Financial Statements Quiz

Principles of Financial Analysis

• Course: FIN 3250
• Instructor: Dr. Lu Wang
• Institution: Silberman College of Business, Fairleigh Dickinson University, Vancouver Campus

Chapter 2: Financial Statements and Long-term Financial Planning

• Learning Objectives:
  • Understand the difference between accounting value (book value) and market value.
  • Know the difference between accounting income and cash flow.
  • Know how to determine a firm's cash flow from its financial statements.
  • Understand the difference between average and marginal tax rates.
  • Understand the basics of Capital Cost Allowance (CCA) and Undepreciated Capital Cost (UCC).

Chapter Outline

• Statement of Financial Position
• Statement of Comprehensive Income
• Cash Flow
• Taxes
• Capital Cost Allowance
• Summary and Conclusions

Statement of Financial Position (Balance Sheet)

• Definition: A snapshot of a firm's assets and liabilities at a specific point in time.
• Asset Listing: Assets are listed in order of liquidity (ease of conversion to cash without significant loss of value).
• Equation: Assets = Liabilities + Stockholders' Equity

Statement of Financial Position (Balance Sheet) - 2014 and 2015 Data

• Includes figures for Canadian Enterprises Limited, showing assets and liabilities/owners' equity for both 2014 and 2015 (in $ millions).

Statement of Financial Position (Balance Sheet) - Diagram

• Diagram illustrating the relationship between total assets, net working capital, current liabilities, long-term debt, and shareholders' equity.

Statement of Financial Position (Balance Sheet) - Net Working Capital

• Calculation: Current Assets - Current Liabilities
• Interpretation: Positive NWC indicates the firm has more cash coming in than going out over the next 12 months; a key indicator of financial health.

Statement of Financial Position (Balance Sheet) - Example Calculation for 2014

• Calculation for the net working capital of Canadian Enterprises Limited in 2014.
• $1,112 million current assets - $428 million current liabilities = $684 million net working capital

Statement of Financial Position (Balance Sheet) - Liquidity

• Definition: Ability to convert to cash quickly without significant loss in value.
• Relationship to Financial Distress: Liquid firms are less likely to experience financial distress.
• Tradeoff: Liquid assets generally earn lower returns than illiquid assets.

Statement of Financial Position (Balance Sheet) - Debt vs. Equity

• Equity Holders' Residual Claim: Equity holders are entitled to the firm's residual value after creditors are paid.
• Shareholders' Equity Equation: Shareholders' equity = Assets - Liabilities
• Financial Leverage: Debt financing increases the firm's financial leverage, magnifying both gains and losses.
• Risk Implications of Leverage: Leverage increases a firm's risk.

Statement of Financial Position (Balance Sheet) - Specific Examples for Canadian Enterprises Limited in 2015

• Total equity calculation
• Long-term financing calculation

Statement of Financial Position (Balance Sheet) - International Financial Reporting Standards (IFRS)

• Historical Cost Method: IFRS permits the historical cost method.
• Revaluation (Fair Value) Method: Also allows the revaluation method (fair value) for asset classes.
• Simultaneous Revaluation: All items within an asset class should be simultaneously revalued.
• Regular Revaluation: Regular revaluation is important so the carrying amount mirrors fair value.

Statement of Financial Position (Balance Sheet) - Value vs. Cost

• Book Value: The statement of financial position displays book value of assets, liabilities and equity.
• Market Value: Market value is the price at which the assets, liabilities, or equity can be bought or sold.
• Distinction: Market value and book value are frequently different.
• Importance to Decision-making: Both book value and market value are useful for different decision-making contexts.

Statement of Comprehensive Income (Income Statement)

• Summary of Performance: The statement summarizes a firm's performance over a period (also called an income statement.
• Revenues-Expenses=Income: Revenues are reported first, followed by expenses deduced.
• Example Income Statement for Canadian Enterprises Limited in 2015

Statement of Comprehensive Income (Income Statement) - Per Share Data

• Earnings Per Share (EPS): Net income expressed on a per-share basis.
• Dividend per Share: Calculation of dividends on a per-share basis given the shares outstanding.

Statement of Comprehensive Income (Income Statement) - Non-cash Items

• Non-cash Items: Expenses charged against revenues but do not directly impact cash flow.
• Examples: Depreciation, interest (as it's financing expense)

Statement of Comprehensive Income (Income Statement) - Time vs Cost

• Using income statements and balance sheets to gather data about different costs to calculate cash flow. These relate to either short-term variable costs or long-term fixed costs.

Statement of Comprehensive Income (Income Statement) - Publicly Traded Companies Reports

• Regulatory Requirements: Publicly traded companies are required to file regular reports with the Ontario Securities Commission.
• Electronically Filed: These reports are generally filed electronically and can be accessed at the SEDAR site (www.sedar.com).

Cash Flow

• Importance: Cash flow is a crucial metric for financial managers to understand the business's operating dynamics.
• Asset Use and Financing: This analysis revolves around using assets and paying those who provide financing for their purchase.

Cash Flow from Assets (CFFA)

• Formula: Cash Flow from Assets = Cash flow to creditors(bondholders) + Cash flow to shareholders
• Decomposition: Operating cash flow– capital spending − additions to net working capital

Operating Cash Flow

• Definition: Daily business operations' cash flow.
• Calculation Excluding Depreciation: Calculated by subtracting costs (excluding depreciation and interest expenses) from revenues.
• Example Calculation: Calculate operating cash flows using the earnings before interest and taxes plus depreciation and minus taxes from an example income statement.

Capital Spending

• Definition: Net spending on fixed assets.
• Formula: Purchase of fixed assets – sales of fixed assets
• Example Calculation: Calculate capital spending based on end and beginning fixed assets and depreciation expense

Additions to Net Working Capital

• Definition: The funding needed for net working capital.
• Formula: Current assets – current liabilities.
• Example: Calculate additions to net working capital based on current year asset and liability information.

Cash flow from Assets/Free Cash Flow

• Definition: Refers to the cash the company can freely distribute (not needed for investment).

Cash Flow to Creditors

• Definition: Firm's interest payments to creditors less net new borrowings.

Cash Flow to Shareholders

• Definition: Dividends paid out by the firm less net new equity raised

Taxes---Individual Tax Rates

• Rates and Income Brackets: Federal and provincial income tax rates and their corresponding income brackets (2017).
• Marginal Tax Rate: Tax rate on the next dollar earned.

Taxes---Average Tax Rate

• Definition: Total taxes paid divided by total taxable income.

Taxes---Corporate Taxes

• Deductible Expenses: Interest is often a tax-deductible expense.
• Tax Advantage of Debt Financing: Debt financing is generally tax-advantaged compared to equity financing.
• Reason: Interest is deducted from EBIT when calculating taxable income; dividends are not.

Taxes---Global Tax Rates

• Variations: Individual and corporate tax rates differ across countries, including calculation methods for taxable income.
• Tax Avoidance: Utilizing differences in tax systems (e.g., moving wealth across borders to take advantage of low-tax jurisdictions).

Taxes---Capital Gains and Carry-back and Carry-forward

• Loss Carry-back: Utilizing capital losses from one year to offset capital gains from prior years.
• Loss Carry-forward: Utilizing capital losses from the current year to offset capital gains in future years.
• Example Calculation: Determining the amount of capital loss carry back for Canadian Enterprises based on available data.
• Example Calculation: Determining the amount of capital loss carry forward for the company.

Taxes---Capital Cost Allowance (CCA)

• Purpose: Depreciation for tax purposes acts as a tax shield.
• Assignment to Asset Classes: Every capital asset is assigned to a specific asset class by the government. This determines the method and rate used for depreciation.
• Half-year Rule: In the initial year, only 50% of an asset's cost is used for CCA purposes.

Taxes---Capital Cost Allowance (CCA)---Asset Purchases and Sales

• Net Acquisition Rule: Calculates the value of assets based on original cost vs. the realized value (whichever is less).
• Example Calculation: Apply the net acquisition rule where assets are both sold and bought. Determine the CCA under this rule.

Taxes---Capital Cost Allowance (CCA)---Closing an Asset Class

• Terminal Loss/Recaptured CCA: When the last asset in an asset class is sold, the class is terminated. At this point, there may be a terminal loss or recaptured CCA depending if UCC or market value was higher).
• Examples of Calculations: For a variety of sale price scenarios, calculate the terminal loss or recaptured CCA.

Test your knowledge on financial statements, including the Statement of Financial Position and Statement of Comprehensive Income. This quiz covers key concepts like liquidity, Net Working Capital, and the differences between accounting income and cash flow. Challenge yourself with questions that address essential financial terms and calculations.