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Unformatted text preview: Chapter 3 Financial Statements, Cash Flow, and Taxes After reading this chapter, students should be able to: Understand each of the key financial statements and recognize the kinds of information they provide to corporate managers and investors. Estimate a firms free cash flow and understand why free cash flow has such an important effect on firm value. Understand the basics of the federal income tax system Chapter 3: Financial Statements, Cash Flow, and Taxes Learning Objectives 21 Learning Objectives Answers to End-of-Chapter Questions 3-1 The four financial statements contained in most annual reports are the balance sheet, income statement, statement of stockholders equity, and statement of cash flows. 3-2 Bankers and investors use financial statements to make intelligent decisions about what firms to extend credit or in which to invest, managers need financial statements to operate their businesses efficiently, and taxing authorities need them to assess taxes in a reasonable way. 3-3 No, because the $20 million of retained earnings would probably not be held as cash. The retained earnings figure represents the reinvestment of earnings by the firm. Consequently, the $20 million would be an investment in all of the firms assets. 3-4 The balance sheet shows the firms financial position on a specific date, for example, December 31, 2008. It shows each account balance at that particular point in time. For example, the cash account shown on the balance sheet would represent the cash the firm has on hand and in the bank on December 31, 2008. The income statement, on the other hand, reports on the firms operations over a period of time, for example, over the last 12 months. It reports revenues and expenses that the firm has incurred over that particular time period. For example, the sales figures reported on the income statement for the period ending December 31, 2008, would represent the firms sales over the period from January 1, 2008, through December 31, 2008, not just sales for December 31, 2008. 3-5 Investors need to be cautious when they review financial statements. While companies are required to follow GAAP, managers still have quite a lot of discretion in deciding how and when to report certain transactions. Consequently, two firms in exactly the same operating situation may report financial statements that convey different impressions about their financial strength. Some variations may stem from legitimate differences of opinion about the correct way to record transactions. In other cases, managers may choose to report numbers in a way that helps them transactions....
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This note was uploaded on 11/08/2011 for the course MAT/FIN 272 taught by Professor Burns during the Spring '11 term at Central Connecticut State University.
- Spring '11