Financial Statements, Taxes and
Cash Flow
Chapter 2


Key Concepts and Skills
• Know the difference between book value

and market value
• Know the difference between accounting
income 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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PPTs t/a Essentials of Corporate Finance by Ross, Trayler,

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Chapter Outline
• The Balance Sheet
• The Income Statement
• Taxes
• Cash Flow

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PPTs t/a Essentials of Corporate Finance by Ross, Trayler,


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Market 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 decisionmaking process?
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PPTs t/a Essentials of Corporate Finance by Ross, Trayler,

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Battler Company
Battler Company
Balance Sheets
Book Value versus Market Value
Book

Market

Assets


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PPTs t/a Essentials of Corporate Finance by Ross, Trayler,

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Income Statement
• The income statement is more like a video

of the firm’s operations for a specified period
of time.
• You generally report revenues first and then
deduct any expenses for the period
• Matching principle – AAS say to show
revenue when it accrues and match the
expenses required to generate the revenue

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PPTs t/a Essentials of Corporate Finance by Ross, Trayler,

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Table 2.2

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income
– What is your tax liability?
– What is the average tax rate?
– What is the marginal tax rate?
• If you are considering a part time job that
will increase your taxable income by
$10,000, what tax rate should you use in
your analysis?
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PPTs t/a Essentials of Corporate Finance by Ross, Trayler,

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Imputation tax
• Major effect is that the double taxation of company

profits is negated
• Company advises the shareholder of the amount of
company tax already paid on the dividend
• Shareholder then adds this amount of tax to the
cash dividend that they have received and pays
personal tax on the grossed up amount
• Shareholder receives a tax (franking) credit
equivalent to the amount of tax paid by the
company
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Essentials of Corporate Finance by Ross, Trayler,


Cash Flow From Assets
• Cash Flow From Assets (CFFA) = Cash

Flow to Creditors + Cash Flow to
Shareholders
• Cash Flow From Assets = Operating
Cash Flow – Net Capital Spending –
Changes in NWC

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Example: OZ Company
• OCF (I/S) = EBIT + depreciation – taxes = $547
• NCS (B/S and I/S) = ending net fixed assets – beginning
•
•
•
•
•

net fixed assets + depreciation = $130
Changes in NWC (B/S) = ending NWC – beginning NWC
= $330
CFFA = 547 – 130 – 330 = $87
CF to Creditors (B/S and I/S) = interest paid – net new
borrowing = $24


2001: NFA = 3000; 2002: NFA = 4000
Depreciation expense = 300

• LT Liabilities and Equity
–
–

2001: LTD = 2200; Common Equity = 500; RE = 500
2002: LTD = 2800; Common Equity = 750; RE = 750

• Income Statement Information
–

EBIT = 2700; Interest Expense = 200; Taxes = 1000; Dividends =
1250

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Example: Cash Flows
• OCF = 2700 + 300 – 1000 = 2000
• NCS = 4000 – 3000 + 300 = 1300
• Changes in NWC = (2000 – 1700) – (1500 –
•
•
•

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