FINANCIAL
MANAGEMENT
SESSION 3
FINANCIAL STATEMENT, CASH FLOW AND TAXES
By Prof. Biranchi Panigrahi
The Annual Report
▪ Balance sheet – provides a snapshot of a
firm’s financial position at one point in time
▪ Income statement – summarizes a firm’s
revenues and expenses over a given period of
time
▪ Statement of cash flows – reports the
impact of a firm’s activities on cash flows over
a given period of time
3-2
A Typical Balance Sheet
1-3
Balance Sheet: Assets
2008 2007
Cash 7,282 57,600
Account Receivable 632,160 351,200
Inventories 1,287,360 715,200
Total Current Asset 1,926,802 1,124,000
Gross Fixed Asset 1,202,950 491,000
Less: Depreciation 263,160 146,200
Net Fixed Asset 939,790 344,800
Total Assets 2,866,592 1,468,800
3-4
Balance Sheet: Liabilities and Equity
2008 2007
Accts payable 524,160 145,600
Notes payable 636,808 200,000
Accruals 489,600 136,000
Total Current Liabilities 1,650,568 481,600
Long-term debt 723,432 323,432
Common stock 460,000 460,000
Retained earnings 32,592 203,768
Total Equity 492,592 663,768
Total Liabilities & Equity 2,866,592 1,468,800
3-5
Balance Sheet: Points to be noted
▪ Working Capital:
▪ Gross Working Capital: Gross working capital equals to current assets.
▪ Net Working Capital: Net working capital (NWC) is calculated as
current assets minus current liabilities – Payables and Accruals.
▪ Other Sources of Fund:
▪ Preferred Stock: It is a hybrid between common stock and debt. In the
event of bankruptcy, preferred stock is paid up after debt and before
common stocks
▪ Convertible Bonds: These are debt securities that give the bondholder
an option to exchange their bonds for shares of common stocks
▪ Depreciation: Accelerated Depreciation (tax purpose) Vs.
Straight line depreciation (reporting purpose)
▪ Market Value Vs. Book Value
1-6
What effect did the expansion have on
net working capital?
NWC = Current assets – (Payables + Accruals)
NWC08 = ($7,282 + $632,160 + $1,287,360)
– ($524,160 + $489,600)
= $913,042
NWC07 = $842,400
3-7
Income Statement
3-8
Income Statement: Points to be Noted
▪ Operating Vs. Non-operating Income
▪ Top line (Sales) Vs. Bottom line (Net Income)
▪ Addition to Retained Earnings = Net Income – Total
Dividends
▪ Earning per share (EPS)= Net Income/ Common shares
outstanding
▪ Dividends per share (DPS)= Dividend paid to common
stock holder/ Common shares outstanding
▪ Income statement reports on operations over a period
of time (Different from Balance Sheet)
▪ Income statement is tied to the balance sheet through
the retained earnings account on the balance sheet 1-9
Does the company pay its suppliers on
time?
▪ Probably not.
▪ A/P increased 260%, over the past year, while
sales increased by only 76%.
▪ If this continues, suppliers may cut off
Company’s trade credit.
3-10
Other Data
2008 2007
Earning (160,176) 87,960
No. of shares 100,000 100,000
Total Dividend Paid 11,000 22,000
Addition to retained earnings (171,176) 65,960
Per Share Data
EPS -1.602 0.88
DPS 0.11 0.22
3-11
Statement of Cash Flows (2008)
3-12
Statement of Cash Flows (2008)
3-13
Cash flow statement: Points to be
noted
▪ Net cash from operations = -164,176, mainly
because of negative NI.
▪ The firm borrowed 836,808 to meet its cash
requirements.
▪ Even after borrowing, the cash account fell by
50,318.
3-14
Statement of Stockholders’
Equity (2008)
Total
Common Stock Retained Stockholders’
Shares Amount Earnings Equity
Balances, 12/31/07 100,000 $460,000 $203,768 $663,768
2008 Net income (160,176)
Cash dividends (11,000)
Addition (subtraction)
to retained earnings (171,176)
Balances, 12/31/08 100,000 $460,000 $ 32,592 $492,592
3-15
Free Cash Flow for firm
▪ Accountant statements are primarily designed for the use by
creditors and tax collectors, not for managers and stock analysis
▪ Therefore, corporate decision makers and security analysts often
modify accounting data to meet their needs
▪ The most important modifications is the concept of free cash flow
(FCF)
▪ Free cash flow (FCF) is a way of looking at a business's or firm’
total cash flow to see what is available for distribution among all
the securities holders (shareholder and bondholder) of a corporate
entity
Depr. and Capital
FCF = EBIT(1 − T) + − + NWC
amortization expenditures
1-16
What was the free cash flow (FCF) for
2008?
Depr. and Capital
FCF = EBIT(1 − T) + − + NWC
amortization expenditures
FCF08 = [-$130,948(1 – 0.4) + $116,960] –
[($1,202,950 – $491,000) + $70,642]
= -$744,201
Is negative free cash flow always a bad sign?
3-17
Corporate Taxes
▪ For companies, income is taxed at a flat rate
of 30% for Indian companies.
▪ Foreign companies pay at the income tax at
the rate of 40%.
▪ An education cess of 3% (on both the tax
and the surcharge) are payable.
▪ Taking into account the surcharge and cess,
the highest effective rate is 32.445% for
domestic companies and 42.024% for foreign
companies
3-18
Personal Taxes
▪ Personal Tax has a progressive structure in India (the higher the income,
the higher the marginal tax rate).
▪ Rates begin at 10% and rise to 30% for individuals with income over Rs.
10,00,000
▪ Education Cess: 3% of the Income Tax
Slabs Income Tax Rate
i. Where the total income does not NIL
exceed Rs. 2,00,000/-.
ii. Where the total income exceeds Rs. 10% of amount by which the
2,00,000/- but does not exceed Rs. total income exceeds Rs.
5,00,000/-. 2,00,000/-
iii. Where the total income exceeds Rs. Rs. 30,000/- + 20% of the
5,00,000/- but does not exceed Rs. amount by which the total
10,00,000/-. income exceeds Rs. 5,00,000/-.
iv. Where the total income exceeds Rs. Rs. 130,000/- + 30% of the
10,00,000/-. amount by which the total 3-19
income exceeds Rs. 10,00,000/-.
Marginal Tax Rate Vs. Average Tax
Rate
▪ Marginal Tax Rate: The tax rate applicable to
the last unit of person’s income
▪ A person is earning Rs 11,00,000 per year. What
is the marginal tax rate for the person?
▪ Ans: 30%
▪ Average Tax Rate: Taxes paid divided by
taxable income
▪ A person is earning Rs 11,00,000 per year. What
is the average Tax rate for the person?
▪ Ans: Total Tax Paid = 1,60,000
Average Tax Rate = 14.5% 1-20
Tax Treatment of Various Uses and
Sources of Funds
▪ Interest paid – tax deductible for corporations
(paid out of pre-tax income), but usually not
for individuals (interest on home loans being
the exception).
▪ Interest earned – usually fully taxable
▪ Dividends:
▪ Dividends paid by a domestic company are
subject to the Dividend Distribution Tax (DDT) at
an effective rate of 16.22%.
▪ Dividends subject to DDT are exempt from tax in
the hands of the recipient.
3-21
More Tax Issues
▪ Tax Loss Carry-Back and Carry-Forward:
▪ Since corporate incomes can fluctuate widely, the Tax Code
allows firms to carry losses back to offset profits in previous
years or forward to offset profits in the future
▪ Business losses and capital losses may be carried forward for
eight years in India
▪ Capital gains:
▪ Defined as the profits from the sale of assets not normally
transacted in the normal course of business
▪ The tax treatment depends on whether the gains are long or
short term. Gains are long term if the asset is held for more
than three years (one year in the case of shares and specified
securities).
3-22
