Abstract
The balance sheet of a company and the income statement are related. The balance sheet is an accounting snapshot at a point of time. The income, profit and loss, or operating statement is a condensation of the firm’s operating experiences over a given period of time. It depicts certain changes that have occurred between the last balance sheet and the present one. The balance sheet (position statement) and the income statement may be reconciled through the retained earnings, or earned surplus, account. If this reconciliation is presented formally, it becomes the surplus statement.
This is a preview of subscription content, log in via an institution to check access.
Access this chapter
Tax calculation will be finalised at checkout
Purchases are for personal use only
Notes
- 1.
Operating statements for internal control can be made up for any feasible time period. Most large firms present quarterly statements for their investors, although the annual results carry the most weight and go into the record books of the financial services, such as Mergent’s (formerly Moody’s), Standard & Poor’s, etc., and are available on line at MSN/Money, as we will illustrate in this chapter.
- 2.
To refer to depreciation charges as a source of funds is the common shorthand usage, which to be frank is somewhat inaccurate. Strictly speaking, only the firm’s operations provide funds. If the firm’s revenues did not exceed its direct expenses, there would be no funds flow for the period. However, since the depreciation charge is added to retained earnings for the period to obtain the total of reinvested internally generated funds, the custom has grown of referring to depreciation as a source of funds.
- 3.
The relationship between common and preferred stock is explained more fully in chapter “The Equity of the Corporation: Common and Preferred Stock.”
- 4.
See the discussion in chapter “The Corporation Balance Sheet” on depreciation and inventory valuation.
- 5.
For a fuller discussion of dividends and their relationship to earnings and the value of common stock, see chapter “The Equity of the Corporation: Common and Preferred Stock.”
- 6.
The previous tax rate, pre-2017, produced taxes of approximately $15.8 MM, producing earnings after taxes of $29.2 MM. The increased net income, $6.35 MM enhances the firm valuation by $63.5 MM, if the firm is valued by analysts with a price-earnings multiple of 10. Christmas came early for the management of many companies, and stock holders, in 2017!
- 7.
The return on assets may be expressed as the ratio of net income to total assets, or the ratio of net income to average total assets. Accountants often prefer to express the ROA as earnings before interest and taxes (EBIT) divided by average total assets (White, Sondhi, & Fried, 1997), p. 147. Alternatively, White, Sondhi, and Fried present the ratio of net income plus after-tax interest cost, relative to average total assets (p. 147). These accountants use average sales and stockholder equity in the ROS and ROE calculations. We use the year-end total assets, sales, and stockholder equity in this text.
- 8.
That is, if the recipient of the income is an individual and not a nontaxable institution or another corporation. An 85% dividend received credit is given to corporations for dividends received from another corporation which is non-consolidated. (To consolidate for tax purposes, the parent must own a minimum of 80% of the subsidiary’s shares.) The other 15% is taxed at the usual corporate income tax rate.
- 9.
Drtina and Largay (1985) examined cash flow reporting with regard to “cash flow from operations” (CFO). Problems can develop because of ambiguity in terms of the definition of “operations,” the measurement of the current position of long-term leases (noted in chapter “Long-Term Debt”), diversity in reporting practices, and reclassification of current and noncurrent accounts. Krishnan and Largay (2000) reported that past direct method cash flows offer better predictions of future operating cash flows than indirect method cash flows information. The direct method of presenting cash flows OCF for time t is predicted to be:
OCFt = ∫ (CSHRDt − 1, CSHPDt − 1, INTRDt − 1, INTPDt − 1, TXPDt − 1)
where
-
CSHRDt−1 = Cash received from customers at time t − 1
-
CSHPDt−1 = Cash paid to suppliers and employees at time t − 1
-
INTRDt−1 = Interest received at time t − 1
-
INTPDt−1 = Interest paid at time t − 1
-
TXPDt−1 = Taxes paid at time t − 1
-
References
Dtrina, R. E., & Largay III, J. A. (1985). Pitfalls in calculating cash flow from operations. The Accounting Review, 40, 314–326.
Guerard Jr., J. B., & Schwartz, E. (2007). Quantitative corporate finance. New York: Springer.
Krishnan, G. V., & Largay III, J. A. (2000). The predictive ability of direct method cash flow information. Journal of Business Finance and Accounting, 27, 215–245.
White, G. I., Sondhi, A. C., & Fried, D. (1997). The analysis and use of financial statements (2nd ed.). New York: John Wiley & Sons, Inc. Chapters 2, 3.
Author information
Authors and Affiliations
Rights and permissions
Copyright information
© 2021 Springer Nature Switzerland AG
About this chapter
Cite this chapter
Guerard, J.B., Saxena, A., Gultekin, M. (2021). The Annual Operating Statements: The Income Statement and Cash Flow Statement. In: Quantitative Corporate Finance. Springer, Cham. https://doi.org/10.1007/978-3-030-43547-9_4
Download citation
DOI: https://doi.org/10.1007/978-3-030-43547-9_4
Published:
Publisher Name: Springer, Cham
Print ISBN: 978-3-030-43546-2
Online ISBN: 978-3-030-43547-9
eBook Packages: HistoryHistory (R0)