Introduction to Corporate Finance

Ross et al.: Fundamentals

of Corporate Finance, Sixth

Edition, Alternate Edition

II. Financial Statements

and Long−Term Financial

Planning

3. Working with Financial
   Statements

(^88) © The McGraw−Hill
Companies, 2002
The net addition to cash is just the difference between sources and uses, and our $14 re-
sult here agrees with the $14 change shown on the balance sheet.
This simple statement tells us much of what happened during the year, but it doesn’t
tell the whole story. For example, the increase in retained earnings is net income (a
source of funds) less dividends (a use of funds). It would be more enlightening to have
these reported separately so we could see the breakdown. Also, we have only considered
net fixed asset acquisitions. Total or gross spending would be more interesting to know.
To further trace the flow of cash through the firm during the year, we need an income
statement. For Prufrock, the results for the year are shown in Table 3.2.
Notice here that the $242 addition to retained earnings we calculated from the
balance sheet is just the difference between the net income of $363 and the dividends
of $121.
The Statement of Cash Flows
There is some flexibility in summarizing the sources and uses of cash in the form of a
financial statement. However it is presented, the result is called the statement of cash
flows. Historically, this statement was called the statement of changes in financial posi-
56 PART TWO Financial Statements and Long-Term Financial Planning
Sources of cash:
Increase in accounts payable $ 32
Increase in common stock 50
Increase in retained earnings 242
Total sources $324
Uses of cash:
Increase in accounts receivable $ 23
Increase in inventory 29
Decrease in notes payable 35
Decrease in long-term debt 74
Net fixed asset acquisitions 149
Total uses $310
Net addition to cash $ 14

TABLE 3.2 PRUFROCK CORPORATION

2002 Income Statement

($ in millions)

Sales $2,311

Cost of goods sold 1,344

Depreciation 276

Earnings before interest and taxes $ 691

Interest paid 141

Taxable income $ 550

Taxes (34%) 187

Net income $ 363

Dividends $121

Addition to retained earnings 242

statement of cash flows
A firm’s financial
statement that
summarizes its sources
and uses of cash over a
specified period.