Principals of Managerial Finance 9th Edition

1. Principals of Managerial Finance9th Edition Chapter 3 Financial Statements, Taxes, Depreciation, and Cash Flow

2. Learning Objectives • Review the format and key components of the income statement, the balance sheet, the statement of retained earnings, the statement of cash flows, and the procedures for consolidating international financial statements. • Understand the effect of depreciation and other non-cash charges on the firm’s cash flows.

3. Learning Objectives • Determine the amount of depreciation allowed each year for tax purposes using the modified accelerated cost recovery system (MACRS). • Analyze the firm’s cash flows and develop and interpret the statement of cash flows.

4. Financial Statements The Income Statement • The income statement provides a financial summary of a company’s operating results during a specified period. • Although they are prepared annually for reporting purposes, they are generally computed monthly by management and quarterly for tax purposes.

5. Financial Statements

6. Financial Statements The Balance Sheet • The balance sheet presents a summary of a firm’s financial position at a given point in time. • Assets indicate what the firm owns, equity represents the owners’ investment, and liabilities indicate what the firm has borrowed.

7. Financial Statements

8. Financial Statements

9. Financial Statements Statement of Retained Earnings • The statement of retained earnings reconciles the net income earned and dividends paid during the year, with the change in retained earnings.

10. Financial Statements

11. Financial Statements Statement of Cash Flows • The statement of cash flows provides a summary of the cash flows over the period of concern, typically the year just ended. • This statement not only provides insight into a company’s investment, financing and operating activities, but also ties together the income statement and previous and current balance sheets.

12. Depreciation • Depreciation is the systematic charging of a portion of the costs of fixed assets against annual revenues over time. • Depreciation for tax purposes is determined by using the modified accelerated cost recovery system (MACRS).

13. Depreciation Depreciation & Cash Flow • Financial managers are much more concerned with cash flows rather than profits. • To adjust the income statement to show cash flows from operations, all non-cash charges should be added back to net profit after taxes. • By lowering taxable income, depreciation and other non-cash expenses create a tax shield and enhance cash flow.

14. Depreciation Depreciable Value & Depreciable Life • Under the basic MACRS procedures, the depreciable value of an asset is its full cost, including outlays for installation. • No adjustment is required for expected salvage value. • For tax purposes, the depreciable life of an asset is determined by its MACRS recovery predetermined period. • MACRS rates are shown in Table 3.8 on the following slides.

15. Depreciation

16. Depreciation An Example Elton Corporation acquired, for an installed cost of $40,000, a machine having a recovery period of 5 years. Using the applicable MACRS rates, the depreciation expense each year is as follows:

17. Analyzing the Firm’s Cash Flows Classifying Sources & Uses of Cash • The statement of cash flows essentially summarizes the sources and uses of cash during a given period.

18. Analyzing the Firm’s Cash Flows Interpreting the Statement of Cash Flows • The statement of cash flows ties the balance sheet at the beginning of the period with the balance sheet at the end of the period after considering the performance of the firm during the period through the income statement. • “Net Increase (decrease) in cash and marketable securities should be equivalent to the difference between the cash and marketable securities on the balance sheet at the beginning of the year and the end of the year.