Financial Statements, Taxes, and

Cash Flow
Chapter 2
FIN311 – Financial Management
Instructor: Lin Tan

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 Key Concepts and Skills
 Know the difference between book value and
market value
 Know the difference between accounting income

and cash flow

 Know the difference between average and

marginal tax rates

 Know how to determine a firm’s cash flow from

its financial statements

2.2
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 Chapter Outline
 The Balance Sheet
 The Income Statement

 Taxes

 Cash Flow

2.3
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 The Balance Sheet
 The balance sheet is a snapshot of the firm’s
assets and liabilities at a given point in time
 Assets are listed in order of liquidity

 Ease of conversion to cash

 Without significant loss of value

 Balance Sheet Identity

 Assets = Liabilities + Stockholders’ Equity

2.4
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 Figure 2.1

2.5
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 US Corporation Balance Sheet –
Table 2.1

2.6
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 Market vs. Book Value
 The balance sheet provides the book value of the
assets, liabilities and equity.
 Market value is the price at which the assets,
liabilities or equity can actually be bought or
sold.
 Market value and book value are often very
different. Why?
 Which is more important to the decision-making
process?
2.7
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 Klingon Corporation
KLINGON CORPORATION
Balance Sheets
Market Value versus Book Value
Book Market Book Market
Assets Liabilities and Shareholders’
Equity
NWC $ 400 $ 600 LTD $ 500 $ 500
NFA 700 1,000 SE 600 1,100
1,100 1,600 1,100 1,600
2.8
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 Income Statement
 The income statement is more like a video of the
firm’s operations for a specified period of time.
 You generally report revenues first and then

deduct any expenses for the period

 Matching principle – GAAP say to show

revenue when it accrues and match the expenses

required to generate the revenue

2.9
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 Table 2.2

2.10
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 Work the Web Example
 Publicly traded companies must file regular
reports with the Securities and Exchange
Commission
 These reports are usually filed electronically
and can be searched at the SEC public site
called EDGAR
 Click on the web surfer, pick a company and see
what you can find!

2.11
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 Taxes
 The one thing we can rely on with taxes is that
they are always changing
 Marginal vs. average tax rates

 Marginal – the percentage paid on the next

dollar earned
 Average – the tax bill / taxable income

 Other taxes

2.12
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 Example: Marginal Vs. Average
Rates
 Suppose your firm earns $150,000 in taxable
income.
 What is the firm’s tax liability?

 What is the average tax rate?

 What is the marginal tax rate?

2.13
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 Example: Average and Marginal Tax
Rate
 Example: Suppose taxable income is $150,000. What are the
average tax rate and the marginal tax rate?
 .15(50,000) = 7,500
 .25(25,000) = 6,250
 .34(25,000) = 8,500
 .39(50,000) = 19,500
 Total 41,750
 Average tax rate = 41,750 / 150,000 = 27.8%

 Marginal tax rate = 39%

2.14
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 The Concept of Cash Flow
 Cash flow is the differnce between the number of
dollars that came in and the number that went out. It
is one of the most important pieces of information
that a financial manager can derive from financial
statements.
 The statement of cash flows does not provide us with

the same information that we are looking at here

 We will look at how cash is generated from utilizing

assets and how it is paid to those that finance the

purchase of the assets
2.15
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 Table 2.5

2.16
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 Example: US Corporation
 OCF (I/S)—operating cash flow
= EBIT + depreciation – taxes
= 694 + 65 - 212
= $547 --- (1)
 NCS ( B/S and I/S) –net capital spending

= ending net fixed assets – beginning net fixed assets + depreciation

= 1709 – 1644 + 65
= $130 ---(2)
 Changes in NWC (B/S) –net working capital

= ending NWC – beginning NWC

= (1403 - 389) – (1112 - 428)
= $330 ---(3)
 CFFA – cash flow from assets

= OCF – NCS - change in NWC

= (1) – (2) –(3)
= 547 – 130 – 330
= $87

 CF to Creditors (B/S and I/S) = 70 – (454- 408) interest paid – net new borrowing = $24
 CF to Stockholders (B/S and I/S) = dividends paid – net new equity raised = 103 –(640-600) =$63
 CFFA = 24 + 63 = $87

2.17
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