FIN 3101 Financial Management

Chapter 2
Financial Statements

DR. HOWARD KEEN FALL 2022

 FORMULAS
34. Assets ≡ Liabilities + Owners’ Equity (Balance Sheet or Accounting Identity)
35.  Retained earnings = net income - distributed earnings
(dividends)
36.  Retained earnings + dividends = net income
37. Revenue - operating expenses = earnings before interest and
taxes (EBIT)
38. Net Income (NI) = revenues – expenses
39. ∆ NI (any expense item) = - ∆ Expense (1 – T)
40. ∆ Cash (any expense item except depreciation) = - ∆ Expense (1 –
T)
41. ∆ Cash (depreciation only) = ∆ Expense * T
 FORMULAS
42. Cash flow from assets (CFFA) = cash flow to creditors (CFTC) + cash flow to
owners (CFTO)
43. Cash flow from assets (CFFA) = operating cash flow – net capital spending –
change in net working capital
44. Operating cash flow (OCF) = EBIT + depreciation – taxes
45. Net Capital Spending (NCS) = purchase of new capital equipment – sale of
existing capital equipment
46. Net capital spending (NCS) = ∆ gross fixed assets = ∆ net fixed assets +
depreciation
47. Net working capital (NWC)= current assets – current liabilities
48.  net working capital (NWC) = ∆ current assets - ∆ current liabilities
49. Cash Flow to Creditors (CFTC)= interest expense - ∆ L. T. liabilities (debt)
50. Cash Flow to Owners (CFTO) = dividends - ∆ common stock
 STEPS IN SOLVING QUANTITATIVE PROBLEMS

1) Read the problem and identify which variable

you’re being asked to find.
2) Find the formula(s) with this variable on the left-
hand side of the equals sign.
3) Identify which right-hand-side variables are given
in the problem.
4) Work the mechanics of the appropriate formula.
 BALANCE SHEET

Assume the following: CA = $600; GFA = $2,100;

NFA = $1,900; NWC = $200; L.T. Debt = $1,000.
What is (a) TA? [ $2,500 ] (b) AD? [ $200 ] (c) CL?
[ $400 ] and (d) Owners’ Equity? [ $1,100 ]
 INCOME STATEMENT

 Assume the following: Revenue = $1,000; COGS

= $300; SGA = $200; EBIT = $400; Taxable income
= $350; Net Income = $210. What is (a)
Depreciation Expense? [ $100 ] (b) Interest
Expense? [ $50 ] (c) Taxes? [ $140 ] (d) the firm’s
tax rate? [ 40% ]
HOW CHANGES IN EXPENSE ITEMS IMPACT NET INCOME AND
CASH

 For any expense item EXCEPT DEPRECIATION impact will

be same on Net Income and cash: In opposite direction from
change in expense item x ( 1 – tax rate).
 Example: Decrease in interest expense of $200 with a tax
rate of 35% will change both Net Income and cash by -(-
$200)(1-.35) = + $130
 Example: Decrease in DEPRECIATION EXPENSE of $200
with a tax rate of 35% will change Net Income by -(-$200)
(1-.35) = + $130 but cash by -$200 x .35 = -$70!
HOW CHANGES IN EXPENSE ITEMS IMPACT NET INCOME AND
CASH

With a tax rate of 35%, what is the impact on

NI and a firm’s amount of cash from (a) an
increase of depreciation expense of $100;
and (b) a decrease in interest expense of
$100?
Δ NI = (a) -$65 (b) +$65
Δ Cash = (a) +$35 (b) +$65
 NET INCOME & OPERATING CASH FLOW (OCF)

If Revenue = $240; COGS = $30; SGA = $18;

Depreciation = $16; Interest Expense = $5;
Tax Rate = 40%.
What is Net Income? [ $102.6 ]
What is OCF? [ $123.6 ]
 NET INCOME & OPERATING CASH FLOW (OCF)

If Revenue = $120; COGS = $15; SGA =

$12; Depreciation = $11; Interest
Expense = $0; and the tax rate is 40%,
what is OCF? [ $60.2 ]
 NET CAPITAL SPENDING (NCS)

Purchase of New Equipment - Sale of Existing Equipment =

NCS
$150 $175
-$25
$90 $55
$35
$40 $40
$0
 NET CAPITAL SPENDING (NCS)

Assume the following: For year 1, Gross Fixed

Assets = $3,000; Accumulated Depreciation =
$700. For year 2, Gross Fixed Assets =
$2,500; Depreciation Expense = $300. What
is NCS in year 2? [ -$500 ]
 CASH AVAILABLE TO SEND TO INVESTORS
Given the following: OCF = $50; ∆NWC =
$12;
∆NFA = $15; Latest depreciation expense =
$8;
How much does this company have available
to send to
its investors? [ $15 ]
By what names is this measure known? [See
 CASH AVAILABLE TO SEND TO INVESTORS

Cash available to send back to investors is known as the

Cash Flow
from Assets (CFFA) and “Free Cash Flow”.
 CASH AVAILABLE TO SEND TO INVESTORS

Given the following: OCF = $20; ∆NWC =

minus $5; ∆NFA = $10; Latest
depreciation expense = $5; How much
does this company have available to send
to its investors? [ $10 ] By what names is
this measure known?
 EXAMPLE: CASH FLOW IDENTITY

 Assume the following: CFFA = -$20; Dividends = $4; Long-term

debt increased in the amount of $7; Interest paid = $2. According
to the Cash Flow Identity, did this company (a) sell additional stock
or (b) repurchase stock and in what amount?
 -$20 = $2 - $7 + $4 – Δ Common Stock
 Δ Common Stock = $2 - $7 + $4 + $20 = +$19 => Company sold additional stock in
amount of $19.
 Company had to cover a total of $26 and after borrowing $7, needed to acquire
another $19 from shareholders by selling stock in the amount of $19.
 EXAMPLE: CASH FLOW IDENTITY

Assume the following: CFFA = $10; Dividends

= $3; Long-term debt paid off in the amount of
$5; Interest paid = $3. According to the Cash
Flow Identity, did this company (a) sell more or
(b) repurchase stock? [ Sell More ] and in
what amount? [ $1 ]
 EXAMPLE: CASH FLOW IDENTITY
 Assume the following: CFFA = $5; Dividends = $2; Additional $15
of Stock sold; Interest paid = $6. According to the Cash Flow
Identity, did this company (a) add to (b) reduce its long-term debt
and in what amount?
 $5 = $6 - Δ L.T. Debt + $2 - $15
 Δ L.T. Debt = $6 + $2 - $15 - $5 = -$12 => Company paid off
debt in amount of $12.
 Company wanted to send out $8 for interest and dividends and had
$15 from selling stock and another $5 from CFFA. Out of this total
available to send to investors of $20, $12 still needs to be sent out
aside from the $8 for interest and dividends and only place to send
it is to creditors in the form of paying down debt.
 EXAMPLE: CASH FLOW IDENTITY

Assume the following: CFFA = $17; Dividends

= $3; Stock repurchased in the amount of $6;
Interest paid = $2. According to the Cash Flow
Identity, did this company (a) add to (b)
reduce its long-term debt? [ Reduce ] and in
what amount? [ $6 ]