Balanced scorecard slide 1

WELCOME
CORPORATE
FINANCE 2020
VO AN HAI, MSc.
Chapter 3: Financial Statements,
Cash Flows, and Taxes
LEARNING OBJECTIVES
1. Explain the balance sheet identity and why a
balance sheet must balance.
Understanding the financial statements and
2.whyDescribe how market-value balance
it is important sheets
differ from book-value balance sheets.

3. Identify the basic equation for the income

Understanding the balance sheet, income
statement and the information it provides.
statement and cash flows in details

4. Understand the calculation of cash flows

from operating, investing, and financing
activities required in the statement of cash
flows.

5. Explain how the four major financial

statements discussed in this chapter are
related.

6. Identify the cash flow to a firm’s investors

using its financial statements. 3
 Financial Statements
Purpose of financial statements

FINANCIAL HEALTH CASH FLOWS

CURRENT CONDITIONS COMPANY’S FINANCIAL

PERFOMANCE
Financial Statements
 1. THE BALANCE SHEET
Balanced
$10,000 scorecard
$10,000
slide$34,000
4 $34,000

ASSETS LIABILITIES ASSETS LIABILITIES

$7,000
$1,000
$9,000
$5,000

$2,000 EQUITY $2,000

$20,000

EQUITY
$1,000
$5,000
$1,000

03/11/2025 $30,000 $5,000 6

 1. THE BALANCE SHEET
Balanced
ASSETS
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LIABILITIES

EQUITY

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The Balance Sheet

ASSETS
CURRENT ASSETS

LONG-TERM ASSETS
 1. THE BALANCE SHEET
Balanced scorecard slide
Assets = Liabilities 4 Equity
+ Shareholders’

CURRENT ASSETS: CURRENT LIABILITIES:

- Cash and cash equivalents - Wages
- Account receivable - Account payable
- Inventory LONG-TERM LIABILITIES:
- Long-term debt

ASSETS L + OE

LONG-TERM ASSETS: OWNER’S EQUITY:

- Equipment - Shareholder’s equity
- Land, buildings - Retained earnings
- Intellectual property,
goodwill

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 The Balance Sheet
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Assets = Liabilities + Shareholders’
Equity

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 The Balance Sheet
Current Assets
• Assets likely to be converted to cash within
a year (or one operating cycle)
 marketable securities
 accounts receivable
 Inventory

Current Liabilities
• Liabilities scheduled to be paid within a
year (or one operating cycle)
 accounts payable
 accrued wages
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 debt with less than a year’s maturity
 The Balance Sheet
Net Working Capital
NET WORKING CAPITAL =
TOTAL CURRENT ASSETS – TOTAL CURRENT
LIABILITIES
• Net working capital is a measure of a firm’s
ability to meet its short-term obligations as they
come due.
• One way that firms maintain their liquidity is by
holding more current assets.
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 The Balance Sheet
Net Working Capital Example
• Diaz Manufacturing
 Total current assets = $1,039.8 million
 Total current liabilities = $377.8 million
 Net working capital = Total current assets
- Total current liabilities
 = $1,039.8 million - $377.8 million
 = $662.0 million
 Is is positive or negative?

13
 The Balance Sheet
Inventory Accounting
• Inventory (least liquid current asset) reported using one of two
methods
 The Balance Sheet
Inventory Accounting
• When the cost of inventory is increasing
 FIFO reporting says a firm sold the less expensive inventory and leads to
higher balance in inventory
lower cost-of-goods-sold
higher taxable income
higher income taxes
higher net income
 LIFO reporting says a firm sold the more expensive inventory and leads to
lower balance in inventory
higher cost-of-goods-sold
lower taxable income
lower income taxes
lower net income
 The Balance Sheet
Inventory Accounting
• When the cost of inventory is decreasing
 FIFO reporting says a firm sold the more expensive inventory and leads to
lower balance in inventory
higher cost-of-goods-sold
lower taxable income
lower income taxes
lower net income
 LIFO reporting says a firm sold the less expensive inventory and leads to
higher balance in inventory
lower cost-of-goods-sold
higher taxable income
higher income taxes
higher net income
 The Balance Sheet
Long-Term Assets
• Real Assets
 land
 buildings
 equipment
• Intangible Assets
 goodwill
 patents
 copyrights
 The Balance Sheet
Long-Term Assets
• Real assets decline with use and are depreciated
 Depreciation expense reduces taxable income and income taxes.
 Assets are depreciated using either the straight line or accelerated
depreciation method.

• Intangible assets lose value over time and are amortized

(equivalent to depreciated)
 The Balance Sheet
Long-Term Liabilities
• Long-term debt
 bank loans
 mortgages
 bonds with a maturity longer than one year
 The Balance Sheet
Equity
• Common Stock
 ownership with control in a firm
• Preferred Stock
 ownership without control in a firm
 features make it an equity security that resembles debt
 The Balance Sheet
Other Balance Sheet Accounts
• Retained earnings
 Profit kept and used to acquire assets.
• Treasury stock
 Shares of its own stock a firm holds rather than sell them to the public.
• Additional paid-in capital
 Money an investor pays above and beyond the par value price of a stock
Link: shorturl.at/moxU3
 Market Value vs. Book Value
Recording Asset Value
• Assets are traditionally reported at
historical cost on a balance sheet
• Balance sheet amount does not reflect
current market value – only the
acquisition cost

Past Future

ACCOUNTING FINANCE
 Market Value vs. Book Value
Asset Valuation
• Better information is provided to
management and investors by marking-to-
market — reporting balance sheet items at
current market values
 difficult to determine market values of assets
• The difference between the market values
of assets and liabilities is a realistic
estimate of the market value of
shareholders’ equity
Market Value vs. Book Value
Market Value vs. Book Value

Why the decline in assets?

Why the decline in stockholders’
equity?
 2. THE INCOME STATEMENT
Balanced scorecard slide 3
res the profitability of a firm for a reporting period

nue: Earnings from sale of goods and services,

t, others

nses: cost of good sold, selling and administrative

ses, interest paid on loan,
set utilization (depreciation and amortization)

come = Revenues - Expenses

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Diaz Manufacturing Income
Statements
Diaz Manufacturing Income
Statements
Revenues
Expenses
(1)
Expenses
(2)
(3)
Expenses
(4)
Expenses
(5)
Expenses
(6)(1)
–
(2)+(3)+(4)+(5
)+(6)
Net
income
No. of
shares
outstandi 28
ng
 The Income Statement
Net Income example
• Diaz Manufacturing
 Revenues = $1,563.7 million
 Expenses = $1,445.2 million
 Net Income = Revenues – Expenses
= $1,563.7 million - $1,445.2 million
= $ 118.5 million
 The Income Statement
Depreciation
• The cost of a physical asset, such as plant or
machinery, is written off over its lifetime.
This is called depreciation, a non-cash
expense
• Firms use one of these depreciation
methods
 straight-line depreciation
 accelerated depreciation
Firms may choose to use one for internal purposes and another for tax purposes or
for statements released to the public.
 The Income Statement
Depreciation
• Example:
 On December 9, 2017, you buy a computer for your business and
pay $2,500 in cash. The computer is estimated to have a useful life
of five years. You create an annual depreciation expense of $500 for
the next five years.
 In 2017, you record a depreciation expense of $500 on the income
statement and an investment of $2,500 on the cash flow statement.
 The next year, you must record a depreciation expense of $500 on
the income statement. There is no investment recorded on the cash
flow statement.
 The $500 depreciation in the example above is a noncash expense
as there is no cash outlay but the expense is recognized. The capital
cost of the asset is recorded only once in the cash flow statement.
 The Income Statement
Amortization
• Amortization expense is related to using
intangible assets
 patents
 licenses
Like depreciation, it is a non-cash expense.
 The Income Statement
Extraordinary Item
• Income or expense associated with events
that are infrequent and abnormal
 separated from the results of ordinary income
 shown separately on the income statement
Examples: Gain or losses from flood, fires, earthquakes or accidents.
 The Income Statement
EBITDA and EBIT
• Earnings-before-interest-taxes-
depreciation-and-amortization (EBITDA)
 income from selling goods and services minus the cost of providing them
• Earnings-before-interest-and-taxes
(EBIT)
 EBITDA minus depreciation and amortization
 The Income Statement
EBT and NI
• Earnings-before-taxes (EBT)
 EBIT minus interest expense
 taxable income
• Net income (NI)
 EBT minus taxes
Statement of Retained Earnings
Retained earnings
• Shows cumulative effect of adjustments
to shareholders’ equity resulting from
profit, losses, and paying dividends
• Shows changes in the account for a
period based on profit, loss, or dividend
paid
Diaz Manufacturing Statement
of Retained Earnings
 CASH FLOW STATEMENTS
Balanced scorecard
Summarizes slide
cash outflows and cash inflows8
during a period. There are 3 kinds of c

The first section of the cash flow

statement is cash flow from
operations, which
includes transactions from all
operational business activities.
Cash flow from investment is the
second section of the cash flow
statement, and is the result of
investment gains and losses.

Cash flow from financing is the final

section, which provides an overview
of cash used from debt and equity.

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 Cash Flows
Statement of Cash Flows
• Summarizes cash outflows and cash
inflows during a period
• Cash flows result from operating
activities, investing activities, and
financing activities
• Net cash flows equals cash inflows minus
cash outflows
 Diaz Manufacturing
Statement of Cash Flows

Uses of cash

• Increases in assets
• Decreases in liabilities and equity
• EX: additional inventory, retirement of debt,
purchase of treasury stock, dividend
payment,…

Sources of cash

• Decreases in assets
• Increases in liabilities and equity
• EX: sales of plant assets,
bond/stock insuance…
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 Cash Flows
o STATEMENT OF CASH FLOWS ORGANIZATION
• Operating Activities
cash inflows
– sell goods and services
cash outflows
– raw materials
– inventory
– salaries and wages
– utilities
– rent

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 Cash Flows
o STATEMENT OF CASH FLOWS ORGANIZATION
• Investing Activities
cash outflows and inflows due to
– buying and selling long-term assets such as plant and equipment
– buying and selling bonds and stocks issued by other firms

42
 Cash Flows
o STATEMENT OF CASH FLOWS ORGANIZATION
• Financing Activities
cash inflow
– issue debt
– issue equity
– borrow money
cash outflow
– pay interest or dividends
– repay loan principal
– purchase treasury stock

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Interrelations Among the
Financial Statements
Interrelations Among the
Financial Statements
 Cash Flows
Net Cash Flows versus Net Income
• Accountants focus on net income and
shareholders focus on net cash flows.
These are not the same because of delays
in inflows and outflows, and non-cash
revenues and expenses
 Cash Flows
Cash Flows to investors
• Cash flows available to investors from
operating activities (CFOA)
 CFOA EBIT – Current Taxes
 Noncash expenses (3.4)

- Depreciation and amortization

- Depletion charge (oil,natural gas,
etc)
- Deferred taxes
- Prepaid expenses (rent, insurance)

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 Cash Flows
CFOA Example
• Diaz Manufacturing
 EBIT = $168.4 million
 Current Taxes = $44.3 million
 Non-cash expenses = $83.1 million

CFOA EBIT – Current Taxes  Non - Cash Expenses

$168.4m - $44.3m  $83.1m

$207.2 million

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 Cash Flows
Cash Flows to Working Capital
• To compute the net cash flows into or out
of working capital
CFNWC NWCCurrent Period - NWCPrevious Period (3.5)

NET WORKING CAPITAL = TOTAL CURRENT ASSETS – TOTAL CURRENT

LIABILITIES (3.2)

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 Cash Flows
CFNWC Example
• Diaz Manufacturing
 NWC 2011 = $662.0 million
 NWC 2010 = $342.0 million

CFNWC 2011
NWC 2011
– NWC 2010

$662.0m - $342.0

$320.0 million
What does this number indicate?

50
 Cash Flows
Cash Flows invested in long-term
assets
• To compute the net cash flows
from the purchases and sales of
long-term assets
CFLTA Long - term assetsCurrent Period - Long - term assetsPrevious Period (3.6)

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 Cash Flows
Putting it all together
• CFNWC and CFLTA are subtracted from
CFOA because investments in both net
working capital and long-term assets
reduce the cash flow available to
investors
CFI CFOA - CFNWC - CFLTA (3.7)

Is a negative or positive
number good?
52
SUMMARY
Understanding the financial statements and
why it is important

1. 4 major financial statements.

Understanding the balance sheet, income
2.statement
Marketandvalue vsinBook
cash flows detailsvalue

3. How 4 major financial statements are

related?

4. The cash flows to investors

lated

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 Which of the following is the best
example of how a market-value
balance sheet item differs from the
firm’s book-value balance sheet item?

A) A firm issued long-term bonds five-years ago that currently

sell for par value.
B) A firm sold common stock twenty-years ago for $20.00 share.
The firm’s common stock is currently selling for $96.50 per share.
C) A firm has $5 million of accrued liabilities on the books.
D) A firm issued preferred stock ten-years ago. These shares of
preferred stock currently are selling for par value. 55
During 2008, Towson Recording Company
increased its investment in marketable
securities by $36,845, funded fixed
assets acquisition by $109,455, and had
marketable securities to the tune of
$14,215 mature. What is the net cash
provided (used) in investing activities?

A) $132,085
B) $145,940
C) –$132,085
D) none of the above 56
 Exercise
3.18
3.20
3.21
Balanced scorecard slide 10

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