Ch.

3 - Understanding Financial
Statements and
Cash Flows

, Prentice Hall, Inc.

 Income Statement

SALES
- EXPENSES
= PROFIT
 Income Statement

Revenue
SALES
- EXPENSES
= PROFIT
 Income Statement

•Cost of Goods Sold

SALES
- EXPENSES
= PROFIT
 Income Statement

•Cost of Goods Sold

SALES
•Operating Expenses
- EXPENSES
= PROFIT
 Income Statement

•Cost of Goods Sold

SALES
•Operating Expenses
- EXPENSES (marketing, administrative)

= PROFIT
 Income Statement

•Cost of Goods Sold

SALES
•Operating Expenses
- EXPENSES (marketing, administrative)
•Financing Costs
= PROFIT
 Income Statement

•Cost of Goods Sold

SALES
•Operating Expenses
- EXPENSES (marketing, administrative)
•Financing Costs
= PROFIT •Taxes
 SALES Income Statement
- Cost of Goods Sold
GROSS PROFIT
- Operating Expenses
OPERATING INCOME (EBIT)
- Interest Expense
EARNINGS BEFORE TAXES (EBT)
- Income Taxes
NET INCOME
- Preferred Stock Dividends
- NET INCOME AVAILABLE
TO COMMON STOCKHOLDERS
 SALES Income Statement
- Cost of Goods Sold
GROSS PROFIT
- Operating Expenses
OPERATING INCOME (EBIT)
- Interest Expense
EARNINGS BEFORE TAXES (EBT)
- Income Taxes
NET INCOME
- Preferred Stock Dividends
- NET INCOME AVAILABLE
TO COMMON STOCKHOLDERS
 SALES Income Statement
- Cost of Goods Sold
GROSS PROFIT
- Operating Expenses
OPERATING INCOME (EBIT)
- Interest Expense
EARNINGS BEFORE TAXES (EBT)
- Income Taxes
NET INCOME
- Preferred Stock Dividends
- NET INCOME AVAILABLE
TO COMMON STOCKHOLDERS
 Balance Sheet

Outstanding
Debt
Total Assets =
+
Shareholders’
Equity
Balance Sheet
 Balance Sheet
Assets
 Balance Sheet
Assets Liabilities (Debt) & Equity
 Balance Sheet
Assets Liabilities (Debt) & Equity
Current Assets Current Liabilities
Cash Accounts Payable
Marketable Securities Accrued Expenses
Accounts Receivable Short-term notes
Inventories Long-Term Liabilities
Prepaid Expenses Long-term notes
Fixed Assets Mortgages
Machinery & Equipment Equity
Buildings and Land Preferred Stock
Other Assets Common Stock (Par value)
Investments & patents Paid in Capital
Retained Earnings
 Free Cash Flows
Free cash flow: cash flow that is free and
available to be distributed to the firm’s
investors (both debt and equity investors)
 Free Cash Flows
Firm’s Operating Firm’s Financing
Free cash flows = Free cash flows

Cash flows generated Cash flows paid to - or

through the firm’s = received by - the
operations and firm’s investors
investments in (creditors &
assets stockholders)
 Calculating Free Cash Flows:
An Operating Perspective

After-tax cash flow

from operations
less
investment in net
operating
working capital
less
investments in fixed
and other assets
 Calculating Free Cash Flows:
An Operating Perspective

After-tax cash flow Operating income

from operations + depreciation
less - cash tax payments
investment in net
operating
working capital
less
investments in fixed
and other assets
 Calculating Free Cash Flows:
An Operating Perspective

After-tax cash flow

from operations
less [Change in current
investment in net assets]
operating -
working capital [change in non-
less interest bearing
investments in fixed current liabilities]
and other assets
 Calculating Free Cash Flows:
An Operating Perspective

After-tax cash flow

from operations
less
investment in net Change in gross
operating fixed assets,
working capital and any other
less assets that are
investments in fixed on the balance
and other assets sheet.
 Calculating Free Cash Flows:
A Financing Perspective
Interest payments to creditors
plus decrease in debt principal
or
minus increase in debt principal
plus dividends paid to stockholders
plus decrease in stock
or
minus increase in stock