Financial Statements, Cash Flow, and Taxes
After reading this chapter, students should be able to:
◆ Briefly explain the history of accounting and financial statements, and how financial statements are used.
◆ List the types of information found in a corporation’s annual report.
◆ Explain what a balance sheet is, the information it provides, and how assets and claims on assets are arranged on a balance sheet.
◆ Explain what an income statement is and the information it provides.
◆ Differentiate between net cash flow and accounting profit.
◆ Identify the purpose of the statement of cash flows, list the factors affecting a firm’s cash position that are reflected in this statement, and identify the three categories of activities that are separated out in this statement.
◆ Specify the changes reported in a firm’s statement of retained earnings.
◆ Discuss what questions can be answered by looking through the financial statements, and explain why investors need to be cautious when they review financial statements.
◆ Discuss how certain modifications to the accounting data are needed and used for corporate decision making and stock valuation purposes. In the process, explain the terms: net operating working capital, total operating capital, NOPAT, operating cash flow, and free cash flow; and explain how each is calculated.
◆ Define the terms Market Value Added (MVA) and Economic Value Added (EVA), explain how each is calculated, and differentiate between them.
◆ Explain why financial managers must be concerned with taxation, and list some of the most important elements of the current tax law, such as the differences between the treatment of dividends and interest paid and interest and dividend income received.
The goal of financial management is to take actions that will maximize the value of a firm’s stock. These actions will show up, eventually, in the financial statements, so a general understanding of financial statements is critically important. Note that Chapter 3 provides a bridge between accounting, which students have just covered, and financial management. Unfortunately, many non-accounting students did not learn as much as they should have in their accounting courses, so we find it necessary to spend more time on financial statements than we would like. Also, at Florida and many other schools, students vary greatly in their knowledge of accounting, with accounting majors being well-grounded because they have had more intense introductory courses and, more importantly, because they are taking advanced financial accounting concurrently with finance. This gives the accountants a major, and somewhat unfair, advantage over the others in dealing with Chapters 3 and 4 on exams. We know of no good solution to this problem, but what we do is pitch the coverage of this material to the non-accountants. If we pitch the lectures (and exams) to the accountants, they simply blow away and demoralize our non-accountants, and we do not want that. Perhaps Florida has more of a difference between accounting and non-accounting students, but at least for us there really is a major difference. What we cover, and the way we cover it, can be seen by scanning the slides and Integrated Case solution for Chapter 3, which appears at the end of this chapter solution. For other suggestions about the lecture, please see the “Lecture Suggestions” in Chapter 2, where we describe how we conduct our classes.
DAYS ON CHAPTER: 2 OF 58 DAYS (50-minute periods)
Answers to End-of-Chapter Questions
The four financial statements contained in most annual reports are the balance sheet, income statement, statement of retained earnings, and statement of cash flows.
Accountants translate physical quantities into numbers when they construct the financial statements. The numbers shown on balance...
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