Financial Statements, Taxes, and Cash Flow - Chapter 2 PDF

Financial Statements, Taxes, and Cash Flow Chapter 2  Chapter outline The Balance Sheet. The Income Statement. Cash Flow from assets and free cash flow. Taxes.  The financial statements The letter to stockholders: The primary communication from MGM in...

Financial Statements, Taxes, and Cash Flow Chapter 2  Chapter outline The Balance Sheet. The Income Statement. Cash Flow from assets and free cash flow. Taxes.  The financial statements The letter to stockholders: The primary communication from MGM in the annual report. The four key financial statements: Income statement, balance sheet, statement of stockholders' equity, and cash flow statement.  The balance sheet The balance sheet presents a summary of a firm’s financial position at a given point of time. The statement balances the firm’s assets (what it owns) against its financing, which can be either debt (what it owes) or equity (what was provided by owners).  The balance Sheet Total Value of Assets Total Value of Liabilities and Shareholders' Equity Net Working Current Liabilities Current Assets Capital Long Term Debt Fixed Assets 1. Tangible 2. Intangible Shareholder Equity Information from Balance Sheet  The balance sheet Liquidity − Speed and ease of conversion to cash without significant loss of value − Valuable in avoiding financial distress Debt versus Equity Shareholders’ equity = Assets – Liabilities Book value = the balance sheet value of the assets, liabilities, and equity. Market value = true value; the price at which the assets, liabilities, or equity can actually be bought or sold. class participation time  The income statement The income statement measures performance over a specified period of time (period, quarter, year). Income Statement Equation: Net Income = Revenue - Expenses Report revenues first and then deduct any expenses for the period End result = Net Income = “Bottom Line” Dividends paid to shareholders Addition to retained earnings Information from income Statement  The income statement GAAP Matching and recognition Principle: Recognize revenue at the time of sale (not necessarily the time of collection). Match those revenues with the costs associated with producing them. Noncash Items Depreciation = most important Revenues ( recognition principle) Expenses (matching principle) Earnings Management Smoothing earnings  The income statement Why might financial managers be tempted to manage earnings? Near the end of each quarter, many companies unveil their quarterly performance. Firms that beat analyst estimates often see their share prices jump, while those that miss estimates by even a small amount, tend to suffer price declines. The practice of manipulating earnings in order to mislead investors is known as earnings management.  The income statement Earnings management “smoothing” Assume that the CFO of Macys expects earnings of the next three years to be as follows: 2023 2024 2025 $2B $8B $2B Without managerial tricks, earnings figure will look like this: Chart Title 8 4 0 2023 2024 2016 2017 2018 2025 Series 1 Column1 Column2  The income statement Earnings management “smoothing” Intensive discounts at the end of 2023, less discounts throughout 2024, and intensive discounts again at the beginning of 2025 would lead to earnings like this: 2023 2024 2025 $3B $ 4.5 B $ 4.5 B Chart Title 5 4 3 2 1 0 2023 2016 201720242018 2025 Series 1 Column1 Column2  The income statement Tax advantage of debt vs equity Debt Co. No-Debt Co. Earnings before interest 200,000 200,000 and taxes Less: interest expense 30,000 0 Earnings before taxes 170,000 200,000 Less: Taxes 51,000 60,000 Earnings after taxes 119,000 140,000 class participation time  Example: Work the Web 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 this link, pick a company, and see what you can find! https://www.sec.gov/edgar/search-and-access