Transcript Financial Statements, Taxes, and Cash Flow

Financial Statements, Taxes, and
Cash Flow
Chapter 2
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Prepare for Capital Budgeting
Part 2: Understand financial statement and cash flow
Chapter 2-Identify cash flow from financial statement
Chapter 3-Financial statement and comparison
Part 3: Valuation of future cash flow
Chapter 4-Basic concepts
Chapter 5-More exercise
Part 4: Valuing stocks and bonds
Chapter 6-Bond
Chapter 7-Stock
Part 5: Capital budgeting
2.1
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Chapter Outline
1.
2.
3.
4.
5.
The Concept of Cash Flow
Balance Sheet
Income Statement
Taxes
Cash Flow from Assets
2.2
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1.The Concept of Cash Flow
 Cash
flow is one of the most important pieces of
information that a financial manager can derive
from financial statements
 The statement of cash flows (in which interest
payment is deducted) does not provide us with
the same information that we are looking at here
 We will look at how cash is generated from
utilizing assets and how it is paid to those that
finance the purchase of the assets
2.3
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Cash Flow From Assets: Identity

Cash Flow From Assets (CFFA) = Cash Flow to
Creditors + Cash Flow to Stockholders
2.4
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2.The Balance Sheet
 The
balance sheet is a snapshot of the firm’s
assets and liabilities at a given point in time
 Assets are listed in order of liquidity
 Ease of conversion to cash
 Without significant loss of value
 Balance Sheet Identity
 Assets = Liabilities + Stockholders’ Equity
2.5
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Balance Sheet Illustration
Net Working Capital=Current Assets – Current Liabilities
2.6
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Market vs. Book Value



The balance sheet provides the book value of the
assets, liabilities and equity.
Market value is the price at which the assets, liabilities
or equity can actually be bought or sold.
Market value and book value are often very different.
1. Historical cost less accumulated depreciation bear little
resemblance to the value could be sold for today.
2. Balance sheet does not include the value of human capital,
customer loyalty, etc.

Which is more important to the decision-making
process?
2.7
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Market vs. Book Value Illustration
30%
2.8
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Klingon Corporation
KLINGON CORPORATION
Balance Sheets
Market Value versus Book Value
Book
Market
Book
Liabilities and Shareholders’
Equity
Assets
NWC
NF Assets
$ 400
700
1,100
Market
$ 600 LT Debt
1,000 SE
1,600
$ 500
$ 500
600
1,100
1,100
1,600
2.9
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3.Income Statement
 The
income statement is more like a video of the
firm’s operations for a specified period of time.
 You generally report revenues first and then
deduct any expenses for the period
Revenues – Expenses = Income
 Matching principle – GAAP say to show revenue
when it accrues and match the expenses required
to generate the revenue, so net income is NOT a
measure of the cash flow during the period.
2.10
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Table 2.2
2.11
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4.Taxes
 The
one thing we can rely on with taxes is that
they are always changing
 Marginal vs. average tax rates
 Marginal – the percentage paid on the next
dollar earned
 Average – the tax bill / taxable income
50%
2.12
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Example: Marginal Vs. Average
Rates
 Suppose
your firm earns $4 million in taxable
income.
 What is the firm’s tax liability?
 What is the average tax rate?
 What is the marginal tax rate?
 If you are considering a project that will increase
the firm’s taxable income by $1 million, what
tax rate should you use in your analysis?
2.13
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Example Solution



Corporate tax rate (textbook, p.31)
Tax liability
.15(50,000)
+
.25(75,000 – 50,000)
+
.34(100,000 – 75,000)
+
.39(335,000 – 100,000)
+
.34(4,000,000 – 335,000)
= $ 1,356,100
Average tax rate
1,356,100 / 4,000,000 = .339025 = 33.9025%
75%
2.14
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5.Cash Flow From Assets:
Calculation
The Cash Flow Identity
 Cash Flow From Assets (CFFA) = Cash Flow to
Creditors + Cash Flow to Stockholders
Cash Flow From Assets
 Cash Flow From Assets = Operating Cash Flow –
Net Capital Spending – Changes in NWC
2.15
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Cash Flow Illustration
Creditor
Company/
Asset
Owner/Stockholder
Government
EBIT+Depr.
OCF
CFFA
2.16
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Table 2.5
2.17
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US Corporation Balance Sheet –
Table 2.1
2.18
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Table 2.2
2.19
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Example 1: US Corporation

OCF (I/S) = EBIT + depreciation – taxes = $547
[Accounting definition of OCF = EBIT – interest – taxes + depreciation]



NCS ( B/S and I/S) = ending net fixed assets – beginning net fixed
assets + depreciation = $130
Changes in NWC (B/S) = ending NWC – beginning NWC = $330
CFFA = 547 – 130 – 330 = $87
CF to Creditors (B/S and I/S) = interest paid – net new borrowing =
$24
 CF to Stockholders (B/S and I/S) = dividends paid – net new equity
raised = $63
 CFFA = 24 + 63 = $87
The CF identity holds.

2.20
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Review Questions
1.
2.
3.
4.
What is the difference between accounting income and
cash flow? Which do we need to use when making
financial management decisions?
What is the difference between book value and market
value? Which should we use for financial management
decision making purposes?
What is the difference between average and marginal tax
rates? How to calculate them? Which should we use when
making financial decisions?
How do we determine a firm’s cash flows? What are the
equations and where do we find the information?
2.21
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Review Questions (cont..)
What is the order of liquidity for the following assets?
Cash, account receivable, inventory, tangible fixed assets,
intangible fixed assets.
 Which of the income statement accounts is(are) non-cash
item(s)?
 What is net working capital?

2.22
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Sample Question
Given the following information from the 2001 financial
statements, calculate cash flow from assets:
 operating cash flow = $36,500,
 net fixed assets declined by $3,000,
 depreciation expense = $9,000,
 net working capital increased by $2,700.
2.23
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Sample Question
An increase in which of the following will cause
cash flow from assets to increase, all else the
same? (may have more than one choice)
I. Interest expense
II. Depreciation
III. Taxes paid
100%
2.24
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