Unlock document.
This document is partially blurred.
Unlock all pages and 1 million more documents.
Get Access
Chapter 02 - Financial Statements, Taxes, and Cash Flow
2-1
Chapter 2
FINANCIAL STATEMENTS, TAXES, AND CASH FLOW
CHAPTER WEB SITES
Section
Web Address
CHAPTER ORGANIZATION
2.1 The Balance Sheet
2.2 The Income Statement
2.5 Summary and Conclusions
Chapter 02 - Financial Statements, Taxes, and Cash Flow
2-2
ANNOTATED CHAPTER OUTLINE
2.1. The Balance Sheet
A. Assets: The Left Side
B. Liabilities and Owners’ Equity: The Right Side
Lecture Tip: Students sometimes find it difficult to see the
Lecture Tip: You may find it useful at this point to spend a few
C. Net Working Capital
Chapter 02 - Financial Statements, Taxes, and Cash Flow
2-3
D. Liquidity
It is important to point out to students that liquidity has two
Lecture Tip: Some students get a little confused when they try to
E. Debt versus Equity
Interest and principal payments on debt have to be paid before cash
Chapter 02 - Financial Statements, Taxes, and Cash Flow
2-4
F. Market Value versus Book Value
Lecture Tip: Accounting, or historical costs, are not very
Lecture Tip: The above example also provides a rationale for the
Lecture Tip: Finance practitioners (and professors) throw around
Chapter 02 - Financial Statements, Taxes, and Cash Flow
2.2. The Income Statement
Lecture Tip: Previously, it was noted that investment decisions are
A. GAAP and the Income Statement
Remember that GAAP requires that we recognize revenue when it
Lecture Tip: In March 2004, Global Crossing reported record
Ethics Note: Publicly traded firms have to file audited annual
Chapter 02 - Financial Statements, Taxes, and Cash Flow
2-6
B. Noncash Items
The largest noncash deduction for most firms is depreciation. It
reduces a firm’s taxes and its net income. Noncash deductions are
part of the reason that net income is not equivalent to cash flow.
Lecture Tip: Students sometimes fail to grasp the distinction
between the economic life of an asset, the useful life of an asset for
Chapter 02 - Financial Statements, Taxes, and Cash Flow
2-7
C. Time and Costs
We need to plan for both short-run cash flows and long-run cash
Lecture Tip: The text notes the ever-changing nature of the tax
code. This can be illustrated by the changes in the Investment Tax
Credit (ITC) between 1962 and 1986.
A. Corporate Tax Rates
It’s important to point out to students that corporations (and
B. Average versus Marginal Tax Rates
The average rate rises to the marginal rate at $50 million of taxable
Chapter 02 - Financial Statements, Taxes, and Cash Flow
2-8
Lecture Tip: The op-ed page of the March 11, 1998, issue of The
2.4. Cash Flow
A. Cash Flow from Assets (CFFA)
B. Cash Flow to Creditors and Stockholders
Cash flow to creditors = interest paid – net new borrowing =
interest paid – (ending long-term debt – beginning long-term debt)
Chapter 02 - Financial Statements, Taxes, and Cash Flow
2-9
C. An Example: Cash Flows for Dole Cola
The following questions may arise from looking at the financial
statements:
1. How do you account for “prepublication costs,” “investments
and other assets” and “goodwill and other intangible assets?” Are
The cash flow identity does not appear to hold when applied in a
reasonable fashion based on the information provided. It is
