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Chapter 3.

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Presentation on theme: "Chapter 3."— Presentation transcript:

1 Chapter 3

2 Understanding Financial Statements and Cash Flows

3 Basic Financial Statements
Income Statement Balance Sheet Statement of Cash Flows

4 Income Statement Profit/Loss Statement
Indicates the amount of profits generated by a firm over a given period of time Sales – Expenses = Profit

5 Income Statement Terminology
Revenue (Sales) Money derived from selling the company’s product or service Cost of Goods Sold (COGS) The cost of producing or acquiring the goods or services to be sold Operating Expenses Expenses related to marketing and distributing the product or service and administering the business Financing costs The interest paid to creditors and the dividends paid to preferred stockholders Tax Expenses Amount of taxes owed, based upon taxable income

6 Income Statement Sales Less cost of goods sold = Gross profit
Less operating expenses = Operating income Less interest expense = Earnings before taxes Less corporate taxes = Earnings before preferred dividends Less preferred stock dividends = Net income available to common stockholders

7 Balance Sheet Examines the firm’s financial position at a specific point in time Assets = Liabilities + Owner’s Equity Assets are resources owned by the firm Liabilities and Owner’s equity indicate how those resources are financed

8 Balance Sheet Terminology
Current Assets or gross working capital Comprise assets that are relatively liquid, or expected to be converted into cash within a year. Current Assets typically include: Cash Accounts Receivable payments due from customers who buy on credit Inventory raw materials, work in process, and finished goods held for eventual sale Prepaid expenses expenses paid for in advance

9 Fixed Assets Assets held for more than one year. Typically Include:
Machinery Equipment Land and Buildings Other Assets Assets that are not current assets or fixed assets Patents Copyrights Goodwill

10 Debt or Liabilities Money that has been borrowed and must be repaid at some predetermined date Debt Capital financing provided by a creditor Current, short-term and long-term Current or short-term must be repaid within the next 12 months

11 Current Liabilities: Long-Term Debt Accounts Payable Other Payables
Credit extended by suppliers Other Payables Interest and taxes that are owed Accrued expenses Liabilities incurred, but not yet paid Short-term Notes Borrowings from a bank or lending institution due and payable within 12 month Long-Term Debt Loans from banks or other institutions for longer than 12 months

12 Includes the shareholder’s investment
Equity Includes the shareholder’s investment Preferred stock Common stock Retained Earnings cumulative total of all the net income over the life of the firm, less common stock dividends that have been paid out. Treasury Stock stock that was once outstanding and has been re-purchased by the company

13 Balance Sheet ASSETS Total Assets LIABILITIES Total Liabilities
Current Assets Fixed Assets Total Assets LIABILITIES Current Liabilities Long-Term Liabilities Total Liabilities OWNER’S EQUITY Preferred Stock Common Stock Retained earnings Total Owner’s Equity Total liabilities + OE

14 Terms Net Working Capital Debt/Equity Mix Accrual Basis Accounting
Current assets – current liabilities Debt/Equity Mix Amount of debt a firm borrows per dollar of equity Accrual Basis Accounting Recording revenues when earned and expenses when incurred, rather than when cash is exchanged Free Cash Flows Cash flow that is free and available to be distributed to the firm’s investors.

15 Cash Flows Cash Flows generated through a firm’s assets always equal its cash flows paid to or received by the company’s investors. Cash flows from assets = cash flows from financing

16 Traditional Statement of Cash Flows
Three sections: Cash flows from Operating Activities Cash flows from Investing Activities Cash flows from Financing Activities

17 Modified Cash Flow Calculations
Cash Flows from Assets = Cash flows from Financing Cash flows from Assets = After-tax cash flows from operations less investment in operating working capital less investments in fixed assets and other assets.

18 Cash Flows from Assets After-tax cash flow from operations -- less--
Investment in operating working capital -- less -- Investment in fixed assets and other assets

19 After-Tax Cash Flows From Operations
Operating Income + Depreciation = Earnings before interest, taxes , depreciation, and amortization - Income taxes = After-tax cash flows from operations

20 Change in Operating Working Capital
Change in current assets - (change in accounts payable + change in accrued expenses)

21 Investment in Fixed Assets
A decrease in long-term assets indicates that the firm is selling assets, which is a source of cash or increases cash An increase in long-term assets indicates that the firm is purchasing assets, which is a “use” of cash or causes cash to go down

22 Cash Flows from Financing
Financing Activities which generate cash include: An increase in debt (a source of cash) Issuing new stock Financing Activities which decrease cash include: Payment of interest Payment of dividends A decrease in debt (indicates payment of principal) A decrease in equity (indicates the re-purchase of outstanding stock

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