Walk through 3 fin. stmts.
- The Income Statement gives the company’s revenue and expenses, and goes down to Net Income, the final line on the statement.
- The Balance Sheet shows the company’s Assets – its resources – such as Cash, Inventory and PP&E, as well as its Liabilities – such as Debt and Accounts Payable – and Shareholders’ Equity. Assets must equal Liabilities plus Shareholders’ Equity.
- ## The Cash Flow Statement begins with Net Income, adjusts for non-cash expenses and working capital changes, and then lists cash flow from investing and financing activities; at the end, you see the company’s net change in cash.”Cash Flow Statement: Net Income; Depreciation & Amortization; Stock-Based Compensation; Changes in Operating Assets & Liabilities; Cash Flow From Operations; Capital Expenditures; Cash Flow From Investing; Sale/Purchase of Securities; Dividends Issued; Cash Flow From Financing.
how do 3 stmts. link together?
Net Income from the Income Statement flows into Shareholders’ Equity on the Balance Sheet, and into the top line of the Cash Flow Statement.
Changes to Balance Sheet items appear as working capital changes on the Cash Flow Statement, and investing and financing activities affect Balance Sheet items such as PP&E, Debt and Shareholders’ Equity. The Cash and Shareholders’ Equity items on the Balance Sheet act as “plugs,” with Cash flowing in from the final line on the Cash Flow Statement.”
- If I were stranded on a desert island, only had 1 statement and I wanted to review the overall health of a company – which statement would I use and why?
You would use the Cash Flow Statement because it gives a true picture of how much cash the company is actually generating, independent of all the non-cash expenses you might have. And that’s the #1 thing you care about when analyzing the overall financial health of any business – its cash flow.
—if could choose 2 do I.S. and B.S. bc can make CFS from both of those
If Depreciation is a non-cash expense, why does it affect the cash balance?
Although Depreciation is a non-cash expense, it is tax-deductible. Since taxes are a cash expense, Depreciation affects cash by reducing the amount of taxes you pay.
Walk me through how Depreciation going up by $10 would affect the statements.
- I.S. - EBIT would fall by $10 - then assuming $40% tax rate (shield of $4)…NI would fall by $6.
- CFS - NI down by $6 at top of stmt. - but $10 deprec. is non-cash expense so it is added back to the -6 = +$4, cash from operations inc. by $4 - no other changes in CFS
- B.S. - Asset side = PP&E down by 10 bc more accum. deprec…but cash up by $4 so the change = dec. $6
- –Shareholders equity - down by $6 in RE bc of the dec. in NI - so then both sides balance at $-6
What happens when Accrued Compensation goes up by $10?
- I.S. this would be an operation expense - so EBIT dec. by $10, tax rate = 40% so NI dec. by $6
- CFS = NI falls but accrued compensation would bring more cash into the firm, making net change in cash at the bottom of CFO up by $4
- Asset = cash up by $4
- -Current liabilities inc. by $4 in accrued compensation - then NI causes RE to dec. by $6 and the total = +$4 and the sides balance
- What happens when Inventory goes up by $10, assuming you pay for it with cash?
- I.S. - no change bc working capital is a capital expense…but if later used in manuf. it into a product and selling it counts as COGS and Operating Expense
- CFS - inventory decreases your CFO by $10
- B.S. - Asset side - Inventory up by $10, but cash is down by $10 so they balance out
Let’s say Apple is buying $100 worth of new iPod factories with debt. How are all 3 statements affected at the start of “Year 1,” before anything else happens?
- At start of year 1…no changes to N.I.
- CFS - the investment in factories (WC) would result in a reduction of $100 in cash…but the $100 worth in debt raised to fund the project is an increase. in CF, so it would cancel the CFI
- B.S. = PP&E up by $100 = asset side
- –liabilities are up by $100 in debt = balance both sides
Now let’s go out 1 year, to the start of Year 2. Assume the debt is high-yield so no principal is paid off, and assume an interest rate of 10%. Also assume the factories depreciate at a rate of 10% per year. What happens?
1 . I.S. - if deprec. 10% ea. year - EBIT would be down by $10 - then with 10% interest rate, the EBT (pre-tax income) would dec. by $20. Assume 40% tax rate - shield of $8 and makes NI down by $12 in total.
- CFS - NI down by $12 by add back non-cash exp. of depreciation of $10 - to make net change in cash from operations = -$2, cash down by $2
- B.S. under assets - net PP&E fall by $10 with the inc. depreciation. and cash is down by $2 so total assets down by $12
- -NI. is down by $12 also and makes the RE fall by $12 on shareholder’s equity side = balanced
- At the start of Year 3, the factories all break down and the value of the equipment is written down to $0. The loan must also be paid back now. Walk me through the 3 statements.
After 2 years (since deprec. by 10% each year) - the book value would be $80.
- IS - $80 write up shows on pre-tax income line. 40% tax rate would create tax shield of $32 and dec. NI by $48.
- CFS - NI down by $48, but write down is a non-cash expense so add $80 back = net change in CFO is $32
- –no change in CFI
- -But CFF there is $100 charge for loan payback so CFF falls by $100 making total net change in cash fall by $68. - B.S. PP&E down by $80 and cash fell by $68, making total asset side fall by $148
- -liabilities: debt would fall by $100 and the NI is a fall of $48 = $148 dec. on this side and they balance
