Ch.

3 - Understanding Financial
Statements and
Cash Flows

* 1
 Income Statement

SALES
- EXPENSES
= PROFIT

* 2
 Income Statement

Revenue
SALES
- EXPENSES
= PROFIT

* 3
 Income Statement

SALES •Cost of Goods Sold

- EXPENSES
= PROFIT

* 4
 Income Statement

SALES •Cost of Goods Sold

•Operating Expenses
- EXPENSES
= PROFIT

* 5
 Income Statement

SALES •Cost of Goods Sold

•Operating Expenses
- EXPENSES (marketing, administrative)
= PROFIT

* 6
 Income Statement

SALES •Cost of Goods Sold

•Operating Expenses
- EXPENSES (marketing, administrative)
= PROFIT •Financing Costs

* 7
 Income Statement

SALES •Cost of Goods Sold

•Operating Expenses
- EXPENSES (marketing, administrative)
= PROFIT •Financing Costs
•Taxes

* 8
 SALES Income Statement
- Cost of Goods Sold
GROSS PROFIT
- Operating Expenses
OPERATING INCOME (EBIT)
- Interest Expense
EARNINGS BEFORE TAXES (EBT)
- Income Taxes
NET INCOME
- Preferred Stock Dividends
- NET INCOME AVAILABLE
TO COMMON STOCKHOLDERS
* 9
 SALES Income Statement
- Cost of Goods Sold
GROSS PROFIT
- Operating Expenses
OPERATING INCOME (EBIT)
- Interest Expense
EARNINGS BEFORE TAXES (EBT)
- Income Taxes
NET INCOME
- Preferred Stock Dividends
- NET INCOME AVAILABLE
TO COMMON STOCKHOLDERS
* 10
 SALES Income Statement
- Cost of Goods Sold
GROSS PROFIT
- Operating Expenses
OPERATING INCOME (EBIT)
- Interest Expense
EARNINGS BEFORE TAXES (EBT)
- Income Taxes
NET INCOME
- Preferred Stock Dividends
- NET INCOME AVAILABLE
TO COMMON STOCKHOLDERS
* 11
 Balance Sheet

Outstanding
Debt
Total Assets =
+
Shareholders’
Equity

* 12
 Balance Sheet

* 13
 Balance Sheet
Assets

* 14
 Balance Sheet
Assets Liabilities (Debt) & Equity

* 15
 Balance Sheet
Assets Liabilities (Debt) & Equity
Current Assets Current Liabilities
Cash Accounts Payable
Marketable Securities Accrued Expenses
Accounts Receivable Short-term notes
Inventories Long-Term Liabilities
Prepaid Expenses Long-term notes
Fixed Assets Mortgages
Machinery & Equipment Equity
Buildings and Land Preferred Stock
Common Stock (Par value)
Other Assets
Paid in Capital
Investments & patents
Retained Earnings
* 16
 Free Cash Flows
Free cash flow: cash flow that is free and
available to be distributed to the firm’s
investors (both debt and equity investors)

* 17
 Free Cash Flows
Firm’s Operating Firm’s Financing
Free cash flows = Free cash flows

Cash flows generated Cash flows paid to - or

through the firm’s
operations and
= received by - the
firm’s investors
investments in (creditors &
*
assets stockholders) 18
 Calculating Free Cash Flows:
An Operating Perspective

After-tax cash flow

from operations
less
investment in net
operating
working capital
less
investments in fixed
and other assets
* 19
 Calculating Free Cash Flows:
An Operating Perspective

After-tax cash flow Operating income

from operations + depreciation
less - cash tax payments
investment in net
operating
working capital
less
investments in fixed
and other assets
* 20
 Calculating Free Cash Flows:
An Operating Perspective

After-tax cash flow

from operations
less [Change in current
investment in net assets]
operating -
working capital [change in
less non-interest
investments in fixed bearing current
and other assets liabilities]
* 21
 Calculating Free Cash Flows:
An Operating Perspective

After-tax cash flow

from operations
less
investment in net Change in gross
operating
fixed assets,
working capital
and any other
less assets that are
investments in fixed on the balance
and other assets sheet.
* 22
 Calculating Free Cash Flows:
A Financing Perspective
Interest payments to creditors
plus decrease in debt principal
or
minus increase in debt principal
plus dividends paid to stockholders
plus decrease in stock
or
minus* increase in stock 23