FINANCIAL STATEMENTS

Accounting and Finance

 The Balance Sheet

 The Income Statement
 The Statement of Cash Flows
 Accounting Practice & Malpractice
 Taxes

Financial Statements reflect the financial resuts of the firm.

 The Balance Sheet
Definition
Financial statements that show
the value of the firm’s assets
and liabilities at a particular
point in time
(from an accounting perspective).
 
The Balance Sheet
The Main Balance Sheet Items

Current Assets Current Liabilities

Cash & Securities Payables
Short-term Debt
Receivables
Inventories
+
+
=
Long-term Liabilities
Fixed Assets
Tangible Assets +
Intangible Assets
Shareholders’ Equity
 Market Value vs. Book Value

Book Values are determined by GAAP

Market Values are determined by current

values

Equity and Asset “Market Values” are usually

higher than their “Book Values”
 Market Value vs. Book Value
Example
According to GAAP, your firm has equity worth $6
billion, debt worth $4 billion, assets worth $10
billion. The market values your firm’s 100 million
shares at $75 per share and the debt at $4 billion.
Q: What is the market value of your assets?

A: Since (Assets=Liabilities + Equity), your

assets must have a market value of $11.5
billion.
 Market Value vs. Book Value
Example (continued)
Book Value Balance Sheet
Assets = $10 bil Debt = $4 bil
Equity = $6 bil

Market Value Balance Sheet

Assets = $11.5 bil Debt = $4 bil

Equity = $7.5 bil
The Income Statement

Definition
Financial statement that shows
the revenues, expenses, and
net income of a firm over a
period of time
(from an accounting perspective).
 The Income Statement
Earnings Before Income & Taxes (EBIT)

EBIT =
Total Revenues - COGS - DEPRECATION
 The Income Statement
Pepsico Income Statement (year end 2001)

Net Sales 26,935

(-) Cost of Goods Sold (10,754)
Gross Profit 16,181
(-) Selling, G&A expenses (10,918)
(-) Depreciation expense (1,082)
EBIT 4,181
(-) Net interest expense (152)
Taxable Income 4,029
(-) Income Taxes (1,367)
Net Income 2,662
 Profits vs. Cash Flows
Differences
 “Profits” subtract depreciation (a non-cash
expense)
 “Profits” ignore cash expenditures on new capital
(the expense is capitalized)
 “Profits” record income and expenses at the time
of sales, not when the cash exchanges actually
occur
 “Profits” do not consider changes in working
capital
The Statement of Cash Flows

Definition
Financial statement that shows
the firm’s cash receipts and cash
payments over a period of time.
 The Statement of Cash Flows
Pepsico Statement of Cash Flows
(excerpt - year end 2001)

Net Income 2,662

Non-cash expenses
Depreciation 1,082
Changes in working capital (41)
A/R=(13) A/P=26 Inv=(118) other=64
Cash Flow from operations 3,703
Cash Flow from investments (1,784)
Cash provided by financing (1,775)
Net Change in Cash Position 144
 Taxes
 Taxes have a major impact on financial
decisions

Marginal Tax Rate is the tax that the

individual pays on each extra dollar of
income.

Average Tax Rate is the total tax bill

divided by total income.
 Taxes
Example - Taxes and Cash Flows can be
changed by the use of debt. Firm A pays part
of its profits as debt interest. Firm B does
not.

Firm A Firm B
EBIT 100 100
Interest 40 0
Pretax Income 60 100
Taxes (35%) 21 35
Net Income 39 65
 Taxes

FOOD FOR THOUGHT - If you were both the debt

and equity holders of the firm, which would
generate more cash flow to you? (assume Net
Income = Cash Flow)
Firm A Firm B
EBIT
Interest
100
40
100
0 ?
Pretax Income 60 100
Taxes (35%) 21 35
Net Income 39 65
 Taxes
FOOD FOR THOUGHT - If you were both the debt
and equity holders of the firm, which would
generate more cash flow to you? (assume Net
Income = Cash Flow)
Firm A Firm B
Net Income 39 65
+ Interest 40 0

?
Net Cash Flow 79 65
Corporate Tax Rates (2002)

Taxable Income ($) Tax Rate (%)

0-50,000 15
50,001-75,000 25
75,001-100,000 34
100,001-18,333,333 34-39
over 18,333,333 35
Personal Tax Rates (2002)

Single Taxable Married Taxable

Income ($) Income ($) Tax Rate (%)
0-6,000 0-12,000 10
6,000-27,950 12,000-46,700 15
27,950-67,700 46,700-112,850 27
67,700-141,250 112,850-171,950 30
141,250-307,050 171,950-307,050 35
over 307,050 over 307,050 38.6
 FINANCIAL RATIOS

Leverage Ratios:
Long Term Debt Ratio= LTD / (LTD+ Equity)
Debt/Equity = Total Debt / Total Equity
Times Interest Earnings: EBIT / Interest payments

Liquidity Ratios:
Current Ratio= Current Assets/ Current Liabilities
Cash Ratio = (Cash+ Marketable Securities) / Current Liabilities
Quick Ratio= (Cash+ Receivables) / Current Liabilities

Efficiency Ratios:
Inventory Turnover= COGS/ Inventory
Receivables Turnover= Net Sales/ Receivables
 FINANCIAL RATIOS

Profitability Ratios:
NPM (Net profit margin)= Net Income / Net Sales
ROE= Net income / Equity

Growth Ratios :
Payout Ratio= Dividends / Net income
Sustainable Growth= ROE/(1- Payout)