow
(Earnings before interest and taxes
plus depreciation minus taxes)
Capital spending
(Acquisitions of fixed assets
minus sales of fixed assets)
Additions to net working capital
Total
Cash Flow of Investors in the Firm
Debt
(Interest plus retirement of debt
minus long-term debt financing)
Equity
(Dividends plus repurchase of
equity minus new equity financing)
Total
$238
Capital Spending
(173)
Purchase of fixed assets
$198
Sales of fixed assets
(23)
$42
(25)
Capital Spending
$173
$36
The other formula:
6
$42
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Capital spending = change
in net fixed asset +
depreciation
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Financial Cash Flow of the
U.S.C.C.
U.S. COMPOSITE CORPORATION
Financial Cash Flow
20X2
(in $ millions)
Cash Flow of the Firm
Operating cash flow
(Earnings before interest and taxes
plus depreciation minus taxes)
Capital spending
(Acquisitions of fixed assets
minus sales of fixed assets)
Additions to net working capital
Total
Cash Flow of Investors in the Firm
Debt
(Interest plus retirement of debt
minus long-term debt financing)
Equity
(Dividends plus repurchase of
equity minus new equity financing)
Total
$238
(173)
(23)
$42
$36
NWC grew from $275
million in 20X2 from
$252 million in 20X1.
This increase of $23
million is the addition to
NWC.
6
$42
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Financial Cash Flow of the
U.S.C.C.
U.S. COMPOSITE CORPORATION
Financial Cash Flow
20X2
(in $ millions)
Cash Flow of the Firm
Operating cash flow
(Earnings before interest and taxes
plus depreciation minus taxes)
Capital spending
(Acquisitions of fixed assets
minus sales of fixed assets)
Additions to net working capital
Total
Cash Flow of Investors in the Firm
Debt
(Interest plus retirement of debt
minus long-term debt financing)
Equity
(Dividends plus repurchase of
equity minus new equity financing)
Total
$238
Cash Flow to Creditors
(173)
(23)
$42
Interest
$49
Retirement of debt
73
Debt service 122
$36
6
$42
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Proceeds from new debt
sales
(86)
Total
36
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Financial Cash Flow of the
U.S.C.C.
U.S. COMPOSITE CORPORATION
Financial Cash Flow
20X2
(in $ millions)
Cash Flow of the Firm
Operating cash flow
(Earnings before interest and taxes
plus depreciation minus taxes)
Capital spending
(Acquisitions of fixed assets
minus sales of fixed assets)
Additions to net working capital
Total
Cash Flow of Investors in the Firm
Debt
(Interest plus retirement of debt
minus long-term debt financing)
Equity
(Dividends plus repurchase of
equity minus new equity financing)
Total
$238
Cash Flow to Stockholders
(173)
Dividends
$43
Repurchase of stock
(23)
$42
6
Cash to Stockholders 49
Proceeds from new stock issue
(43)
$36
Total
$6
6
$42
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Summary of Cash flow of the firm
• Operating cash flow = EBIT + Depreciation – tax
• Capital spending = change in net fixed assets +
depreciation
• Net working capital = net working capital in the
second year – net working capital in the first year
• For cash flow to creditors and shareholders, see
previous slides.
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Balance Sheet
Beg
End
Beg
End
Cash
$100
$150
A/P
$100
$150
A/R
200
250
N/P
200
200
Inv
300
300
C/L
300
350
C/A
$600
$700
LTD
$400
$420
NFA
400
500
C/S
50
60
R/E
250
370
$300
$430
$1000
$1200
Total
$1000
$1200
Total
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Income Statement
Sales
$2000
Costs
1400
Depreciation
100
EBIT
500
Interest
100
Taxable Income
400
Taxes
200
Net Income
Dividends
Addition to R/E
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$200
$_____
_____
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1. Operating cash flow=EBIT + _____________ – Taxes
= $500 + 100 – 200
= $_____
2. Change in NWC
= ___________ – ___________
= $350 – $_____
= $_____
3. Net capital spending
= $_____ + Dep – _____
= $500 + 100 – 400
= $_____
4. Cash flow from assets
= OCF – chg. NWC – Cap. sp.
=
=
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Financial Ratios
A. Short-term Solvency, Activity
•Current ratio
•Quick ratio
•Total Asset Turnover
•Receivable Turnover
•Inventory Turnover
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B. Financial Leverage
• Debt ratio
• Interest rate coverage
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Profitability
• Profit margin
• Return on assets
• Return on equity
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Market Value Ratios
•
•
•
•
Market price
Price-to-earning ratio (P/E)
Dividend yield
Market-to-book (M/B) value and Q ratio
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