Professional Documents
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Chapter 3
Financial Statements
Liuren Wu
Overview
1. An Overview of the Firms Financial Statements
2.
3.
4.
5.
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Learning Objectives
1. Understand the content of the 4 basic financial statements.
Focus on
Income statement
Balance sheet statement
Cash flow statement
2. Evaluate firm profitability using the income statement.
3. Estimate a firms tax liability using the corporate tax
schedule and distinguish between the average and marginal
tax rate.
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2.
3.
Cash flow statement How did the cash come and go?
cash received and cash spent by the firm over a period of time
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Its goods and services were exchanged for cash or accounts receivable; or
2.
The matching principle: Expenses are matched with the revenues they
helped produce.
The historical cost principle: Most assets and liabilities are reported in the
financial statements at historical cost, i.e., the price the firm paid to acquire
them. The historical cost generally does not equal the current market value
of the assets or liabilities.
FIN3000, Liuren Wu
An Income Statement
Sales
Minus Cost of Goods Sold
= Gross Profit
Minus Operating Expenses
Selling expenses
General and Administrative expenses
Depreciation and Amortization Expense
= Operating income (EBIT)
Minus Interest Expense
= Earnings before taxes (EBT)
Minus Income taxes
= Net income (EAT)
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= $2.57
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GPM indicates the firms mark-up on its cost of goods sold per
dollar of sales.
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Checkpoint 3.1
Constructing an Income Statement
Use the following information to construct an income statement for Gap, Inc. (GPS).
The Gap is a specialty retailing company that sells clothing, accessories, and personal
care products under the Gap, Old Navy, Banana Republic, Piperlime, and Athleta brand
names. Use the scrambled information below to calculate the firms gross profits,
operating income, and net income for the year ended January 31, 2009. Calculate the
firms earnings per share and dividends per share.
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Reconstruct the Gaps income statement assuming the firm is able to cut its
cost of goods sold by 10% and the firm pays taxes at 40% tax rate. What is the
firms net income and earnings per share?
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Equals Gross
profit
Equals: net
Operating income
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Step 3: Solve
Revenues = $14,526,000,000
Less: Cost of goods sold
= $8,171,100,000
Less: Operating expenses
=$3,899,000,000
Equals: profit
=$6,354,900,000
Equals: net
Operating income
=$2,455,900,000
Equals: earnings
Before taxes
=$2,454,900,000
Equals:
NET INCOME
=$1,472,940,000
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Step 4: Analyze
The firm is profitable since it earned net
income of $1,472,940,000.
The shareholders were able be earn $2.06 per
share. However, the dividends per share were
only $0.34 indicating that the difference of
$1.72 was reinvested in the corporation.
Compute gross profit margin, operating profit
margin, and net profit margin.
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Corporate Taxes
A firms income tax liability is calculated
using its taxable income and the tax rates
on corporate income.
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Marginal
tax rate
Incrementa Cumulativ
l Tax
e Tax
Liability
Liability
Average
Tax Rate
$50,000
15%
7,500
7,500
15.00%
$75,000
25%
6,250
13,750
18.33%
$100,000
34%
8,500
22,250
22.25%
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For example, DLK corporations par value per share is $2.00 and the firm has 30 million shares
outstanding such that the par value of the firms common equity is $60 million. If the stocks
were issued to investors for $240 million, $180 million represents paid in capital.
2. The amount of the firms retained earnings: the portion of net income
that has been retained (i.e., not paid in dividends) from prior years
operations.
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Checkpoint 3.2
Constructing a Balance Sheet
Construct a balance sheet for Gap, Inc. (GPS) using the following list of jumbled
accounts for January 31, 2009. Identify the firms total assets and net working capital:
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Step 4: Analyze
The firm has invested a total of $7.564B in
assets, funded by $2.158B current liability,
$1.019B long-term liability, and $4.387B
owner equity.
The firm has $4.005B in current assets and
$2.158B in current liability, leaving the firm
with a net working capital of $4.005-2.1581.847B.
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Current Liabilities
Accounts payable
Short-term debt
Other current liabilities
Total current liabilities
Total Assets
Long-term Liabilities
Long-term debt
Owners Equity
Par value of common stock
Paid-in-capital
Retained earnings
Total equity
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Step 3: Solve
Cash
Inventories
Other current
assets
756,000,000
1,506,000,000
743,000,000
Current liabilities
1,158,000,000
Total current
assets
3,005,000,000
Total current
liabilities
1,158,000,000
Net Property,
Plant and
equipment
2,993,000,000
Long-term
liabilities
1,019,000,000
Other long-term
assets
626,000,000
Common Equity
4,387,000,000
Total Assets
$6,564,000,000
Total Liabilities
and Equity
$6,564,000,000
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Step 4: Analyze
We can make the following observations from Gaps Balance
sheet:
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In general,
Liuren Wu
an increase in anFIN3000,
asset
account = use of cash
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5.
6.
7.
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Uses of Cash
Increase in inventory =
$148.50
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Uses of Cash
Decrease in an asset
account
Increase in a liability
account
Increase in an asset
account
Decrease in a liability
account
Increase in an owners
equity account
Decrease in an owners
equity account
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Operating activities represent the companys core business including sales and
expenses. Basically any activity that affects net income for the period.
Investing activities include the cash flows that arise out of the purchase and sale of
long-term assets such as plant and equipment.
Financing activities represent changes in the firms use of debt and equity such as issue
of new shares, payment of dividends.
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Checkpoint 3.3:
Interpreting the Statement of Cash Flow
Chesapeake Energy Inc. (CHK) is the largest producer of natural gas in
the United States and is headquartered in Oklahoma City. The firms
cash flow statements for 2004 through 2007:
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Analyze
Chesapeake has had positive & growing cash flows from operations in all 4
years.
The primary contributor were the firms net income and depreciation expense.
Working capital is a source of cash in 3 out of 4 years, indicating the net reduction
in the firms investment in working capital.
Chesapeake has been very aggressive in new fixed assets and acquisitions of
new oil and gas properties. Total investments have been roughly two times the
cash flow from operation, which meant that the firm had to raise a substantial
amount of money.
Chesapeake has been a regular issuer of both equity and debt. $13.5 billion
was raised in the 4-year period. Chesapeake has made relatively modest
modest cash distributions and retained most earnings.
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Step 3: Solve
Cash flow from operating activities
EXCO had a positive cash flow from operating
activities of $577.83 million in 2007. In 2006, the
cash flow from operating activities was much
lower at $227.86.
The primary contributors to the operating cash
flows in 2007 were the firms
depreciation/depletion expense and non-cash
expense. Net working capital is a use of cash.
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Step 4: Analyze
The cash flow statement for 2007 depicts a profitable firm
with positive cash flow from operations.
The firm has been aggressively investing in fixed assets to the
tune of almost 4 times its operating cash flows.
The firm has been able to successfully raise money from
capital markets by issuing stocks of nearly $2,000 million.
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