02_IM_CHAPTER2

02_IM_CHAPTER2 - CHAPTER 2 Understanding Financial...

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CHAPTER 2 Understanding Financial Statements, Taxes, and Cash Flows CHAPTER ORIENTATION In this chapter, we review the contents and meaning of a firm’s income statement and balance sheet. We also look very carefully at how to compute a firm’s cash flows from a finance perspective, which is called free cash flows. CHAPTER OUTLINE I. Basic Financial Statements A. The Income Statement 1. The income statement reports the results from operating the business for a period of time, such as a year. 2. It is helpful to think of the income statement as comprising five types of activities: a. Selling the product b. The cost of producing or acquiring the goods or services sold c. The expenses incurred in marketing and distributing the product or service to the customer along with administrative operating expenses d. The financing costs of doing business: for example, interest paid to creditors and dividend payments to the preferred stockholders e. The taxes owed based on a firm’s taxable income 3. An example of an income statement is provided in Table 2-1 for the Harley-Davidson Corporation. 9
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B. The Balance Sheet 1. The balance sheet provides a snapshot of the firm’s financial position at a specific point in time, presenting its asset holdings, liabilities, and owner-supplied capital. a. Assets represent the resources owned by the firm (1) Current assets - consisting primarily of cash, marketable securities, accounts receivable, inventories, and prepaid expenses (2) Fixed or long-term assets – comprising equipment, buildings, and land (3) Other assets – all assets not otherwise included in the firm’s current assets or fixed assets, such as patents, long-term investments in securities, and goodwill b. The liabilities and owners’ equity indicate how the assets are financed. (1) The debt consists of such sources as credit extended from suppliers or a loan from a bank. (2) The equity includes the stockholders’ investment in the firm and the cumulative profits retained in the business up to the date of the balance sheet. 2. The balance sheet is not intended to represent the current market value of the company, but rather reports the historical transactions recorded at their costs. 3. Balance sheets for the Harley-Davidson Corporation are presented in Table 2-2. II Computing a Company’s Taxes A. Types of taxpayers 1. Sole proprietors a. Report business income on personal tax returns b. Pay taxes at personal tax rate 2. Partnerships a. The partnership reports income but does not pay taxes b. Each partner reports his or her portion of income and pays the corresponding taxes. 10
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3. Corporations a. Corporation reports income and pays taxes b. Owners do not report these earnings except when all or part of the profit is paid out as dividends. c.
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02_IM_CHAPTER2 - CHAPTER 2 Understanding Financial...

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