FIN3002_lecture02_financial_statements_and_cash_flow.ppt

Lecture 2 Financial Statements, Taxes and Cash Flows 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 Lecture Outline The Balance Sheet The Income Statement Taxes Net Working Capital Financial Cash Flow The Balance Sheet Figure 2.1 U.S. Corporation Balance Sheet – Table 2.1 Balance Sheet Analysis When analyzing a balance sheet, the Finance Manager should be aware of three concerns: Liquidity Debt versus equity Value versus cost Liquidity Refers to the ease and quickness with which assets can be converted to cash (without a significant loss in value) Current assets are the most liquid. Some fixed assets are intangible. The more liquid a firm’s assets, the less likely the firm is to experience problems meeting short-term obligations. Liquid assets frequently have lower rates of return than fixed assets. Debt versus Equity Creditors generally receive the first claim on the firm’s cash flow. Shareholder’s equity is the residual difference between assets and liabilities. Value versus Cost Under Generally Accepted Accounting Principles (GAAP) or Financial Reporting Standards (FRS), audited financial statements of firms carry assets at cost. Market value is the price at which the assets, liabilities, and equity could actually be bought or sold, which is a completely different concept from historical cost. 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? Klingon Corporation The Income Statement Measures financial performance over a specific period of time The accounting definition of