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Chapter 3
 

Chapter 3

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    Chapter 3 Chapter 3 Presentation Transcript

    • Chapter 3 Understanding Financial Statements and Cash Flows Foundations of Finance Arthur J. Keown John D. Martin J. William Petty David F. Scott, Jr.
    • Chapter Objectives
      • Compute a company’s profits as reflected by an income statement.
      • Determine a firm’s accounting book value, as presented in a balance sheet.
      • Measure a company’s free cash flows.
    • Principles Used in this Chapter
      • Principle 3 : Cash-Not Profits-Is King
      • Principle 7 : Managers Won’t Work for the Owners Unless It’s in Their Best Interest
    • Basic Financial Statements
      • Income Statement
      • Balance Sheet
      • Statement of Cash Flows
    • Income Statement
      • Profit/Loss Statement
      • Indicates the amount of profits generated by a firm over a given period of time
      • Sales – Expenses = Profit
    • Income Statement Terminology
      • Revenue (Sales)
        • Money derived from selling the company’s product or service
      • Cost of Goods Sold (COGS)
        • The cost of producing or acquiring the goods or services to be sold
      • Operating Expenses
        • Expenses related to marketing and distributing the product or service and administering the business
      • Financing Costs
        • The interest paid to creditors and the dividends paid to preferred stockholders
      • Tax Expenses
        • Amount of taxes owed, based upon taxable income
    • Income Statement
      • Sales
      • Less cost of goods sold
      • = Gross profit
      • Less operating expenses
      • = Operating income
      • Less interest expense
      • = Earnings before taxes
      • Less corporate taxes
      • = Earnings before preferred dividends
      • Less preferred stock dividends
      • = Net income available to common stockholders
    • Starbucks Corporation Income Statement 2003 ($M)
      • Sales $4,076
      • Cost of Goods Sold 3,207
      • Gross Profit $ 869
      • Operating Expenses
        • Marketing expenses and general and
        • Administrative expenses $227
        • Depreciation Expense 206
      • Total Operating Expenses $ 433
      • Operating Profits $ 436
      • Interest Expense 3
      • Earnings before taxes $ 433
      • Income taxes 165
      • Net income $ 268
    • Balance Sheet
      • Provides a firm’s financial position at a specific point in time
      • Assets are resources owned by the firm
      • Liabilities and owner’s equity indicate how those resources are financed
      • Total Assets =
      • Liabilities (debt) + Shareholder’s Equity
      • Or…A= L+OE
    • Balance Sheet Terminology
      • Current assets or gross working capital comprise assets that are relatively liquid, or expected to be converted into cash within 12 months.
      • Current assets typically include:
        • Cash
        • Accounts Receivable
          • payments due from customers who buy on credit
        • Inventory
          • raw materials, work in process, and finished goods held for eventual sale
        • Other expenses
          • Prepaid expenses are those items paid for in advance
      • Fixed Assets – Assets held for more than one year. Typically Include:
        • Machinery and equipment
        • Buildings
        • Land
      • Other Assets – Assets that are not current assets or fixed assets
        • Patents
        • Copyrights
        • Goodwill
      Balance Sheet Terminology
      • Debt (Liabilities)
        • Money that has been borrowed and must be repaid at some predetermined date
        • Debt Capital
          • financing provided by a creditor
          • Current or short-term debt and long-term debt
          • Current or short-term must be repaid within the next 12 months
      Balance Sheet Terminology
      • Current Liabilities :
        • Accounts payable
          • Credit extended by suppliers to a firm when it purchases inventories
        • Accrued expenses
          • Short term liabilities incurred in the firm’s operations but not yet paid for
        • Short-term notes
          • Borrowings from a bank or lending institution due and payable within 12 months
      • Long-Term Debt
        • Loans from banks or other institutions for longer than 12 months
      Balance Sheet Terminology
      • Equity
      • Includes the shareholder’s investment
        • Preferred stock
        • Common stock
      • Treasury Stock
        • stock that was once outstanding and has been re-purchased by the company
      • Retained Earnings
        • cumulative total of all the net income over the life of the firm, less common stock dividends that have been paid out over the years
      Balance Sheet Terminology
    • Balance Sheet
      • ASSETS
        • Current Assets
        • Fixed Assets
      • Total Assets
      • LIABILITIES
        • Current Liabilities
        • Long-Term Liabilities
      • Total Liabilities
      • OWNER’S EQUITY
        • Preferred Stock
        • Common Stock
        • Retained earnings
      • Total Owner’s Equity
      • Total liabilities + OE
    • Terms
      • Net Working Capital
        • Current assets – current liabilities
      • Debt Ratio
        • Percentage of debt a firm uses to finance its assets
      • Accrual Basis Accounting
        • Recording revenues when earned and expenses when incurred, rather than when cash is exchanged
      • Free Cash Flows
        • Cash flow that is free and available to be distributed to the firm’s investors.
    • Free Cash Flows
      • Free cash flows:
      • (After-tax cashflows from operations)
      • Less
      • (Increase or decrease in net working capital)
      • Less
      • (Increase or decrease in gross fixed assets)
    • Traditional Statement of Cash Flows
      • Three sections :
        • Cash flows from Operating Activities
        • Cash flows from Investing Activities
        • Cash flows from Financing Activities
    • After-Tax Cash Flows From Operations
      • Operating Income (EBIT)
      • + Depreciation
      • - Income tax expense
      • = After-tax cash flows from operations
    • Change in Operating Working Capital
      • Change in operating working capital =
      • (change in current assets) -
      • (change in current liabilities)
    • Compute the Change in Fixed Assets
      • The final step involves computing the change in Gross Fixed Assets (not net Fixed Assets)
    • Starbucks Free Cash Flows ($M) After-tax cash flows from operations $477 Less 2003 investments in: Investments in net working capital $ 4 Investments in Long Term Assets 566 Total investments $ 570 Free cash flows $ (93)
    • Financing Cash Flows
      • A firm can either receive money from or distribute money to its investors. The firm can:
      • Pay interest to lenders
      • Pay dividends to stockholders
      • Increase or decrease in long-term debt
      • Issue stock to new shareholders or repurchase stock from current shareholders