Chapter 2
Financial Statements,
Taxes, and Cash Flow
McGraw-Hill/Irwin
Copyright © 2010 by The McGraw-panies, Inc. All rights reserved.
1
Key Concepts and Skills
Know the difference between book value and market value
Know the difference between accounting e and cash flow
Know the difference between average and marginal tax rates
Know how to determine a firm’s cash flow from its financial statements
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Chapter Outline
The Balance Sheet
The e Statement
Taxes
Cash Flow
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Balance Sheet
The balance sheet is a snapshot of the firm’s assets and liabilities at a given point in time
Assets are listed in order of decreasing liquidity
Ease of conversion to cash
Without significant loss of value
Balance Sheet Identity
Assets = Liabilities + Stockholders’ Equity
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The Balance Sheet - Figure
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Net Working Capital and Liquidity
Net Working Capital
= Current Assets – Current Liabilities
Positive when the cash that will be received over the next 12 months exceeds the cash that will be paid out
Usually positive in a healthy firm
Liquidity
Ability to convert to cash quickly without a significant loss in value
Liquid firms are less likely to experience financial distress
But liquid assets typically earn a lower return
Trade-off to find balance between liquid and illiquid assets
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US Corporation Balance Sheet – Table
Place Table (US Corp Balance Sheet) here
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Market Value vs. Book Value
The balance sheet provides the book value of the assets, liabilities, and equity.
Market value is the price at which the assets, liabilities ,or equity can actually be bought or sold.
Market value and book value are often very different. Why?
Which is more important to the decision-making process?
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Example Klingon Corporation
KLINGON CORPORATION
Balance Sheets
Market Value versus Book Value
Book
Market
Book
Market
Assets
Liabilities and Shareholders’ Equity
NWC
$ 400
$ 600
LTD
$ 500
$ 500
NFA
700
1,000
SE
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