1-Fin Statements, Taxes and CashFlow

Financial Statements, Taxes, and Cash Flow

Key Concepts & Skills

  • Book Value vs. Market Value

    • Book Value: Historical cost of the firm's assets.

    • Market Value: Price at which assets can be bought or sold.

  • Accounting Income vs. Cash Flow

    • Accounting income includes non-cash expenses like depreciation.

    • Cash flow focuses on the actual inflow and outflow of cash.

  • Average vs. Marginal Tax Rates

    • Average Tax Rate: Total tax bill divided by taxable income.

    • Marginal Tax Rate: Tax rate on the next dollar earned.

  • Determining Cash Flow

    • Cash flow can be derived from financial statements through adjustments.

Chapter Outline

  • The Balance Sheet

  • The Income Statement

  • Cash Flow

  • Taxes

  • Summary and Conclusions

Detailed Understanding of Financial Statements

Balance Sheet

  • Snapshot of assets and liabilities at a specific time.

  • Assets Order: Listed by liquidity (ease of conversion to cash without significant loss).

  • Balance Sheet Identity:

    • Formula: Assets = Liabilities + Stockholders' Equity.

    • Provides a picture of the company's financial position.

Key Components of Assets & Liabilities (Alpine Ski House Example)

  • Assets:

    • Current Assets: Cash, Accounts Receivable, Inventories, etc.

    • Fixed Assets: Machinery, Equipment, Buildings, Land, Depreciation.

  • Liabilities:

    • Current Liabilities: Accounts Payable, Notes Payable, Accruals.

    • Long-term Debt: Reflects the total debts of the company.

  • Equity: Comprised of Common Stock, Retained Earnings, and Total Common Equity.

Understanding Net Working Capital and Liquidity

  • Formula: Net Working Capital (NWC) = Current Assets - Current Liabilities.

  • Positive NWC indicates more cash inflows over the next 12 months exceed cash outflows.

  • Importance: Liquid firms can more easily meet short-term obligations but earn lower returns on liquid assets.

Income Statement Overview

  • A summary of income and expense items for a specific period.

    • Items listed include Net Sales, Cost of Goods Sold, Operating Income (EBIT), Interest, Taxes, Net Income.

  • Net Income Calculation:

    • Net Income = Dividends + Addition to Retained Earnings.

  • Per Share Data: EPS, DPS, BVPS considerations are critical for evaluating firm performance.

Cash Flow Analysis

  • Importance of Cash Flow: Essential for understanding the firm's financial health and operational efficiency.

    • Operating Cash Flow (OCF), Net Capital Spending (NCS), Changes in Net Working Capital (NWC).

  • CFFA Relationships:

    • Formula: Cash Flow from Assets (CFFA) = Cash Flow to Bondholders + Cash Flow to Stockholders.

Taxes

Understanding Tax Structures

  • Marginal vs. Average Tax Rates: Essential for financial planning and decision-making.

    • Example scenarios involving individual taxes in Quebec and their implications.

  • Use of Tax Shelters: Specific tax benefits for dividend incomes to mitigate double taxation.

Taxation on Investment Income

  • Tax Rates on Dividends: Effective taxation rates based on gross up and tax credits.

  • Taxation on Interest Income: Tax implications for various income types, focusing on comparative effectiveness.

  • Capital Gains Tax: Less burdened compared to other income types, emphasizing favorable conditions for investors.

Summary of Key Points

  • Balance sheet shows accounting values on a specific date.

  • Income statement summarizes performance over time.

  • Cash flow is a determining factor post-tax measurements of income into the firm.