© 2009 Cengage Learning/South-Western

Financial Statement and Cash Flow Analysis

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Financial Statements

Accrual-based

approach

• Revenues are recorded at the point of sale and costs when they are incurred, not necessarily when a firm receives or pays out cash.

Cash flow approach

• Used by financial professionals to focus attention on current and prospective inflows and outflows of cash.

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Financial Statements

Statement ofRetained Earnings

Balance Sheet

Income Statement

Statement ofCash Flows

Notes toFinancial Statements

Financial Statemen

ts

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Balance Sheet

• A firm’s balance sheet presents a “snapshot” view of the company’s financial position at a specific point in time.assets = liabilities + stockholders’ equity

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Balance Sheet for Global Petroleum Corporation

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Income Statement

• Income is also called profit, earnings, or margin.

Income = revenue expenses

Measures of Income

• Gross profit• Operating profit• Other income• Earnings before interest and

taxes• Pretax income• Net income / net profit after

taxes

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Income Statement for Global Petroleum Corporation

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Statement of Retained Earnings

• The statement of retained earnings reconciles

• the net income earned during a given year, and any cash dividends paid,

• with the change in retained earnings between the start and end of that year.

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Statement of Retained Earningsfor Global Petroleum Corporation

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Financial Statements

Statement of Cash Flows

• Reconciles• the firm’s operating,

investment, and financing cash flows

• with changes in its cash and marketable securities

• during the year.

Notes to Financial

Statements

• Explanatory notes • that provide detailed

information on the accounting policies, calculations, and transactions

• underlying entries in the financial statements.

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Cash Flow Analysis

• Although financial managers are interested in the information contained in the firm’s accrual-based financial statements, their primary focus is on cash flows.

• Without adequate cash to pay obligations on time, to fund operations and growth, and to compensate owners, the firm will fail.

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The Firm’s Cash Flows

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Free Cash Flow

• Operating cash flow= earnings before interest and taxes

taxes+ depreciation

• Free cash flow= operating cash flow

change in gross fixed assets change in current assets+ change in account payables+ change in accrued liabilities

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Inflows and Outflows of Cash

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Statement of Cash Flows for Global Petroleum Corporation

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Analyzing Financial PerformanceUsing Ratio Analysis

Liquidity Ratios

• Measure a firm’s ability to satisfy its short-term obligations as they come due.

Activity Ratios

• Measure the speed at which a firm converts various accounts into sales or cash.

Debt Ratios• Measure the proportion of total assets

financed by a firm’s creditors.

Profitability Ratios

• Relate a firm’s earnings to its sales, assets, or equity.

Market Ratios

• Relate a firm’s market value to certain accounting values.

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Using Financial Ratios

Benchmark 1

• Analysts compare the current year’s financial ratios with previous years’ ratios

• to identify trends that help them evaluate the firm’s prospects.

Benchmark 2

• Analysts compare the ratios of one company with those of other firms in the same industry.

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Liquidity Ratios

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Activity Ratios

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Debt Ratios

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Profitability Ratios

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Profitability Ratios

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Profitability Ratios

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Corporate Taxes

Corporate taxes represent a significant cash outflow.

Ordinary corporate income

• Progressive tax rate schedule• Average tax rate: tax divided

by the pretax income• More relevant for financial

decision making: marginal tax rate

Corporate capital gains

• Under existing tax laws, ordinary income tax rates apply

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Financial Statement and Cash Flow Analysis

• Balance Sheet

• Income Statement

• Cash Flow Analysis

• Liquidity Ratios

• Activity Ratios

• Debt Ratios

• Profitability Ratios

• Market Ratios