Taylors University

Dual Degree Program

Introduction
to Finance
Topic 2
Financial
Statements, Taxes
and Cash Flow
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Acknowledgement Ross et al, 2011, Essentials of Corporate Finance, 7th Ed, McGraw-Hill Companies, Inc..

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Learning Outcomes
At the end of the lesson, students should be
able to:
differentiate between book value and market
value
differentiate between accounting income and
cash flow
differentiate between average and marginal
tax rates
calculate how to determine a firms cash flow
from its financial statements
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Chapter Outline
The Balance Sheet/Statement of
Financial Position
The Income Statement
Taxes
Cash Flow

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The Balance Sheet/Statement of Financial

Position
The balance sheet/Statement of
Financial Position is a snapshot of the
firms assets, liabilities and equities at a
given point in time
Assets are listed in order of decreasing
liquidity
Ease of conversion to cash without
significant loss of value

Balance Sheet Identity

Assets = Liabilities + Stockholders Equity
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Figure 2.1

U.S. Corporation Balance Sheet

Table 2.1

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Market vs. Book Value

The balance sheet provides the book value
of the assets, liabilities, and equity.
Market value is the price at which the assets,
liabilities, or equity can actually be bought or
sold (easily determined for listed companies).
Market value and book value are often very
different. Why? . refer notes
Which is more important to the decisionmaking process? .. refer notes
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Income Statement
The income statement is more like a
video of the firms operations for a
specified period of time
You generally report revenues first and
then deduct any expenses for the period
Matching principle To recognize
revenue when it is fully earned
(recognition principle) and match
expenses required to generate revenue
to the period of recognition
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U.S. Corporation Income

Statement - Table 2.2

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Taxes
The one thing about taxes we can rely
on is that they will always be changing!!
Marginal vs. average tax rates
Marginal the percentage paid on the next
dollar earned
Average the tax bill / taxable income

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Taxes

Table 2.3 Corporate tax rate

Taxable income ($)

Tax rate

0 -

50,000

15%

50,001 -

75,000

25%

75,001 -

100,000

34%

100,001 -

335,000

39%

335,001 -

10,000,000

34%

10,000,001 -

15,000,000

35%

15,000,001 -

18,333,333

38%

18,333,334+

35%
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Example: Marginal vs. Average

Rates
Suppose your firm earns $4 million in
taxable income.
What is the firms tax liability?
= 0.15(50,000) + 0.25(75,000 50,000) +
0.34(100,000 75,000) + 0.39(335,000
100,000) + 0.34(4,000,000 335,000)
= $1,356,000
What is the average tax rate?
= $1,356,000 / $4,000,000 = .34 or 34%

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Example: Marginal vs. Average

Rates
Suppose your firm earns $4 million in
taxable income.
What is the marginal tax rate?
it comes from the table. It is 34%

If you are considering a project that will

increase the firms taxable income by $1
million, what tax rate should you use in
your analysis?
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The Concept of Cash Flow

Cash flow is one of the most important
pieces of information that a financial
manager
can
derive
from
financial
statements
The statement of cash flows (formal
statement prepared by companies) does not
provide us with the same information that we
are looking at here
We will look at how cash is generated from
utilizing assets and how it is paid to those
who finance the purchase of the assets
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Cash Flow From Assets

Cash Flow From Assets (CFFA) =
Operating Cash Flow Net Capital
Spending Changes in NWC
Cash Flow From Assets (CFFA) = Cash
Flow to Creditors + Cash Flow to
Stockholders

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U.S. Corporation Balance Sheet

Table 2.1

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U.S. Corporation Income

Statement - Table 2.2

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Example: U.S. Corporation

OCF (I/S) = EBIT + depreciation taxes =
$694 + $65 - $212 = $547
NCS (B/S and I/S) = ending net fixed assets
beginning net fixed assets + depreciation = $1709 $1,644 + $65 =$130
Changes in NWC (B/S) = ending NWC beginning
NWC = ($1,403 - $1,112) - ($389 - $428) = $330
CFFA (CF from Assets) = 547 130 330 = $87
CF to Creditors (B/S and I/S) = interest paid net
new borrowing ($454 - $408) = $70 - $46 = $24
CF to Stockholders (B/S and I/S) = dividends paid
net new equity raised = $103 - $40 = $63
CFFA = 24 + 63 = $87
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Table 2.5
Refer to own C/Flow Excel s/sheet referring to
P&L (Table 2.2 on pg 28) & B/S (Table 2.1 on pg 25)

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