2023 Financial Statements

REVIEWING FINANCIAL STATEMENTS
Bodie, Chapter 3
Cornett, Chapters 2 & 3
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1
Content
1.Balance Sheet
2.Income Statement
3.Statement of Cash Flows
4.Free Cash Flow
5.Statement of Retained Earnings
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2
• Song wants to invest in DPH Tree
Farm Inc. Song has a set of recent
Looking financial statements from DPH Tree
Farm’s annual report but is not sure
for a perfect how to read them or what are the
company meanings of all these numbers and
reports.
• What are the four financial statements?
• What information can she gets from
these statements?
Financial Statements 13 4
An annual report
• Four basic financial statements:
1. The balance sheet
2. The income statement
3. The statement of cash flows
4. The statement of retained earnings
• A financial statement provides an accounting-
based picture of a firm’s financial position.
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4
The balance sheet
• Assets = Liabilities + Equity
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5
7
16
Financial Statements
Net working capital
• Net working capital = Current assets – Current liabilities
Financial Statements 17
7
Book vs Market Value
• Balance Sheet shows its

book (or historical cost) value
based on generally accepted
accounting principles.
• Because of inflation and
market forces, many assets
are more worth now thatn
they were worth when the
firm bought them.
• Book values can differ widely from market
values for the same assets.
8
Book vs Market Value
9
Computing Book vs Market Value
• D2K Inc. lists fixed assets and current assets
of $25 million and $10 million respectively on
its balance sheet. The firm’s fixed assets and
current assets were recently appraised at $32
and $ 11 million respectively.
• The current liabilities’ book and market values
stand at $6 million and the firm’s long-term
debt is $15 million.
• What are the book value and market value of
the firm’s shareholders equity? Construct the
book value and market value balance sheet for
D2K Inc.
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10
0
Computing Book Value
Lucas Inc. is a start-up computer software
development firm. It currently owns computer
equipment worth $30,000 and has cash on hand of
$20,000 contributed by firm’s owners.
For each of the following transactions, identify the real
and/or financial assets that trade hands.
Are any financial assets created or destroyed in the
transaction?
a. Firm takes out a bank loan. It receives $50,000 in
cash and signs a note promising to pay back
the loan over 3 years.
b. Firm uses the cash from the bank plus $20,000 of
its own funds to finance the development of new
financial planning software.
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10
1
Corporation
11
2
Commercial bank
Income Statement
3
Some equations
1. EPS
2. DPS
3. BVPS
4. MVPS = Market price of the firms’ common stock
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11
4
13
11
5
Corporate Income Taxes
• Corporate Tax Rates as of 2012
14
• The U.S tax structure is progressive, meaning

that the larger the income, the higher the taxes
assessed.
Average Tax Rate
vs Marginal Tax Rate
• Average tax rate =

• Marginal tax rate is the additional
taxes a firm must pay out for every
additional dollar of taxable income it
earns.
15
Calulating the tax rate
• E.g: Antonio Inc. earned $17 mill taxable
income (EBT) in 2012. Use the tax schedule to
compute the firm’s 2012 tax liability, its average
tax rate and its marginal tax rate.
16
Effect of Debt vs Equity Financing on Returns
• Supposed you wonder between two alternative

investments (in Firm A or Firm B). Both are active
in the same industry and have identical operating
incomes of $10 million.
✓ Firm A finances its $24 million in assets with $22
million in debt (on which it pays 10% interest)
and $2 million in equity.
✓ Firm B finances its $24 million in assets with
$24 million in equity and no debt. Both firm has
pay 30% tax on their taxable income.
• Calculate the income that each firm has available
to pay its debt and shareholders and the ROEs.
17
The Statement
of Cash Flow
• Financial managers and

investors are far more
interested in actual cash
flows than in the
backward- looking profit
listed on the income
statement.
• A financial statement
that shows the firm’s
cash flows over a given
period of time.
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The Statement of Cash Flow
19
The Statement of Cash Flow
12
2
Statement of Cash Flows
12
21
3
Free Cash Flow
• The cash that is actually available for
distribution to the investors in the firm after the
investments that are necessary sustain the
firm’s ongoing operations are made.
22
Computing FCF
• What was DPH Tree Farm’s free cash flow for
2012?
23
Statement of Retained Earnings
• Increases in retained earnings occur not just
because a firm has net income, but also
because the firm’s common shareholders
agree to let management reinvest net income
back into the firm rather than pay it out as
dividends.
• Reinvesting net income back into retained
earnings allows the firm to grow by providing
additional funds that can be spent on plant and
equipment, inventory, and other assets needed
to generate even more profit.
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Statement of Retained Earnings
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25
7

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REVIEWING FINANCIAL STATEMENTS

4.Free Cash Flow

5.Statement of Retained Earnings

• Net working capital = Current assets – Current liabilities

• Balance Sheet shows its

4. MVPS = Market price of the firms’ common stock

• The U.S tax structure is progressive, meaning

• Average tax rate =

• Supposed you wonder between two alternative

• Financial managers and

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