managerial finance exam
nimab8
Ch2Balancesheetsincomestatementscashflows.pptxDr. Ekaterina Chernobai
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FRL 3000
Instructor: Dr. Ekaterina Chernobai
Chapter 2 “Financial Statements”
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Dr. Ekaterina Chernobai
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In Chapter 2:
Review “Balance Sheets”
Review “Income Statements”
“Cash inflow” vs. “cash outflow”
Dr. Ekaterina Chernobai
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Financial statements – big picture (1 of 2)
Firms regularly prepare financial statements that illustrate their profits, costs, loans, value of all assets, …
Individuals
What is my house worth now?
How much do I still owe in credit card bills? Student loans? Home loan?
How much did I earn this month?
How much did I spend this month?
How much did I save this month?
Firms
What are Firm’s assets worth now?
How much does Firm owe to long-term creditors & suppliers?
How much did Firm earn this month?
How much did Firm spend this month?
How much profit did Firm make this month?
At a point of time
Over a period of time
A financial statement prepared by a Firm every year that shows a snapshot of its financial situation is called “Balance Sheet”
A financial statement prepared by a Firm every year that shows its activities during the past 1 year is called “Income Statement”
Dr. Ekaterina Chernobai
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Financial statements – big picture (2 of 2)
time line
Jan. 1, 2019
Jan. 1, 2018
Jan. 1, 2017
Jan. 1, 2016
“AT A POINT OF TIME”
…
“OVER A PERIOD OF TIME”
Dr. Ekaterina Chernobai
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Balance Sheet (1 of 14)
Balance Sheet
Assets
Liabilities & Equity
How much are all of Firm’s assets worth?
How much does the Firm owe in debt?
What is Firm’s “net worth”?
“Equity” =
If the Firm were to sell all of its assets & pay off all of its debt, how much would be left?
Dr. Ekaterina Chernobai
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Balance Sheet (2 of 14)
Balance Sheet Identity:
Assets ($) = Liabilities ($) + Equity ($)
The Balance Sheet “balances” because the $$$ on the left-hand side is always equal to the $$$ value on the right-hand side
Dr. Ekaterina Chernobai
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Balance Sheet (3 of 14)
Assets
Liabilities & Equity
How much are all of Firm’s assets worth?
How much does the Firm owe in debt?
What is Firm’s “net worth”?
Assets
current
fixed
1.) cash
2.) inventory
3.) accts receivable
1.) tangible
- buildings
- computers
- etc.
2.) intangible
- patents
- etc.
= cash, or can be converted into cash within 1 year
Dr. Ekaterina Chernobai
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Balance Sheet (4 of 14)
current assets
fixed assets
Dr. Ekaterina Chernobai
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Balance Sheet (5 of 14)
Assets
Liabilities & Equity
How much are all of Firm’s assets worth?
How much does the Firm owe in debt?
Liabilities
current
long-term
1.) accts payable
2.) notes payable
1.) long-term debt
= will be paid off within 1 year
What is Firm’s “net worth”?
Dr. Ekaterina Chernobai
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Balance Sheet (6 of 14)
current liabilities
long-term liabilities
Dr. Ekaterina Chernobai
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Balance Sheet (7 of 14)
Levered firm = a Firm with debt in its capital structure
Unlevered firm = a Firm without debt in its capital structure
Firm’s profits
Loan
The use of debt is known as financial leverage
Dr. Ekaterina Chernobai
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Balance Sheet (8 of 14)
Assets
Liabilities & Equity
How much are all of Firm’s assets worth?
How much does the Firm owe in debt?
What is Firm’s “net worth”?
Equity
= Shareholders’ equity
= Stockholders’ equity
= Common equity
= Owners’ equity
1.) part of Equity –-- total $ received when stock shares were first sold
(“common stock & paid-in surplus”)
2.) part of Equity –-- total $ retained by Firm & reinvested into its projects (“retained earnings”)
Dr. Ekaterina Chernobai
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Balance Sheet (9 of 14)
equity
Dr. Ekaterina Chernobai
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Balance Sheet (10 of 14)
Net Working Capital = Current Assets – Current Liabilities
Means: The cash that will become available over the next 12 months, less money that needs to be paid off over the next 12 months
Having a positive NWC is a good thing, because it indicates that Firm maintains healthy operations. But – like with too many liquid assets – too high NWC may not be smart!
Cash
Inventory
Accounts receivable
Short-term loans
Accounts payable
Dr. Ekaterina Chernobai
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Balance Sheet (11 of 14)
What is Net Working Capital (NWC) in 2011?
Solution:
NWC = ____________
= ____________
EXAMPLE
1,112 – 428
684
Dr. Ekaterina Chernobai
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Balance Sheet (12 of 14)
Book Value
Market Value
Dr. Ekaterina Chernobai
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Balance Sheet (13 of 14)
= What the Balance Sheet shows for assets, liabilities, and equity, based on the Generally Accepted Accounting Principles (GAAP)
= Historical costs
E.g., book value of equity is the price per share when shares were first sold by the Firm, times the total # of shares issued at that time
BOOK VALUE
MARKET VALUE
= Not in the Balance Sheet!
= The price at which the assets, liabilities, or equity can actually be bought or sold today
E.g., Each share was originally issued for $80 each. Total of 10,000 shares sold. Equity in Firm’s Balance Sheet is $800,000
E.g., each share is now worth $95. Total of 10,000 shares outstanding. Market value of shares is $950,000
Dr. Ekaterina Chernobai
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Balance Sheet (14 of 14)
| KLINGON CORPORATION | |||||
| Balance Sheets | |||||
| Book Value versus Market Value | |||||
| Book | Market | Book | Market | ||
| Assets | Liabilities and Shareholders’ Equity | ||||
| Current | $ 400 | $ 600 | Liabilities | $ 500 | $ 500 |
| Fixed | 700 | 1,000 | Equity | 600 | 1,100 |
| 1,100 | 1,600 | 1,100 | 1,600 |
Company has grown…
Stock shares are worth a lot more now than when they were first issued…
Dr. Ekaterina Chernobai
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Income Statement (1 of 6)
Income Statement
= A financial statement prepared by a Firm that shows its performance over a period of time (usually 1 quarter or 1 year)
time line
Jan. 1, 2019
Jan. 1, 2018
Jan. 1, 2017
Jan. 1, 2016
…
“OVER A PERIOD OF TIME”
Dr. Ekaterina Chernobai
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Income Statement (2 of 6)
Income Statement
This financial statement shows how Firm’s income (i.e., profit) is calculated for a particular year
By definition,
income (or profit) = revenues – expenses
Dr. Ekaterina Chernobai
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An Income Statement for a 1-year period:
–
–
–
–
=
=
=
Income Statement (3 of 6)
Income, or profit
revenue
expenses
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Dr. Ekaterina Chernobai
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Income Statement (4 of 6)
According to the Generally Accepted Accounting Principles (GAAP), income statements should show revenues & costs when they accrue – not necessarily when the money is actually received/spent
There may be mismatch between when $$$ is actually received & paid
Example: Firm sells $500,000 worth of products
Sales were made to customers who bought on credit
“Net Sales” in Income Statement shows $500,000, even though the money is not yet received!
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Dr. Ekaterina Chernobai
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Income Statement (5 of 6)
Income Statement contains a noncash item
Firms are allowed to expense a purchased fixed asset gradually over time. This spreads the cost of the asset over its serviceable life.
Example:
Firm paid $650m for equipment. Its useful life is 10 years. Then, annual depreciation = $65m. $650m worth of assets get added to balance sheet, and $65m enters income statement as “depreciation” for 10 years for tax purposes
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Dr. Ekaterina Chernobai
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Income Statement (6 of 6)
EXAMPLE
“Corner Bakery” has sales of $687,000 with costs of $492,000. Interest expense is $26,000 and depreciation is $42,000. The corporate income tax rate is 35 percent.
What is the net income?
Solution:
Sales $687,000
- Costs 492,000
- Depreciation 42,000
= EBIT 153,000
- Interest 26,000
= Taxable income 127,000
- Taxes $127,000 x 35% = 44,450
= Net income 82,550
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Dr. Ekaterina Chernobai
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Cash flows from assets (1 of 3)
Cash inflow = $$$ received in some year
Cash outflow = $$$ spent in some year
And so it is important to realize that we may have “non-cash items” in our financial statements! Remember “Depreciation”??
Question: What is a “cash flow”?
Answer: It is $$$ actually received or spent in some year
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Dr. Ekaterina Chernobai
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Cash flows from assets (2 of 3)
From the Balance Sheet:
Assets Liabilities & Equity
Liabilities
Assets
Equity
cash flow identity
Cash flows from assets
Cash flows to creditors
Cash flows to stockholders
=
+
“cash inflow”
“cash outflow”
“cash outflow”
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Dr. Ekaterina Chernobai
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Cash flows from assets (3 of 3)
“Cash flow from assets” is also known as “free” cash flow
Idea: The Firm is “free” to distribute it between creditors and stockholders
Ch.10: How do we calculate
“Cash Flow from Assets”?
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Dr. Ekaterina Chernobai
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Example
EXAMPLE
1) Which items belong to a Balance Sheet? Income Statement?
_________________________________________________________
2) What is the net working capital in 2011?
=__________________________________________________________
3) What tax rate was used to compute Taxes in 2011?
____________________________________________________________
____________________________________________________________
Income Statement: first four & last. Balance Sheet: the rest
Cash+accts rec.+inventory–current liab.=313+1,162+1,521-1,051=1,945
Taxable Income = Sales–COGS–Deprec.–Interest
=6,423-4,109-122-280 = 1,912 Tax rate=Taxes/Tax.Inc.=670/1,912 =35%
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Dr. Ekaterina Chernobai
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Summarize
2 financial statements regularly reported by Firms:
(1) Balance Sheets (“at a point of time”, “snapshot”)
(2) Income Statements (“over a period of time”)
Cash Flow from Assets (a.k.a. “free cash flow”)
Cash Flow from Assets = Cash Flow to Creditors + Cash Flow to Stockholders
Ch.10: How do we calculate
“Cash Flow from Assets”?
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