Financial Management Theory and Practice

Tenth Edition

Chapter 2
Financial Statements, Cash Flows and Taxes
Instructor: Sanam Taimoor Institute of Business Management

Eugene F. Brigham Michael C. Ehrhardt

Topics
Financial Statements and Reports Importance of Cash Flow statement Net Cash Flow Market Value Added Economic Value Added

Chapter 2 Brigham & Ehrhardt 10th ed.

 Annual Report

Financial Statements and Reports

An annual publication that public corporations must provide to shareholders to describe their operations and financial conditions
(Investopedia)

Presents:
Information regarding firms operating results during past year and potential developments affecting future Four basic financial statements

The information is used by

Managers to make operating decision making Investors to make investment decisions and form expectations about future earnings and dividends
Chapter 2 Brigham & Ehrhardt 10th ed. 3

Financial Statements
Balance Sheet
Summarizes firms assets, liabilities and shareholders equity at a specific time.

Income Statement
Gives financial results of a firm for a specific period

Statement of Retained Earnings

Outlines the changes in retained earnings for a specific period

Statement of Cash Flows

Summarizes the companies cash inflows and outflows for a specific period Chapter 2 Brigham & Ehrhardt 10th ed. 4

Balance Sheet
Important point regarding balance sheet: 1. Cash versus other assets 2. Liabilities versus shareholders equity 3. Preferred versus common stock 4. Common Equity account 5. Inventory accounting 6. Depreciation method 7. Time dimension
Chapter 2 Brigham & Ehrhardt 10th ed. 5

Income Statement
Revenues and Costs EPS Cash versus non cash items Depreciation and amortization EBITDA

Chapter 2 Brigham & Ehrhardt 10th ed.

Statement of Retained Earnings

Also know as statement of owner's equity, equity statement or statement of shareholders' equity Changes in retained earnings occur because shareholders let the management reinvest funds that otherwise could be distributed as dividends The balance sheet amount of retained earnings does not represent cash Retained earnings are not used for payment of dividends
Chapter 2 Brigham & Ehrhardt 10th ed. 7

Statement of Cash Flows

Net Cash Flow versus Accounting Profit Non-cash adjustment
Add non-cash expenses Deduct non-cash revenues

Changes in working capital Activities

Operating Investing Financing
Chapter 2 Brigham & Ehrhardt 10th ed. 8

Operating Assets and Operating Capital

Operating Assets
Assets necessary to operate the business Sub divided into operating current assets and long term operating assets

Non Operating Assets

Assets above the level required for normal operations

Operating Current Liabilities

All non interest bearing current liabilities Source of funds to acquire assets

Non Operating Liabilities

Interest bearing liabilities
Chapter 2 Brigham & Ehrhardt 10th ed. 9

Operating Assets and Operating Capital

Net Operating Working Capital
Equals all current assets that do not pay interest less all current liabilities that do not charge interest Or Operating Current Assets Operating Current Liabilities

Total Operating Capital

NOWC plus Operating Long-Term Assets

Net Operating Profit after Taxes

An amount that a company would generate if it had no debt or financial asset NOPAT = EBIT(1 - Tax rate)
Chapter 2 Brigham & Ehrhardt 10th ed. 10

Free Cash Flows

The cash available to all of the firms investors, including stockholders and bondholders, after the firm buys and sells products, provides services, pays its cash operating expenses and makes short and long term investments FCF = NOPAT Net investment in operating assets

Chapter 2 Brigham & Ehrhardt 10th ed.

11

Free Cash Flows

Uses of Free Cash Flows
Pay interest to debt holders Repay debt holders Pay dividends to shareholders Repurchase stock Buy non operating assets

Chapter 2 Brigham & Ehrhardt 10th ed.

12

MVA and EVA

MVA
Is the difference between the market value of the firm and its book value Equals market value of stock less equity capital supplied by shareholders The higher the MVA, the better.

Chapter 2 Brigham & Ehrhardt 10th ed.

13

MVA and EVA

EVA
NOPAT Operating Capital * WACC Economic value added attempts to capture the true economic profit of a company.

Chapter 2 Brigham & Ehrhardt 10th ed.

14