Accounting Statements

&
Cash Flow

Chapter 2
 The Balance Sheet
The balance sheet is an accountants snapshot of
the firms accounting value on a particular date.
What the firms owns and how it is financed
Assets = Liabilities + Stockholders equity
(this equation must always hold)
Stockholders equity = Assets Liabilities
(equity is what the stockholders would have
remaining after the firm discharged its obligations)
 Analyzing A Balance Sheet
Concerns
Liquidity

Debt Versus Equity

Value Versus Cost

 The Income Statement
The income statement measures performance
over a specific period of time

Revenue Expense = Income

Operations Section: Revenues & Expenses
Earnings Before Interest & Taxes (EBIT): Earnings
before taxes and financing cost
Net Income (frequently expressed per share of
common stock, i.e. Earnings per share (EPS)
 The Income Statement
Generally Accepted Accounting Principles
(GAAP)
Noncash Items:
Depreciation
Deferred Taxes
Time & Costs
Variable Costs (raw material costs)
Fixed Costs (manufacturing overheads, property
taxes)
Period Costs: Are allocated to a time period
(selling, general, & administrative expenses)
 Net Working Capital
Current Assets Current Liabilities=NWC
Positive when current assets are greater than
current liabilities
The change in networking capital is investment in
net working capital by a firm
(usually positive in a growing firm)
Current Assets Current Liabilities Net Working Capital
($ million) ($ million) ($ million)
2012 761 486 275
2013 707 455 252
The change in net working capital=$23 million
 Statement of Cash Flows
Reports the amount of cash collected and paid
out by a company in operating, investing and
financing activities for a period of time.
How did the company receive cash?
How did the company use its cash?
Complementary to the income statement.
Indicates ability of a company to generate
income in the future.
 Statement of Cash Flows

Cash inflows
Sell goods or services
Sell other assets or by borrowing
Receive cash from investments by owners
Cash outflows
Pay operating expenses
Expand operations, repay loans
Pay owners a return on investment
 Statement of Cash Flows
Covers the same period as the income
statement
Three sections
Cash flows from operating activities
Cash flows from investing activities
Cash flows from financing activities
 Match Classification of
Cash Flows
Operating activities Transactions and
events that enter into the determination of
net income.
Investing activities Transactions and
events that involve the purchase and sale of
securities, property, plant, equipment, and
other assets not generally held for resale,
and the making and collecting of loans.
Financing activities Transactions and
events whereby resources and obtained
from, or
repaid to, owners and creditors.
 Operating Activities

Cash Inflow Cash Outflow

Sale of goods or Inventory payments
services Interest payments
Sale of investments Wages
in trading securities Utilities, rent
Interest revenue Taxes
Dividend revenue
 Investing Activities
Cash Inflow Cash Outflow
Sale of plant assets Purchase of plant
Sale of securities, assets
other than trading Purchase of
securities securities, other
Collection of than trading
principal on loans securities
Making of loans to
 Financing Activities

Cash Inflow Cash Outflow

Issuance of own Dividend payments
stock Repaying principal
Borrowing on borrowing
Treasury stock
purchase
 Statement of Cash Flows Analysis

Operating Investing Financing General Explanation

Building up pile of cash,
1. + + + Possibly looking for
Acquisition

2. + Operating cash flow being

Used to buy fixed assets
And pay down debt

3. + + Operating cash flow and sale of fixed assets

being used to pay down debt.

Operating cash flow and borrowed

4. + + money being used
to expand
 Statement of Cash Flows Analysis

Operating Investing Financing General Explanation

Operating cash flow problems covered by sale

5. + + of fixed assets, borrowing and owner
contributions.

6. Rapid growth, short falls in operating cash

flow; purchase of fixed assets.
+
Sale of fixed assets is financing operating cash
7. flow shortages.

+
Company is using reserves
to finance cash flow
8. short falls.
 The Example Company
Statement of Cash Flows
December 31, 2011

Cash Flows From Operating Activities:

Receipts 48
Payments (43) 5

Cash Flows From Investing Activities:

Receipts 0
Payments (4) (4)

Cash Flows Used By Financing Activities:

Receipts 10
Payments (6) 4

Net Cash Flow 5

 Cash Flow Statement
Cash--Op. Act. $ 973,000
Cash--Inv. Act. (1,188,000)
Cash--Fin. Act. 245,000
Net increase $ 30,000
Beg. cash 80,000
End. cash $ 110,000
Balance
Sheet 12/31/11

Balance Sheet 12/31/10 Cash $ 110,000

Income Statement Other 4,975,000
Cash $ 80,000 Total $5,085,000
Revenues $12,443,000
Other 4,550,000
Expenses 11,578,400
Total $4,630,000 Liabilities $2,860,400
Net income $ 864,600
Cap. stock 1,000,000
Liabilities $2,970,000 R/E 1,224,600
Cap. stock 900,000
R/E 760,000 Stmt of Retained Earnings Total $5,085,000

Total $4,630,000 R/E 12/31/10 $ 760,000

Net income 864,600
Dividends (400,000)
R/E 12/31/11 $1,224,600
 Financial Cash Flow
Cash flow of the firm:
a)Operating Cash Flow = EBIT + Depreciation Taxes
b) Capital Spending = Acquisitions of Fixed Assets
Sale of Fixed Assets
c) Additions to Net Working Capital

Cash flow to investors in the firm:

Debt = Interest + Retirement of Debt L T Debt Financing
Equity = Dividends + Repurchase of Equity New Equity
Financing
 Financial Cash Flow
Cash Flows received from the firms assets
=
Cash Flows to the firms creditors & equity
investors
CF(A) = CF(B) +CF(S)

The Statement of Cash Flows

Explains the change in accounting cash and
equivalents
The Accounting Statement of Cash Flows

Cash Flow from Operating Activities

Net Income
+
Noncash expenses
(Depreciation)
+
Adjust for changes in current assets & current
liabilities (other than cash)
Cash Flow from Investing Activities
Changes in Capital Assets

Purchases of fixed assets (cash outflow) and

sales of fixed assets (cash inflow)

Net Capital Expenditure

Cash Flow from Financing Activities
Retirement of debt is Cash Outflow

Proceeds from long-term debt sales is Cash Inflow

Dividends is Cash Outflow

Repurchase of stock is Cash Outflow

Proceeds from new stock issue is Cash Inflow

 USC CORPORATION
Balance Sheet 2010 & 2009 ($ in millions)
Assets 2010 2009 Liabilities & 2010 2009
Stockholders Equity
Current assets: Current liabilities:
Cash & equivalents 140 107 Accounts payable 263 250
Accounts receivables 294 270
Inventories 269 280 Accrued expenses 223 205
Other 58 50 Total 486 455 Total 761 707 Long-term liabilities:
Fixed Assets: Deferred taxes 117 104
Property, plant & equip. 1,423 1,274 Long-term debt 471 458
Less accumulated depreciation -550 - 460 Total 588 562 Net property, plant & equip
873 814 Stockholders equity:
Intangible assets & others 245 221 Preferred stock 39 39
Total fixed assets 1,118 1,035 Common stock ($1 par value) 55 32
Capital Surplus 347 327
Accumulated retained earning 390 347
Less treasury stock - 26 -20
Total equity 805 725
Total liabilities and
Total Assets 1,879 1,742 stockholders equity 1,879 1,742
 USC CORPORATION
Income Statement 2010
($ in million)
Total operating revenues 2,262
Cost of goods sold 1,655
Selling, general, & administrative expenses 327
Depreciation 90
Operating income 190
Other income 29
EBIT 219
Interest expense 49
Pretax income 170
Taxes 84
Current:$71
Deferred: $13
Net income 86 Addition to retained earnings: 43 Dividends:
43
 U.S. Composite Corporation
Financial Cash Flow
2010
($ in millions)

Cash flow of the firm

Operating cash flow 238
(EBIT + depreciation taxes)
Capital spending -173
(Acquisitions of fixed assets sales of fixed assets)
Additions to net working capital - 23
Total 42
Cash flow to investors in the firm
Debt 36
(Interest + retirement of debt long term debt financing)
Equity 6
(Dividends plus repurchase of equity new equity financing) ____
Total 42
Operating cash flow (cash flow from operations)
EBIT (Earnings before interest and taxes) $219
Depreciation 90
Current taxes - 71
Operating cash flow $238

Capital spending (cash flow used for capital spending)

Acquisition of fixed assets $198
Sales of fixed assets - 25
Capital spending $173
($149 + 24 = increase in property, plant, and equipment + increase in
intangible assets)
Capital Spending = Ending net fixed assets Beginning net fixed
assets + Depreciation

Additions to net working capital $23

 Cash Flow Paid to Creditors
($ in millions)
Interest 49
Retirement of debt 73
Debt service 122

Proceeds from long-term debt sales - 86

36

Cash flow paid to creditors = Interest Net new debt

Net new debt = Ending long-term debt Beginning long-term debt
 Cash Flow to Stockholders
($ in millions)
Dividends 43
Repurchase of stock 6 Cash to
stockholders 49
Proceeds from new stock issue - 43
6

Cash flow to stockholders = Dividends paid Net new equity raised

Net new equity raised = Stock sold Stock repurchased
 Question No 1
The following table presents the long-term
liabilities & stockholders equity of ICM of one
year ago Long-term debt $50,000,000
Preferred stock 30,000,000
Common stock 100,000,000
Retained earnings 20,000,000

During the past year, ICM issued $10 million of new

common stock. The firm generated $5 million of net
income and paid $ 3 million of dividends. Construct
todays balance sheet reflecting the changes that
occurred at ICM during the year.
 Solution
No change in long-term debt
No change in preferred stock

Common stock increased by $10,000,000 (new issue)

100,000,000 + 10,000,000 = $110,000,000
Net Income Dividends = Retained Earnings
(5,000,000 3,000,000 = 2,000,000)
Retained earning increased by $ 2,000,000
20,000,000 + 2,000,000 = 22,000,000
 Todays Balance Sheet
(Long-term debt & stockholders equity)

Long-term debt $50,000,000

Preferred stock 30,000,000
Common stock 110,000,000
Retained earnings 22,000,000
 Question No 2
During 2011, the ST Limited had gross sales of $ 1
million.
The firms cost of goods sold and selling expenses
were $ 300,000 and $ 200,000 respectively.
These figures do not include depreciation.
ST also had notes payable of $ 1 million. These
notes carried an interest rate of 10%.
Depreciation was $ 100,000.
STs tax rate was 35% in 2011.
 Question No 2
What was the firms net operating income?

What were the firms earnings before taxes?

What was the firms net income?

What was the firms cash flow from operating

activities?
 Solution
Gross Sales $ 1,000,000
Cost of goods sold (300,000)
Selling expenses (200,000)
Depreciation (100,000)

Net operating Income = $ 400,000

 Solution
Earnings before tax = Net operating income Interest expense
$ 400,000 100,000 = $ 300,000
(Interest Expense = 1,000,000 x 0.1)
Net Income = EBT Tax
Tax = EBT x Tax Rate
= 300,000 x .35 = 105,000
NI = 300,000 105,000= $195,000
OR
NI=EBT x (1- Tax Rate)
NI = 300,000 x (1-0.35)
= 300,000 x 0.65 = $ 195,000
 Solution
Operating Cash Flow
=
Net Income + Depreciation
$ 195,000 + 100,000 = $ 295,000
 Question No 3
The Stancil Corporation provided the following
current information
Proceeds from long-term borrowing $ 19,000
Proceeds from the sale of common stock $ 3,000
Purchases of fixed assets $15,000
Purchases of inventories $ 1,500
Payment of dividends $ 19,500
Calculate the cash flow from the firm & the cash
flows to investors of the firm
 Solution
Cash flows from the firm:
Capital spending$ (15,000)
Additions to NWC (1,500)
Cash flows from the firm $ (16,500)

Cash flows to investors of the firm

Sale of long-term debt $ (19,000)
Sale of common stock (3,000)
Dividends paid 19,500
Cash flows to investors of the firm$ (2,500)