Principles of Managerial Finance

CHAPTER 3 Cash Flow and Financial Planning 103

TABLE 3.4 Baker Corporation Income

Statement ($000) for the

Year Ended December 31,

2003

Sales revenue $1,700

Less: Cost of goods sold  (^1) , (^0)  (^0)  (^0) 
Gross profits $ (^7)  (^0)  (^0) 
Less: Operating expenses
Selling expense $ 70
General and administrative expense 120
Lease expensea 40
Depreciation expense  (^1)  (^0)  (^0) 
Total operating expense  (^3)  (^3)  (^0) 
Earnings before interest and taxes (EBIT) $ 370
Less: Interest expense  (^7)  (^0) 
Net profits before taxes $ 300
Less: Taxes (rate40%)  (^1)  (^2)  (^0) 
Net profits after taxes $ 180
Less: Preferred stock dividends  (^1)  (^0) 
Earnings available for common stockholders $

1

7

0

Earnings per share (EPS)b $1.70
aLease expense is shown here as a separate item rather than
included as interest expense as specified by the FASB for financial-
reporting purposes. The approach used here is consistent with tax-
reporting rather than financial-reporting procedures.
bCalculated by dividing the earnings available for common stock-
holders by the number of shares of common stock outstanding
($170,000100,000 shares$1.70 per share).
Note that a firm can have a net loss(negative net profits after taxes) and still
have positive cash flow from operations when depreciation (and other non-
cash charges) during the period are greater than the net loss. In the statement
of cash flows, net profits after taxes (or net losses) and depreciation (and
other noncash charges) are therefore treated as separate entries.

3. Because depreciation is treated as a separate cash inflow, only grossrather
   than netchanges in fixed assets appear on the statement of cash flows. This
   treatment avoids the potential double counting of depreciation.


4. Direct entries of changes in retained earnings are not included on the state-
   ment of cash flows. Instead, entries for items that affect retained earnings
   appear as net profits or losses after taxes and dividends paid.

Preparing the Statement of Cash Flows

The statement of cash flows for a given period is developed using the income
statement for the period, along with the beginning- and end-of-period balance
sheets. The income statement for the year ended December 31, 2003, and the
December 31 balance sheets for 2002 and 2003 for Baker Corporation are given
in Tables 3.4 and 3.5, respectively. The statement of cash flows for the year