BM2213 BM2213

FINANCIAL STATEMENTS AND CASH FLOW • Long-term assets are expected to be used for more than one (1) year, including plant and equipment and
intellectual property such as patents and copyrights. Plant and equipment are generally reported net of
Financial Statements and Reports accumulated depreciation.

The annual report is the most important report that corporations issue to stockholders, containing two (2) types The claims against assets are of two (2) basic types: liabilities (or money the company owes to others) and
of information. First, there is a verbal section, often presented as a letter from the chairperson, which describes stockholders’ equity.
the firm’s operating results during the past year and discusses new developments that will affect future • Current liabilities consist of claims that must be paid off within one (1) year, including accounts payable,
operations. Second, the report provides these four (4) basic financial statements (Brigham & Houston, 2022): accruals (total of accrued wages and accrued taxes), and notes payable to banks and other short-term
1. Balance sheet - Shows what assets the company owns and who has claims on those assets as of a given lenders due within one (1) year.
date (for example, December 31, 201X). It is also called a Statement of Financial Position. • Long-term debt includes bonds that mature in more than a year.
2. Income statement - Shows the firm’s sales and costs (and thus profits) during some past period (for • Stockholders’ equity can be thought of in two (2) ways. First is the amount that stockholders paid to the
example, 201X). It is also called the Profit and Loss Statement. company when they bought shares the company sold to raise capital, in addition to all of the earnings the
company has retained over the years.
3. Statement of cash flows - Shows how much cash the firm began the year with, how much cash it ended up
with, and what it did to increase or decrease its cash.
𝑆𝑡𝑜𝑐𝑘ℎ𝑜𝑙𝑑𝑒𝑟𝑠 ′ 𝐸𝑞𝑢𝑖𝑡𝑦 = 𝑃𝑎𝑖𝑑 − 𝑖𝑛 𝑐𝑎𝑝𝑖𝑡𝑎𝑙 + 𝑅𝑒𝑡𝑎𝑖𝑛𝑒𝑑 𝑒𝑎𝑟𝑛𝑖𝑛𝑔𝑠
4. Statement of Stockholders’ Equity - Shows the amount of equity the stockholders had at the start of the
year, the items that increased or decreased equity, and the equity at the end of the year. • The retained earnings are not just the earnings retained in the latest year - they are the cumulative total of
These statements are related to one another. They provide an accounting picture of the firm’s operations and all the earnings the company has earned and retained during its life.
financial position. • Stockholders’ equity can also be thought of as a residual.

The Balance Sheet 𝑆𝑡𝑜𝑐𝑘ℎ𝑜𝑙𝑑𝑒𝑟𝑠 ′ 𝑒𝑞𝑢𝑖𝑡𝑦 = 𝑇𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠 − 𝑇𝑜𝑡𝑎𝑙 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠

A balance sheet is a “snapshot” of a firm’s position at a specific time. The Income Statement

CURRENT ASSETS CURRENT LIABILITIES An income statement is a report that summarizes a firm’s revenues, expenses, and profits during a reporting
Cash and equivalents Accrued wages and taxes period, generally a quarter or a year. Net sales are shown at the top of the statement; then, operating costs,
Accounts receivable Accounts payable interest, and taxes are subtracted to obtain the net income available to common shareholders.
Inventory Notes payable
Earnings per share (EPS) is often called “the bottom line,” denoting that of all items on the income statement,
EPS is the most important to stockholders. A typical stockholder focuses on the reported EPS, but professional
LONG-TERM ASSETS security analysts and managers differentiate between operating and non-operating income.
Net plant and equipment LONG-TERM LIABILITIES
Other long-term assets Operating income is derived from the firm’s regular core business. Moreover, it is calculated before deducting
interest expenses and taxes, which are considered to be non-operating costs. Operating income is also called
earnings before interest and taxes (EBIT).
STOCKHOLDERS’ EQUITY
Common stock 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝐼𝑛𝑐𝑜𝑚𝑒 (𝐸𝐵𝐼𝑇) = 𝑆𝑎𝑙𝑒𝑠 𝑅𝑒𝑣𝑒𝑛𝑢𝑒𝑠 − 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝐶𝑜𝑠𝑡𝑠
Retained earnings
Different firms have different amounts of debt, different tax carrybacks and carryforwards, and different amounts
of non-operating assets such as marketable securities. These differences can cause two (2) companies with
identical operations to report significantly different net incomes. For example, suppose two (2) companies have
TOTAL ASSETS TOTAL LIABILITIES AND EQUITY similar sales, operating costs, and assets. However, one company uses some debt, and the other uses only
common equity. Despite their identical operating performances, the company with no debt (and therefore no
interest expense) would report a higher net income because no interest was deducted from its operating income.
Figure 1. Typical Balance Sheet Consequently, in comparing two (2) companies’ operating performances, it is best to focus on the operating
Source: Fundamentals of Financial Management, 2022 income.

The left side of the statement shows the company's assets, and the right side shows the firm’s liabilities and Statement of Cash Flows
stockholders’ equity, which are claims against the firm’s assets.
Net income, as reported on the income statement, is not cash; and in finance, “cash is king.” Management’s
Two (2) major categories of assets are current assets and fixed, or long-term, assets. goal is to maximize the price of the firm’s stock, and the value of any asset, including a share of stock, is based
• Current assets consist of assets that should be converted to cash within one (1) year, including cash and on the cash flows the asset is expected to produce. Therefore, managers strive to maximize the cash flows
cash equivalents, accounts receivable, and inventory. available to investors. The statement of cash flows is the accounting report that shows how much cash the firm
generates. The statement is divided into four (4) sections:

03 Handout 1 *Property of STI 03 Handout 1 *Property of STI

 [Link]@[Link] Page 1 of 8  [Link]@[Link] Page 2 of 8

BM2213 BM2213

I. Operating activities. This section deals with items that occur as part of normal ongoing operations. business to generate a profit. In addition, it reveals the volume of sales, and the nature of the various types of
a. Net income. This is the first operating activity and the first source of cash. If all sales were for cash, if expenses, depending on how expense information is aggregated. When reviewed over multiple periods, the
all costs required immediate cash payments, and if the firm were in a static situation, net income would income statement can also be used to analyze trends in the results of company operations.
equal cash from operations. However, these conditions do not hold, so net income does not equal cash
from operations. Adjustments shown in the remainder of the statement must be made. As a group, the entire set of financial statements can also be assigned the following additional uses
b. Depreciation and amortization. The first adjustment relates to depreciation and amortization. (AccountingTools, Limitations of Financial Statements, 2022):
Depreciation is deducted in computing net income because it is a non-cash charge. Therefore, • Credit decisions. Lenders use the entire set of information in the financials to determine whether they should
depreciation must be added back to net income when cash flow is determined. extend credit to a business or restrict the amount of credit already extended.
c. Increase in inventories. The firm must use cash to make or buy inventory items. • Investment decisions. Investors use the information to decide whether to invest and the price per share they
d. Increase in accounts receivable. Inventories sold on credit must be replaced to stay in business, but want to invest. An acquirer uses the information to develop a price at which to offer to buy a business.
they won’t yet have received cash from the credit sale. So, if the firm’s accounts receivable increase, • Taxation decisions. Government entities may tax a business based on their assets or income and can derive
this will amount to the use of cash. this information from the financials.
e. Increase in accounts payable. Accounts payable represent a loan from suppliers. • Union bargaining decisions. A union can base its bargaining positions on the perceived ability of a business
f. Increase in accrued wages and taxes. The same logic applies to accruals as to accounts payable. to pay; this information can be gleaned from the financial statements.
g. Net cash provided by operating activities. All previous items are part of normal operations arising
from doing business. When sum, the net cash flow from operations is obtained. Limitations of Financial Statements
II. Long-term investing activities. All activities involving long-term assets are covered in this section.
h. Additions to property, plant, and equipment. This is an outflow; therefore, it is shown in parentheses. The limitations of financial statements are those factors that a user should be aware of before relying on them
i. Net cash used in investing activities. This item on the cash flow statement reports the aggregate excessively. Knowledge of these factors could result in reduced invested funds in a business or actions taken
change in a company's cash position resulting from investment gains or losses and changes resulting to investigate further. The following are the limitations of financial statements.
from amounts spent on investments in capital assets. • Dependence on historical costs. Transactions are initially recorded at their cost. It is a concern when
reviewing the balance sheet, where the values of assets and liabilities may change over time. Some items,
III. Financing activities. All of the company’s financing activities are shown in this section. such as marketable securities, are altered to match changes in their market values, but other items, such
j. Increase in notes payable. It is a cash inflow. When a company repays the loan, this will be an outflow. as fixed assets, do not change. Thus, the balance sheet could be misleading if a large part of the amount
k. Increase in bonds (long-term debt). It is shown as an inflow but will become an outflow when the firm presented is based on historical costs.
repays bonds for some years.
l. Payment of dividends to stockholders. Dividends are paid in cash. • Inflationary effects. If the inflation rate is relatively high, the amounts associated with assets and liabilities
m. Net cash provided by financing activities. It is the sum of the three (3) financing entries. in the balance sheet will appear inordinately low since they are not being adjusted for inflation. It mostly
applies to long-term assets.
IV. Summary. This section summarizes the change in cash and cash equivalents over the year. • Intangible assets not recorded. Many intangible assets are not recorded as assets. Instead, any
n. Net decrease in cash. It is the net sum of operating, investing, and financing activities. expenditures made to create an intangible asset are immediately charged to expense. This policy can
o. Cash and equivalents at the beginning of the year. It is the amount of funds in a company's account drastically underestimate the value of a business, especially one that has spent a large amount on building
at the beginning of a new financial period. It is the first entry in the accounts, either when a company is up a brand image or developing new products. It is a problem for startup companies that have created
first starting up its accounts or after a year-end (Debitoor, 2022). intellectual property but have so far generated minimal sales.
p. Cash and equivalents at the end of the year. It is the amount of cash a company has when adding
the change in cash and beginning cash balance for the current fiscal period. It equals the cash and • Based on a specific period. A user of financial statements can gain an incorrect view of a business's financial
cash equivalents line on the balance sheet (YCharts, 2022). results or cash flows by only looking at one reporting period. Any period may vary from the normal operating
results of a business, perhaps due to a sudden spike in sales or seasonality effects. It is better to view a
large number of consecutive financial statements to gain a better view of ongoing results.
Statement of Stockholders’ Equity • Not always comparable across companies. If a user wants to compare the results of different companies,
their financial statements are not always comparable because the entities use different accounting
The statement of stockholders’ equity reports the changes in stockholders’ equity during the accounting practices. These issues can be located by examining the financial statements' disclosures.
period. This statement shows how much a firm’s equity changed during the year and why this change occurred. • Subject to fraud. The management team of a company may deliberately skew the results presented. This
Note that “retained earnings” represents a claim against assets, not assets per se. Stockholders allow situation can arise when there is undue pressure to report excellent results, such as when a bonus plan
management to retain earnings and reinvest them in the business, use retained earnings for additions to plant calls for payouts only if the reported sales level increases. One might suspect the presence of this issue
and equipment, add to inventories, and the like. Companies do not just pile up cash in a bank account. Thus, when the reported results spike to a level exceeding the industry norm.
retained earnings as reported on the balance sheet do not represent cash and are not “available” for dividends • No discussion of non-financial issues. The financial statements do not address non-financial issues, such
or anything else.” (Brigham & Houston, 2022) as the environmental attentiveness of a company's operations or how well it works with the local community.
A business reporting excellent financial results might be a failure in these other areas.
Uses and Limitations of Financial Statements
• Not verified. Suppose the financial statements have not been audited. In that case, no one has examined
the issuer's accounting policies, practices, and controls to ensure that it has created accurate financial
Uses of Financial Statements
statements. An audit opinion accompanying the financial statements is evidence of such a review.
The general purpose of financial statements is to provide information about the results of operations, financial • No predictive value. Financial statements provide information about either historical results or the financial
position, and cash flows of an organization. The readers of financial statements use this information to make status of a business as of a specific date. The statements do not necessarily give any value in predicting
decisions regarding the allocation of resources. The income statement informs the reader about the ability of a what will happen in the future. For example, a business could report excellent results in one month and no
sales at all in the next month, because a contract on which it was relying has ended.

03 Handout 1 *Property of STI 03 Handout 1 *Property of STI

 [Link]@[Link] Page 3 of 8  [Link]@[Link] Page 4 of 8
 BM2213 BM2213

Free Cash Flow million in capital and the current cost of capital is 10%, the annual cost of capital would be P100,000. The funds
raised from this capital are invested in various net fixed assets and net operating working capital. In any given
Financial statements prepared by accountants are designed primarily for use by creditors and tax collectors and year, NOPAT is the amount of money these investments have generated for the company’s investors after
not for managers and stock analysts. Therefore, corporate decision-makers and security analysts often modify paying operating costs and taxes. In this regard, it represents the benefits of capital investments. EVA estimates
accounting data to meet their needs. The most important modification is the concept of free cash flow (FCF), a business’s true economic profit for a given year and often differs sharply from accounting net income. The
defined as “the amount of cash that could be withdrawn without harming a firm’s ability to operate and to produce main reason for this difference is that although accounting income considers the cost of debt (the company’s
future cash flows.” interest expense), it does not deduct the cost of equity capital. By contrast, EVA considers the total cost of all
capital, including the cost of debt and equity capital. If EVA is positive, then after-tax operating income exceeds
𝐹𝐶𝐹 = [𝐸𝐵𝐼𝑇(1 − 𝑇) + 𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 𝑎𝑛𝑑 𝐴𝑚𝑜𝑟𝑡𝑖𝑧𝑎𝑡𝑖𝑜𝑛] − [𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝐸𝑥𝑝𝑒𝑛𝑑𝑖𝑡𝑢𝑟𝑒𝑠 + 𝑁𝑒𝑡 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝐶𝑎𝑝𝑖𝑡𝑎𝑙] the cost of the capital needed to produce that income, and management’s actions add value for stockholders.
Positive EVA on an annual basis will help ensure that MVA is also positive. Whereas MVA applies to the entire
• The first bracketed term represents the amount of cash the firm generates from its current operations. EBIT firm, EVA can be determined for divisions and the company, so it is a useful guide to “reasonable” compensation
(1-T) is often referred to as net operating profit after taxes (NOPAT). Depreciation and amortization are for divisional and corporate managers (Brigham & Houston, 2022).
added back because these are non-cash expenses that reduce EBIT but do not reduce the amount of
available cash to pay the company’s investors. Comprehensive Illustration:
• The second bracketed term indicates the amount of cash the company invests in its fixed assets (capital Balance Sheet
expenditures) and operating working capital to sustain ongoing operations. A positive level of FCF indicates
that the firm is generating more than enough cash to finance current investments in fixed assets and working 20Xb 20Xa
capital. By contrast, negative free cash flow means that the company does not have enough internal funds Assets:
to finance investments in fixed assets and working capital and will have to raise new money in the capital Current Assets:
market to pay for these investments (Brigham & Houston, 2022). Cash and Equivalents P 10,000 P 80,000
Accounts Receivable 375,000 315,000
Market Value Added (MVA) and Economic Value Added (EVA) Inventories 615,000 415,000
Total Current Assets P 1,000,000 P 810,000
Items reported on the financial statements reflect historical, in-the-past values, not current market values, and Net Plant and Equipment (cost minus depreciation) 1,000,000 870,000
there are often substantial differences between the two. Changes in interest rates and inflation affect the market
TOTAL ASSETS P 2,000,000 P 1,680,000
value of the company’s assets and liabilities but often do not affect the corresponding book values shown in the
financial statements. Perhaps, more importantly, the market’s value assessment considers its ongoing
Liabilities and Equity:
evaluation of current operations and future opportunities. For example, it cost Microsoft very little to develop its
Current Liabilities:
first operating system, but that system was worth many billions that were not shown on its balance sheet. For a
Accounts Payable P 60,000 P 30,000
given level of debt, these increases in asset value also lead to a corresponding increase in the market value of
Accruals 140,000 130,000
equity.
Notes Payable 110,000 60,000
To illustrate, consider the following situation. A firm was started with P1 million of assets at book value (historical Total Current Liabilities P 310,000 P 220,000
cost), P500,000 of which was provided by bondholders and P500,000 by stockholders (50,000 shares Long-term Bonds 750,000 580,000
purchased at P10 per share). However, this firm became very successful; the market value of the firm’s equity Total Liabilities P 1,060,000 P 800,000
is now worth P19.5 million (the current stock price of 50,000 at P390 per share). The firm’s managers have Common Equity:
done a marvelous job for the stockholders. Common Stock (50,000 shares) P 130,000 P 130,000
Retained Earnings 810,000 750,000
The accounting statements do not reflect market values, so they are insufficient to evaluate managers’ Total Common Equity P 940,000 P 880,000
performance. Financial analysts have developed two (2) additional performance measures to help fill this void; Total Liabilities and Equity P 2,000,000 P 1,680,000
the first is the market value added (MVA). MVA is simply the difference between the market value of a firm’s
equity and the book value shown on the balance sheet, with the market value found by multiplying the stock Net Working Capital: Current assets minus current liabilities
price by the number of outstanding shares. The hypothetical firm's MVA is P19.5 million - P0.5 million = P19
million. 𝑁𝑒𝑡 𝑊𝑜𝑟𝑘𝑖𝑛𝑔 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 = 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠 − 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 = 𝑃1,000,000 − 𝑃310,000 = 𝑃690,000

A related concept, economic value added (EVA), sometimes called “economic profit,” is closely associated Net Operating Working Capital (NOWC): Current assets minus non-interest-bearing current liabilities
with MVA and is computed as follows:
𝑁𝑒𝑡 𝑜𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑊𝑜𝑟𝑘𝑖𝑛𝑔 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 (𝑁𝑂𝑊𝐶) = 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠 − (𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 − 𝑁𝑜𝑡𝑒𝑠 𝑃𝑎𝑦𝑎𝑏𝑙𝑒)
𝐸𝑉𝐴 = 𝑁𝑂𝑃𝐴𝑇 − 𝐴𝑛𝑛𝑢𝑎𝑙 𝐶𝑜𝑠𝑡 𝑜𝑓 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 = 𝑃1,000,000 − (𝑃310,000 − 𝑃110,000) = 𝑃800,000
= 𝐸𝐵𝐼𝑇(1 − 𝑇) − (𝑇𝑜𝑡𝑎𝑙 𝐼𝑛𝑣𝑒𝑠𝑡𝑒𝑑 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 × 𝐴𝑓𝑡𝑒𝑟 𝑡𝑎𝑥 𝑝𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑐𝑜𝑠𝑡 𝑜𝑓 𝑐𝑎𝑝𝑖𝑡𝑎𝑙)
Income Statements for Years Ending December 31 (except for per share data)
Companies create value (and realize positive EVA) if the benefits of their investments exceed the cost of raising
the necessary capital. Total invested capital represents the amount of money that the company has grown from 20Xb 20Xa
debt, equity, and other capital sources (such as preferred stock). The annual cost of capital is the total invested Net Sales P 3,000,000 P 2,850,000
capital multiplied by the after-tax percentage cost of this capital. So, for example, if the company has raised P1 Operating Costs except Depreciation and Amortization 2,616,200 2,497,000

03 Handout 1 *Property of STI 03 Handout 1 *Property of STI

 [Link]@[Link] Page 5 of 8  [Link]@[Link] Page 6 of 8

BM2213 BM2213

Depreciation and Amortization 100,000 90,000 Likewise, its NOWC for 20Xa can be calculated as:
Total Operating Costs P 2,716,200 P 2,587,000
Operating income, or Earnings Before Interest and Taxes (EBIT) P 283,800 P 263,000 𝑁𝑂𝑊𝐶20𝑋𝑎 = 𝑃810,000 − (𝑃220,000 − 𝑃60,000) = 𝑃650,000
Less: Interest 88,000 60,000
Earnings Before Taxes (EBT) P 195,800 P 203,000 Thus, the company’s change in net operating working capital ∆𝑁𝑂𝑊𝐶 is P150,000 (P800,000 - P650,000).
Taxes 78,300 81,200 Putting everything together, the company’s free cash flow can be calculated as follows:
Net Income P 117,500 P 121,800
𝐹𝐶𝐹 = [𝐸𝐵𝐼𝑇(1 − 𝑇) + 𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 𝑎𝑛𝑑 𝐴𝑚𝑜𝑟𝑡𝑖𝑧𝑎𝑡𝑖𝑜𝑛] − (𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝐸𝑥𝑝𝑒𝑛𝑑𝑖𝑡𝑢𝑟𝑒𝑠 + ∆𝑁𝑒𝑡 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑊𝑜𝑟𝑘𝑖𝑛𝑔 𝐶𝑎𝑝𝑖𝑡𝑎𝑙)
Statement of Cash Flows for 20Xb
𝐹𝐶𝐹2𝑜𝑋𝑏 = [170,280 + 100,000] − (230,000 + 150,000) = −𝑃109,720
a. I. Operating Activities 20Xb
b. Net income P 117,500 The company’s FCF is negative, which is not good. Note, though, that the negative FCF is attributable primarily
c. Depreciation and amortization 100,000 to the P230,000 expenditure for a new processing plant. This plant is large enough to meet production for
d. Increase in inventories (200,000) several years, so another new plant will not be needed until 20Xf. Therefore, the company’s FCF for 20Xc and
e. Increase in accounts receivable (60,000) the next few years should increase, which means that the company’s financial situation is not as bad as the
f. Increase in accounts payable 30,000 negative FCF might suggest. Most rapidly growing companies have negative FCFs - the fixed assets and
g. Increase in accrued wages and taxes 10,000 working capital needed to support a firm’s rapid growth generally exceed cash flows from its existing operations.
h. Net cash provided by (used in) operating activities (P 2,500) This is not bad, provided a firm’s new investments are eventually profitable and contribute to its FCF.
i. II. Long-Term Investing Activities
j. Additions to property, plant, and equipment (P 230,000)
References
k. Net cash used in investing activities (P 230,000)
AccountingTools. (2022). Limitations of Financial Statements. Retrieved from AccountingTools:
l. III. Financing Activities [Link]
m. Increase in notes payable P 50,000 Brigham, E. F., & Houston, J. F. (2022). Fundamentals of Financial Management. Cengage Learning.
n. Increase in bonds 170,000 Debitoor. (2022). Debitoor. Retrieved from Debitoor: [Link]
o. Payment of dividends to stockholders (57,500) YCharts. (2022). YCharts. Retrieved from YCharts: [Link]
p. Net cash provided by financing activities P 162,500
q. IV. Summary
r. Net decrease in cash (Net sum of I, II, and III) P 70,000
s. Cash and equivalents at the beginning of the year 80,000
t. Cash and equivalents at the end of the year P 10,000

Statement of Stockholders’ Equity, December 31, 20Xb

Total
Retained
Shares Amount Stockholders’
Earnings
Equity
Balances, December 31, 20Xa 50,000 P 130,000 P 750,000 P 880,000
20Xb, Net Income 117,500
Cash Dividends (57,500)
Addition to retained earnings 60,000
Balances, December 31, 20Xb 50,000 P 130,000 P 810,000 P 940,000

The pieces needed to calculate its free cash flow can be collected by looking at the illustrations' key financial
statements. First, the EBIT is obtained from the income statement, followed by depreciation and amortization
expense. 20Xb operating income (EBIT) was P283,800. Because the company’s tax rate is 40%, it follows that
its NOPAT= EBIT(1-T) = P283,800(1-0.4) = P170,280. The company’s depreciation and amortization expense
in 20Xb was P100,000. The company’s capital expenditures (the cash used to purchase new fixed assets) can
be found under the statements of cash flows' investment activities. Capital expenditures in 20Xb totaled
P230,000. Finally, the change in net operating working capital (NOWC) will be calculated. NOWC is current
assets minus non-interest-bearing current liabilities (where non-interest-bearing current liabilities are calculated
as current liabilities minus notes payable).

𝑁𝑂𝑊𝐶20𝑋𝑏 = 𝑃1,000,000 − (𝑃310,000 − 𝑃110,000) = 𝑃800,000

03 Handout 1 *Property of STI 03 Handout 1 *Property of STI

 [Link]@[Link] Page 7 of 8  [Link]@[Link] Page 8 of 8