Ch. 2 Understanding Financial Statements, Taxes, and Cash Flows

 2002 , Prentice Hall, Inc.

Income Statement

SALES - EXPENSES = PROFIT

Income Statement

Revenue SALES - EXPENSES = PROFIT

Income Statement

SALES - EXPENSES = PROFIT

Income Statement

SALES - EXPENSES = PROFIT

•

Cost of Goods Sold

Income Statement

SALES - EXPENSES = PROFIT

•

Cost of Goods Sold

•

Operating Expenses

Income Statement

SALES - EXPENSES = PROFIT

•

Cost of Goods Sold

•

Operating Expenses

(marketing, administrative)

Income Statement

SALES - EXPENSES = PROFIT

•

Cost of Goods Sold

•

Operating Expenses

(marketing, administrative)

•

Financing Costs

Income Statement

SALES - EXPENSES = PROFIT

•

Cost of Goods Sold

•

Operating Expenses

(marketing, administrative)

•

Financing Costs

•

Taxes

SALES - Cost of Goods Sold GROSS PROFIT - Operating Expenses

Income Statement

OPERATING INCOME (EBIT) - Interest Expense EARNINGS BEFORE TAXES (EBT) - Income Taxes EARNINGS AFTER TAXES (EAT) - Preferred Stock Dividends NET INCOME AVAILABLE TO COMMON STOCKHOLDERS

SALES - Cost of Goods Sold GROSS PROFIT - Operating Expenses

Income Statement

OPERATING INCOME (EBIT) - Interest Expense EARNINGS BEFORE TAXES (EBT) - Income Taxes EARNINGS AFTER TAXES (EAT) - Preferred Stock Dividends NET INCOME AVAILABLE TO COMMON STOCKHOLDERS

SALES - Cost of Goods Sold GROSS PROFIT - Operating Expenses

Income Statement

OPERATING INCOME (EBIT) Interest Expense EARNINGS BEFORE TAXES (EBT) - Income Taxes EARNINGS AFTER TAXES (EAT) - Preferred Stock Dividends - NET INCOME AVAILABLE TO COMMON STOCKHOLDERS

Balance Sheet

Total Assets = Outstanding Debt + Shareholders’ Equity

Balance Sheet

Assets

Balance Sheet

Assets

Balance Sheet

Liabilities (Debt) & Equity

Assets

Balance Sheet

Liabilities (Debt) & Equity

Current Assets Cash Marketable Securities Accounts Receivable Inventories Prepaid Expenses Fixed Assets Machinery & Equipment Buildings and Land Other Assets Investments & patents Current Liabilities Accounts Payable Accrued Expenses Short-term notes Long-Term Liabilities Long-term notes Mortgages Equity Preferred Stock Common Stock (Par value) Paid in Capital Retained Earnings

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Current Assets :

Assets

Assets

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Current Assets : assets that are relatively liquid, and are expected to be converted to cash within a year.

Assets

•

Current Assets : assets that are relatively liquid, and are expected to be converted to cash within a year.

–

Cash, marketable securities, accounts receivable, inventories, prepaid expenses.

Assets

•

Current Assets : assets that are relatively liquid, and are expected to be converted to cash within a year.

–

Cash, marketable securities, accounts receivable, inventories, prepaid expenses.

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Fixed Assets :

Assets

•

Current Assets : assets that are relatively liquid, and are expected to be converted to cash within a year.

–

Cash, marketable securities, accounts receivable, inventories, prepaid expenses.

•

Fixed Assets : machinery and equipment, buildings, and land.

Assets

•

Current Assets : assets that are relatively liquid, and are expected to be converted to cash within a year.

–

Cash, marketable securities, accounts receivable, inventories, prepaid expenses.

•

Fixed Assets : machinery and equipment, buildings, and land.

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Other Assets :

Assets

• •

Current Assets : assets that are relatively liquid, and are expected to be converted to cash within a year.

–

Cash, marketable securities, accounts receivable, inventories, prepaid expenses.

•

Fixed Assets : machinery and equipment, buildings, and land.

Other Assets : any asset that is not a current asset or fixed asset.

Assets

• •

Current Assets : assets that are relatively liquid, and are expected to be converted to cash within a year.

–

Cash, marketable securities, accounts receivable, inventories, prepaid expenses.

•

Fixed Assets : machinery and equipment, buildings, and land.

Other Assets : any asset that is not a current asset or fixed asset.

–

Intangible assets such as patents and copyrights.

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Debt Capital :

Financing

Financing

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Debt Capital : financing provided by a creditor.

Financing

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Debt Capital : financing provided by a creditor.

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Short-term debt :

Financing

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Debt Capital : financing provided by a creditor.

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Short-term debt : borrowed money that must be repaid within the next 12 months.

Financing

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Debt Capital : financing provided by a creditor. Short-term debt : borrowed money that must be repaid within the next 12 months.

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Accounts payable, other payables such as interest or taxes payable, accrued expenses, short-term notes.

Financing

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Debt Capital : financing provided by a creditor.

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Short-term debt : borrowed money that must be repaid within the next 12 months.

–

Accounts payable, other payables such as interest or taxes payable, accrued expenses, short-term notes.

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Long-term debt :

Financing

• • •

Debt Capital : financing provided by a creditor. Short-term debt : borrowed money that must be repaid within the next 12 months.

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Accounts payable, other payables such as interest or taxes payable, accrued expenses, short-term notes.

Long-term debt : loans from banks or other sources that lend money for longer than 12 months.

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Equity Capital :

Financing

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Financing

Equity Capital : shareholders’ investment in the firm.

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Financing

Equity Capital : shareholders’ investment in the firm.

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Preferred Stockholders :

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Financing

Equity Capital : shareholders’ investment in the firm.

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Preferred Stockholders : receive fixed dividends, and have higher priority than common stockholders in event of liquidation of the firm.

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Financing

Equity Capital : shareholders’ investment in the firm.

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Preferred Stockholders : received fixed dividends, and have higher priority than common stockholders in event of liquidation of the firm.

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Common Stockholders :

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Financing

Equity Capital : shareholders’ investment in the firm.

• •

Preferred Stockholders : received fixed dividends, and have higher priority than common stockholders in event of liquidation of the firm.

Common Stockholders : residual owners of a business. They receive whatever is left after creditors and preferred stockholders are paid.

Corporate Income Tax Rates

Since 1993

Taxable Income Corporate Tax Rate $1 - $50,000 15% $50,001 - $75,000 25% $75,001 - $100,000 34% $100,001 - $335,000 39% $335,001 - $10,000,000 34% $10,000,001 - $15,000,000 $15,000,001 - $18,333,333 over $18,333,333 35% 38% 35%

Free Cash Flows

Free cash flow: cash flow that is free and available to be distributed to the firm’s investors (both debt and equity investors)

Free Cash Flows

Firm’s Operating Free cash flows = Firm’s Financing Free cash flows Cash flows generated through the firm’s operations and investments in assets = Cash flows paid to - or received by - the firm’s investors (creditors & stockholders)

Calculating Free Cash Flows:

An Operating Perspective After-tax cash flow from operations

less

investment in net operating working capital

less

investments in fixed and other assets

Calculating Free Cash Flows:

An Operating Perspective After-tax cash flow from operations

less

investment in net operating working capital

less

investments in fixed and other assets Operating income + depreciation - cash tax payments

Calculating Free Cash Flows:

An Operating Perspective After-tax cash flow from operations

less

investment in net operating working capital

less

investments in fixed and other assets [Change in current assets] [change in non-interest bearing current liabilities]

Calculating Free Cash Flows:

An Operating Perspective After-tax cash flow from operations

less

investment in net operating working capital

less

investments in fixed and other assets Change in gross fixed assets, and any other assets that are on the balance sheet.

Calculating Free Cash Flows:

A Financing Perspective Interest payments to creditors change in debt principal dividends paid to stockholders change in stock = Financing Free Cash Flows

Tax Example:

• •

Space Cow Computer has sales of $32 million , cost of goods sold at 60% of sales, cash operating expenses of $2.4 million , and $1.4 million in depreciation expense. The firm has $12 million in 9.5% bonds outstanding. The firm will pay $500,000 in dividends to its common stock holders.

Calculate the firm’s tax liability.

Sales Cost of Goods Sold Operating Expenses Depreciation Expense EBIT or NOI Interest Expense Taxable Income $32,000,000 (19,200,000) (2,400,000) (1,400,000) 9,000,000 (1,140,000) 7,860,000

Income tax rate tax payment $50,000 x .15 = $ 7,500 $25,000 x .25 = 6,250 $25,000 x .34 = 8,500 $235,000 x .39 = 91,650 $7,525,000 x .34 = 2,558,500 Total Tax payment $2,672,400

short cut:

$7,860,000 x .34 = $2,672,400