ch03 fin statements cash flows

7/29/2019 Ch03 Fin Statements Cash Flows

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Chapter 3

UNDERSTANDING

FINANCIAL STATEMENTS

& CASH FLOWS

3-0 2011 Pearson Prentice Hall. All rights reserved.


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Slide Contents

1. The Income Statement

2. The Balance Sheet

3. Measuring Cash Flows


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1. The Income Statement

It is also known as Profit/Loss Statement

It measures the results of firms operation over aspecific period.

The bottom line of the income statement shows thefirms profit or loss for a period.

Sales Expenses = Profits


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Income Statement Terms

Revenue (Sales)

Money derived from selling the companys product or service

Cost of Goods Sold (COGS)

The cost of producing or acquiring the goods or services to be sold

Operating Expenses

Expenses related to marketing and distributing the product or

service and administering the business

Financing Costs The interest paid to creditors

Tax Expenses

Amount of taxes owed, based upon taxable income


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Figure 3-1 (cont.)



Common-sizeIncome Statement

Common-size income statement restates the

income statement items as a percentage of

sales.

Common-size income statement makes it

easier to compare trends over time and

across firms in the industry.



Table 3-2



Profit-to-Sales analysis from

Common-size income statement

See Table 3-2

Gross profit margin (or percentage of

sales going towards gross profit) is 23.3% Operating profit margin (or percentage

of sales going towards operating profit) is

12.5%

Net profit margin (or percentage of salesgoing towards net profit) is 7%



2. The Balance Sheet

The balance sheet provides a snapshot of a firmsfinancial position at a particular date.

It includes three main items: assets, liabilities and

equity. Assets (A) are resources owned by the firm

Liabilities (L) and owners equity (E) indicate how thoseresources are financed

A = L + E

The transactions in balance sheet are recordedhistorically at cost price, BV current market value.



Figure 3-3


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Current assetscomprise assets that are relativelyliquid, or expected to be converted into cash within

12 months. Current assets typically include:

Cash

Accounts Receivable (payments due from customers who

buy on credit)

Inventory (raw materials, work in process, and finished

goods held for eventual sale)

Other assets (ex.: Prepaid expenses are items paid for in

advance)

Balance Sheet Terms: Assets


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Fixed Assets

assets that will be used for 1 year.

Machinery and equipment

Buildings

Land

Other Assets

long-term investments

intangible assets (patents, copyrights, and goodwill)

Balance Sheet Terms: Assets


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Debt (Liabilities)

Money that has been borrowed from a creditor

and must be repaid at some predetermined date. Debt could be current(must be repaid within

twelve months) orlong-term(repayment time

exceeds one year).

Balance Sheet Terms:Liabilities


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Current Debt:

Accounts payable (Credit extended by suppliers to a firm

when it purchases inventories)

Accrued expenses (Short term liabilities incurred in the firmsoperations but not yet paid for)

Short-term notes (Borrowings from a bank or lending

institution due and payable within 12 months)

Long-Term Debt Borrowings from banks and other sources for more than 1

year

Balance Sheet Terms:Liabilities


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Equity:Shareholders investment in the firm in the form ofpreferred stock and common stock. Preferred stockholdersenjoy preference with regard to payment of dividend andseniority at settlement of bankruptcy claims.

Treasury Stock:Stock that have been re-purchased by thecompany.

Retained Earnings:Cumulative total of all the net income overthe life of the firm, less common stock dividends that have been

paid out over the years. Note retained earnings are not equal tohard cash!

Balance Sheet Terms:Equity


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Balance Sheet: A = L + E

ASSETS (A)

Current Assets

Fixed Assets

Total Assets

LIABILITIES (L) Current Liabilities

Long-Term Liabilities

Total Liabilities

OWNERS EQUITY (E) Preferred Stock

Common Stock Retained earnings

Total Owners Equity

Total liabilities + Equity


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Net Working Capital

NWC = Current assets current liabilities

Larger the net working capital, better the firmsability to repay its debt

Net working capital can be or0 or

An increase in net working capital may not alwaysbe good news. For example, if the level ofinventory goes up, current assets will increaseand thus net working capital will also increase.However, increasing inventory level may well be asign of inability to sell.


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Debt Ratio

Debt ratio is the percentage of assets thatare financed by debt.

Debt ratio is an indication of financialrisk. Generally, higher the ratio, the morerisky the firm is, as firms have to pay

interest on debt regardless of the earningsor cash flow situation.


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3. Measuring Cash Flows

Profits in the financial statements are

calculated on accrual basis rather than

cash basis What is accrual basis?

Thus profits are not equal to cash.


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Accrual Basis Accounting

Accrual basis is the principle of recording

1) revenues when earned (include credit sales)

2) expenses when incurred (include credit purchases)

rather than when cash is received or paid. Thus sales revenue recorded in the income statement

includes both cash and credit sales.

Treatment oflong-term assets: written off every year as depreciation expense.


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Figure 3-6


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Three sources of cash flows

Cash flows from Operations(ex. Sales revenue, labor expenses)

Cash flows from Investments(ex. Purchase of new equipment)

Cash flows from Financing(ex. Borrowing funds, payment of dividends)


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Three sources ofcash flows (cont.)

If we know the cash flows from

operations, investments and financing

=>we can understand the firms cashflow position better, that is, how cash

was generated and how it was used.


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Income Statement Conversion:From Accrual to Cash Basis

Two steps:

Add back depreciation (as it is a non-

cash expense) to net income Subtract any uncollected sales (i.e.

increase in accounts receivable) and cash

payment for inventories (i.e. increase in

inventories less increase in accounts

payables)


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Figure 3-7


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Table 3-5

Table 3 6


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Table 3-6


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Table 3-7


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Figure 3-2 (cont.)


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Figure 3-4


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Table 3-4


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3 35

TUTORIAL

Please prepare answers for thefollowing STUDY PROBLEMS before

attending tutorial next week:

CHAPTER 2

2.1, 2.4 & 2.5 CHAPTER 3

3.3 & 3.5

ch03 fin statements cash flows

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