Chapter 2.

Financial Statements
Course: Corporate Finance
Lecturer: Dr. Anh Tram Luong
"The limits of my language mean the limits of my world."
Ludwig Wittgenstein
Let’s have a look!

https://www.apple.com/newsroom/pdfs/FY22_Q4_Consolidated_
Financial_Statements.pdf
Content
1. Balance Sheet

2. Income Statement and Corporate tax rates

FINANCIAL
STATEMENT

3. Statement of Cash flows

4. Notes to the financial statements

Content
1. Balance Sheet

2. Income Statement and Corporate tax rates

FINANCIAL
STATEMENT

3. Statement of Cash flows

4. Notes to the financial statements

1. Balance sheet
Balance sheet: Financial statement showing a firm’s accounting value on
a particular date.

Snapshot
=> Firm’s
position

Figure. The balance

sheet (Ross et.al, 2017)

The balance sheet identity:

Assets = Liabilities + Shareholders’ equity
1. Balance sheet
Asset
1. Balance sheet
Asset
• The assets in the balance sheet are listed in
order of decreasing liquidity (the most liquid
assets are listed first)
• Liquidity refers to the speed and ease with
which an asset can be converted to cash
- A highly liquid asset can be quickly sold
without significant loss of value.
- An illiquid asset cannot be quickly converted
to cash without a substantial price reduction.
 1. Balance sheet
Asset
• The numbers shown on the balance sheet for the firm’s assets are book values
• They are based on historical cost
• They are NOT what the assets are actually worth

Book value Accounting rule

Riskiness &
Market value Cashflow

When we say the goal of the financial manager is to increase the value of
the stock, is it book value or market value?
 1. Balance sheet
Liabilities and
Equity
1. Balance sheet
Liabilities and Equity
Shareholders’ equity = Assets - Liabilities

If a firm borrows money, it usually gives the first claim to the firm’s cash
flow to creditors => If the firm sells its assets and pays its debts, whatever
cash is left belongs to the shareholders

Debt Equity
1. Balance sheet
Liabilities and Equity
Some important concepts:

• Retained earnings: Earnings are not paid out as dividends

• Common stock: Equity claims held by the “residual owners” of the firm
who are the last to receive any distribution of earnings or assets.

• Preferred stock: A type of stock whose holders are given certain priority
over common stockholders in the payment of dividends. Usually the
dividend rate is fixed at the time of issue and no voting rights are given.
1. Balance sheet
The balance sheet identity: Assets = Liabilities + Shareholders’ equity
Asset Current asset Asset has a life of less than one year. This means that
(Working capital) the asset will convert to cash within 12 months

Fixed asset Asset has a relatively long life

(Non-current asset) - Tangible assets, such as machinery and equipment.
- Intangible assets, such as patents and trademarks.
Liability Liability Current liability: A debt has a life of less than one year
and (meaning they must be paid within the year)
Equity Long-term liability: A debt is not due in the coming year
Shareholders’ The difference between the total value of the assets
equity (common and the total value of the liabilities
equity or owners’
equity)
1. Balance sheet
Net working capital = Current assets – Current liabilities
 1. Balance sheet

Potential creditors?

Who looks at the balance

sheet and for what reason?
Suppliers?

Investors?

Managers?
Content
1. Balance Sheet

2. Income Statement and Corporate tax rates

FINANCIAL
STATEMENT

3. Statement of Cash flows

4. Notes to the financial statements

2. Income statement
Income statement: Financial statement summarizing a firm’s performance
over a period of time.

Video recording
=> Firm’s
performance

The income statement identity:

Net income =
Total revenue/sales - Total expenses
2. Income statement
Accounting principles:

The recognition or realization The matching principle: revenues is

principle: revenue is recognized at first recognized by the recognition
the time of sale, which need not be principle and then match those
the same as the time of collection. revenues with the costs associated
with producing them

Income statement may not be at all representative of the

actual cash inflows and outflows
 2. Income statement

Gross profit/
Total sales Cost of good sold
Gross margin

Selling, general,
Gross profit/ Depreciation &
Operating income and administrative
Gross margin Amortization
expenses + R&D

Earning before
Other income
interest and taxes Operating income
(if available)
(EBIT)

Net income EBIT Interest expense Taxes

2. Income statement
Operating expense is an expense that a business incurs through its normal
business operations, including:
• Cost of goods sold
• Selling and administrative expenses
• Research and Development cost
• Depreciation
• Interest expense

Capital expenditures (CapEx) are funds used by a company to acquire, upgrade,

and maintain physical assets such as property, plants, buildings, technology, or
equipment.
 2. Income statement
Noncash items: Expenses charged against revenues that do not directly affect
cash flow
• Depreciation: the accountant’s estimate of the cost of equipment used up in
the production process.
Eg: An asset with a 5-year life and no resale value is purchased for $1,000. If
straight-line depreciation is used, how much will the depreciation expense be
incurred each year?
• Amortization: the process of writing down the value of an intangible asset.

Accounting income Cash flow

2. Income statement

Product costs are reported on the income statement as costs of goods

sold. Eg: raw materials, direct labor expense, and manufacturing
overhead. They include both fixed and variable costs.

Period costs are incurred during a particular time period. Eg: selling,
general, and administrative expenses. Some of these period costs may
be fixed and others may be variable.
2. Income statement
Corporate tax in Vietnam (Last reviewed – January 2022)

Enterprise Tax rate

Standard corporate income tax rate 20%
Enterprises operating in the oil and gas industry (depending
32% - 50%
on the location and specific project conditions)
Enterprises engaging in prospecting, exploration, and
exploitation of mineral resources, e.g. silver, gold, gemstones, 40% - 50%
(depending on the project’s location)

Average tax rate: Total taxes paid divided by total taxable income
Marginal tax rate: Amount of tax payable on the next dollar earned
Corporate tax in Vietnam is a flat-rate tax
=> Average tax rate = Marginal tax rate
 2. Income statement
Corporate tax in the United States

Table. Corporate
tax rate in the US
(Ross et.al, 2017)
Average tax rate: Total taxes paid divided by total taxable income
Marginal tax rate: Amount of tax payable on the next dollar earned
Corporate tax in the US is not a flat-rate tax
=> Average tax rate <> Marginal tax rate
Content
1. Balance Sheet

2. Income Statement and Corporate tax rates

FINANCIAL
STATEMENT

3. Statement of Cash flows

4. Notes to the financial statements

3. Statement of Cash flows
Cash flow: The difference between how much cash came in and how much
cash went out
Statement of cash flows: A firm’s financial statement that summarizes its
sources and uses of cash over a specified period.

Statement of cash flows = Sources of cash + Uses/Application of cash

A firm’s activities A firm’s activities in

that generate cash which cash is spent
3. Statement of Cash flows

Sources of Uses of
cash cash

Increase Increase
liability assets

Increase Decrease
equity liability

Decrease Decrease
assets equity
 3. Statement of Cash flows
All the changes in cash are grouped into three categories:

Category Operating activities Investing activities Financing activities

Cash generated from

Cash generated from acquisition,
Cash generated from
Definition a firm’s normal construction, disposal
activities that cause
business activities and sale of long-term
changes in the size
that are not assets and other
and structure of a
investment or investments that are
firm’s capital
financing activities not classified as cash
equivalents
3. Statement of Cash flows
3. Statement of Cash flows

Indirect appoarch Direct appoarch

 3. Statement of Cash flows

Cash flow identity:

Cash flow from asset = Cash flow to creditors + Cash flow to stockholders

Free cash flow to firm = Operating cash flow (OCF) – Net capital spending – Change in net operating working capital

Cash flow that results The amount spent

Cash that firm is free to from the firm’s day- on net operating
distribute to creditors and to-day activities of Net spending working capital
stockholders because it is not producing and selling on fixed assets
needed for fixed assets or
working capital investments
31
 3. Statement of Cash flows

• Operating cash flow (OCF): Cash flow that results from the firm’s day-to-day
activities of producing and selling. It tells us, on a basis level, whether a
firm’s cash inflows from its business operations are sufficient to cover its
everyday cash outflows.
• Formula
OCF = EBIT + (Depreciation + Amortization) – Taxes

it’s not a cash outflow

(noncash expense)
 3. Statement of Cash flows
• Net capital spending (CAPEX) is just money spent on fixed assets less money received from the sale of
fixed assets
Net capital spending = Ending net fixed assets – (Beginning net fixed assets – Depreciation)

money spent on the actual net fixed assets at the net fixed assets at year’s end if the
fixed assets during year’s end when the firm firm didn’t purchase any new fixed asset
the year purchase any new fixed asset
Exclude assets that are Exclude liabilities that
not used for operating are treated as
purposes. Eg: market financing expenses.
• Change in net operating working capital securities Eg: note payables

Net operating working capital: NOWC = Operating current assets - Operating current liabilities.
Change in net working capital:
Change in NOWC = Ending NOWC – Beginning NOWC
3. Statement of Cash flows

• Cash flow to creditors/ bondholders

Cash flow to creditors = Interest paid – Net new borrowing

• Cash flow to owners/ stockholders

Cash flow to stockholders = Dividends paid – Net new equity raised
3. Statement of Cash flows
Content
1. Balance Sheet

2. Income Statement and Corporate tax rates

FINANCIAL
STATEMENT

3. Statement of Cash flows

4. Notes to the financial statements

4. Notes to the financial statements

Notes to the financial statements: Disclose the detailed assumptions

made by accountants when preparing a company’s: balance
sheet, income statement, statement of cash flows.
The notes are essential to fully understanding these documents.
References
Textbooks:
- Ross, S., Westerfield, R. and Jordan, B. (2010). Chapter 2. Financial
Statements, Taxes, and Cash Flow. Fundamentals of Corporate Finance
(10th edition). New York: McGraw-Hill/Irwin
- Block, S., Hirt, G. and Danielsen, B. (2009). Chapter 2. Review of
Accounting. Foundations of Financial Management (16th edition). New
York: McGraw-Hill/Irwin