Ch. 2 - Understanding Financial Statements, Taxes, and Cash Flows, Prentice Hall, Inc.
Financial Statements, Cash Flows, Taxes, and the Language of Finance
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Transcript of Financial Statements, Cash Flows, Taxes, and the Language of Finance
© 2004 Pearson Education Canada Inc.
2-1
Chapter TwoFinancial Statements, Cash
Flows, Taxes, and the Language of Finance
Principles of Managerial Finance
First Canadian Edition
Lawrence J. Gitman and Sean Hennessey
© 2004 Pearson Education Canada Inc.
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Learning Goals
LG1 – Review characteristics, format, key components, and relationships between Income Statement, Balance Sheet, Statement of Retained Earnings, and Statement of Cash Flows.
LG2 – Analyze a firm’s cash flows; develop and interpret the statement of cash flows.
© 2004 Pearson Education Canada Inc.
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Learning Goals (continued)LG3 – Introduce basics of corporate taxation in
Canada.LG4 – Understand tax deductibility of
expenses, how they reduce actual, after-tax costs to a profitable company.
LG5 – Discuss and illustrate Capital Cost Allowance (CCA), the tax version of amortization, and how CCA increases cash flows.
© 2004 Pearson Education Canada Inc.
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Learning Goals (continued)
LG6 – Review the information provided in a publicly traded company’s annual report to shareholders.
LG7 – Discuss some key concepts in finance and review the language of finance.
© 2004 Pearson Education Canada Inc.
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Four Principal Financial Statements
Developed by the Canadian Institute of Chartered Accountants:
1. Income Statement
2. Balance Sheet
3. Statement of Retained Earnings
4. Statement of Cash Flows
© 2004 Pearson Education Canada Inc.
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Income Statement
• Provides financial summary of operating results for a specified period.
• Main operating results consist of:– Sales revenues, Cost of goods sold, Operating
expenses, Interest expenses, Taxes, and Preferred share dividends.
© 2004 Pearson Education Canada Inc.
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Income Statement (continued)
• Important sub-totals of these operating results are:– Gross margin.– Operating earnings (EBIT).– Earnings before taxes (EBT).– Net Income after taxes (NIAT).– Earnings available for common shareholders (EAC).
© 2004 Pearson Education Canada Inc.
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Balance Sheet
• Presents summary of firm’s financial position at a given point in time.
• Assets = Liabilities + Equity.
• In the short term, working capital management focuses on current assets and current liabilities.
© 2004 Pearson Education Canada Inc.
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Balance Sheet (continued)• Current Assets:
– Cash, Marketable securities, Accounts receivable, Inventories
• Gross Fixed Assets:– Land & Buildings,
Machinery & equipment, Furniture, Vehicles, Others
• Less: Accumulated amortization
• Current Liabilities:– Accounts payable,
Line of credit, Accruals
• Long-term debt• Shareholder’s equity:
– Preferred shares, Common shares, Retained earnings
© 2004 Pearson Education Canada Inc.
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Statement of Retained Earnings
• Details changes in Retained Earnings from the beginning to the end of the fiscal year.
Retained Earning Balance (start of year)
Plus: Net Income After Taxes
Less: Cash Dividends Paid
Retained Earning Balance (end of year)
© 2004 Pearson Education Canada Inc.
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Statement of Cash Flows
• Provides summary of all inflows and outflows of cash over the same period as the Balance Sheet.
• Provides insights into the firm’s operating, investment, and financing cash flows.
• Reconciles changes in cash and marketable securities.
© 2004 Pearson Education Canada Inc.
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The Firm’s Cash Flows
Operating Flows:• Payments:
– Accruals, Credit purchases, Taxes, Overhead expenses
• Receipts:– Cash sales, Collection
of credit sales, Tax refunds
Investment Flows:• Purchases & Sales:
– Fixed assets, Business interests
Financing Flows:• Increases in Debt or
Equity• Reductions in Debt or
Equity
© 2004 Pearson Education Canada Inc.
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Figure 2.2 Cash Flows
© 2004 Pearson Education Canada Inc.
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Inflows vs. Outflows
1. Decrease in any asset.2. Increase in any
liability.3. Net income after
taxes.4. Amortization and
other non-cash expenses.
5. Sale of shares.
1. Increase in any asset.2. Decrease in any
liability.3. Net loss.
4. Dividends paid.
5. Repurchase or retirement of shares.
© 2004 Pearson Education Canada Inc.
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Developing Cash Flow Statement
1. Cash and marketable securities (start of year).
2. Calculate net cash from operations.
3. Determine total changes in non-cash working capital accounts.
4. Determine cash flows from investing activities.
5. Determine cash flows from financing activities.
6. Determine change in cash and marketable securities (end of year).
© 2004 Pearson Education Canada Inc.
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Taxation of Business Income• Corporations can earn four types of income:
– Active Business Income
– Passive Income
– Intercorporate Dividends
– Capital Gains
• Types of Corporations for tax purposes:– Non-Manufacturing
– Manufacturing or Processing
– Canadian-controlled private corporation (CCPC)
© 2004 Pearson Education Canada Inc.
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Deductions from Federal Tax Rate
• Federal Corporate Tax for general Non-Manufacturing is 29.12%.
• Manufacturing and processing deduction (Federal Tax of 22.12% of earnings).
• Small business deduction (Federal Tax of 13.12% on earnings up to $200,000).
• CCPC rate reduction (Federal Tax of 22.12% on earnings between $200,000 and $300,000).
© 2004 Pearson Education Canada Inc.
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Tax-Deductible Expenses
• There are two main categories of deductible expenses for all types of Canadian Corporation:– Operating Expenses– Interest Expenses
© 2004 Pearson Education Canada Inc.
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CCA-Capital Cost Allowance
• Canadian Customs and Revenue Agency (CCRA) requires companies to use their schedule of Capital Cost Allowance (CCA) as a means of amortizing expenses of capital equipment for tax purposes.
• Like the concept of amortization, CCA is a non-cash expense item that is deductible for tax purposes.
© 2004 Pearson Education Canada Inc.
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Company Annual Report
• Required for all publicly traded firms
• Letter to Shareholders
• Management’s Discussion and Analysis
• Financial Statements:– Income statement, Balance Sheet, Statement of
retained earnings, Statement of cash flows
• Summary
© 2004 Pearson Education Canada Inc.
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Language of Finance
• Basic accounting
• Financial forecasting
• Financial markets
• Cost of capital
• Capital budgeting