Financial Statements, Cash

Flow,
and Taxes

Chapter 3
Objectives:

1. To describe the basic financial statements,

2. To present background information on
cash flows,
3. To differentiate between cash flow and
accounting income
4. To provide an overview of the federal
income tax system.
Unlocking the Valuable Information in
Financial Statements

Financial statements convey a lot of useful information that helps the

insiders and outsiders of the company.

At first glance, financial statements can be overwhelming—but if we

know what we are looking for, we can quickly learn a great deal about a
company after a quick review of its financial statements. (BS, IS, SCF)
Financial Statements and Reports
Annual Report - a report issued annually by a corporation to its
stockholders. It contains basic financial statements as well as
management’s analysis of the firm’s past operations and future
prospects.

1. Balance Sheet
2. Income Statement
3. Statement of Cash Flows
4. Statement of Stockholders’ Equity
The Balance Sheet is a “snapshot” of a firm’s position at a specific
point in time.
Stockholders’ equity can be thought of in two ways.

Stockholders’ equity = Total assets - Total liabilities

Stockholders’ equity = Paid-in capital + Retained earnings

Retained Earnings represent the cumulative total of all earnings kept by

the company during its life.
The Income Statement is a report summarizing a
firm’s revenues, expenses, and profits during a reporting
period, generally a quarter or a year.
Depreciation - The charge to reflect the cost of assets depleted in the
production process.

Amortization - A noncash charge similar to depreciation except that it

represents a decline in value of intangible assets.
Statement of Cash Flows A report that shows how items that
affect the balance sheet and income statement affect the firm’s
cash flows.
Statement of Stockholders’ Equity - A statement that
shows by how much a firm’s equity changed during the
year and why this change occurred.
 ..continuation of chapter 3
3-6 Uses and Limitations of Financial Statements
3-7 Free Cash Flow
3-8 MVA and EVA
3-9 Income Taxes
3-9A Individual Taxes
3-9B Corporate Taxes
Uses and Limitations of
Financial Statements
Uses of Financial Statements

1. Bridging the Gap in Management

2. Availing Credit from Lenders
3. Use for Investors
4. Use for Government
5. Information on Investments
Limitations of Financial Statements

1. Not a reflection of the present Financial Position

2. Possibility of Bias
3. The Absence of Vital Information
4. Lack of Qualitative Information
5. Lack of Details
Free Cash Flow (FCF)

 The amount of cash that could be

withdrawn without harming a firm’s
ability to operate and to produce
future cash flows.
 Market Value Added (MVA)
- Refers to the excess of the market value of equity over its book value.
For example:
A firm started with 1 million of assets at book value, P500K from
bondholders, P500k from stockholders (50k shares purchased at P10
per share).
However, this firm became very successful; the market value of the
firm’s equity is now worth P19.5 million, and its current stock price is
P19.5 million/50k = P390 per share.
The market value added is P19.5 million – P500k = P19 million.
 Importance of MVA

1. Increased Attractiveness to
prospective Investors
2. High Returns for Investors
3. Survival of the Company
4. Good Management in Place
 Economic Value Added (EVA)

– Refers to the excess of NOPAT over capital costs.

- It is sometimes called “economic profit”
- It is a measure of surplus value created on a given
investment.
- If EVA is negative, it means the enterprise is reducing
the value on the funds invested in it.
 Importance of EVA
1. Wealth maximization is more important as compared to
profit maximization.
2. Organizations tend to focus on profits and ignore the
cash flow.
3. It takes into account both short-term as well as long-
term perspectives.
 Income Taxes

Individual Corporate
Taxes Taxes
Individual Taxes

Salaries and wages

Investments
Profits of proprietorships
Source: R.A. no. 10963 TRAIN Law
Several Methods used to present a Tax Rate
1. Statutory – legally imposed rate
2. Average – the ratio of the total amount of taxes paid to the
total tax base; (tax brackets)
3. Marginal – tax rate applicable to the last unit of a person’s
income.
4. Effective – use to measure the total tax paid as a
percentage of the company’s accounting income, instead a
percentage of the taxable income
 Capital Gain vs. Capital Loss
Capital Gain – The profit from the sale of a capital asset
(stocks, bonds, and real estate) for more than its
purchase price.

Capital Loss – The loss from the sale of a capital assets

for less than its purchase price.
PERA (Personal Equity and
Retirement Account)
- A long-term and tax-free voluntary retirement
investment program in the Philippine created
through the Republic Act 9505.
- Offered by Banco de Oro (BDO) and Bank of
the Philippine Island (BPI)
 Corporate Taxes

1. Corporations including partnerships

2. Domestic corporations receiving income from
sources within and outside the Philippines
3. Foreign corporations receiving income from
sources within the Philippines
4. Estates and trusts engaged in trade or business
 Corporate Loss Carryback and
Carryforward

Ordinary corporate operating losses can be

carried backward for 2 years and carried
forward for 20 years to offset taxable income
in a given year.