Financial Statement and

Cash Flow Analysis

Chapter 2

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 What Companies Do

Financial Signs of an Improving Economy

• One indicator of a recovering economy is a
decrease in the time it takes customers to pay
their bills.
• A study conducted by REL, a consulting firm,
and CFO Magazine found a 5.1 day decrease in
DSO from 2007 to 2008.

Source: “Working It Out: The 2010 Working Capital Scorecard,” by David M. Katz, CFO Magazine, June 1, 2010, CFO.com,
www.cfo.com/article.cfm/14499542

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 What CFOs Do

CFO Survey Evidence

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 Financial Statements

• Revenues are recorded at the point of

Accrual-based sale and costs when they are incurred,
approach not necessarily when a firm receives or
pays out cash.

• Used by financial professionals to focus

Cash flow attention on current and prospective
approach inflows and outflows of cash.

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 Financial Statements

Balance Sheet

Income Statement

Financial Statement of
Retained Earnings
Statements
Statement of
Cash Flows

Notes to
Financial Statements
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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

• Gross profit
• Operating profit
Measures of
• Other income
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 Earnings
for Global Petroleum Corporation

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 What Companies Do Globally

Assessing the Market Value of Global Brands

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 What CFOs Do

CFO Survey Evidence

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 Financial Statements

• Reconciles
• the firm’s operating, investment,
Statement of and financing cash flows
Cash Flows • with changes in its cash and
marketable securities
• during the year.

• Explanatory notes
Notes to • that provide detailed information on
Financial the accounting policies, calculations,
Statements 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
• Net Operating Profit After Tax (NOPAT) = EBIT x (1-t)
• t= tax rate (%)
• Operating cash flow (OCF) = EBIT - T + D
= earnings before interest and taxes (EBIT)
 taxes (T) = EBIT x t
+ depreciation (D)
• Free cash flow (FCF) = OCF - Δ FA - Δ NWC
= operating cash flow (OCF)
 change in gross fixed assets – Δ FA
 change in current assets
+ change in account payables - Δ NWC
+ change in accrued liabilities
NWC – Net Working Capital
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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 Performance
Using 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.

• Measure the proportion of total assets

Debt Ratios
financed by a firm’s creditors.

Profitability • Relate a firm’s earnings to its sales,

Ratios assets, or equity.

• Relate a firm’s market value to certain

Market Ratios
accounting values.
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 Using Financial Ratios

• Analysts compare the current year’s

Benchmark financial ratios with previous years’ ratios
1 • to identify trends that help them evaluate
the firm’s prospects.

• Analysts compare the ratios of one company

Benchmark with those of other firms in the same
2 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
DuPont System of Analysis

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 Market Ratios

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 Corporate Taxes

Corporate taxes represent a significant cash

outflow.

• Progressive tax rate schedule

Ordinary • Average tax rate: tax divided by
corporate the pretax income
income • More relevant for financial
decision making: marginal tax rate

Corporate • Under existing tax laws, ordinary

capital income tax rates apply
gains
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 Table 2.6
Corporate Income Tax Rates

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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
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