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    • 1. Chapter 2 - Understanding Financial Statements, Taxes, and Cash Flows  2005, Pearson Prentice Hall
    • 2. Income Statement <ul><li>SALES </li></ul><ul><li>- EXPENSES </li></ul><ul><li>= PROFIT </li></ul><ul><li>Cost of Goods Sold </li></ul><ul><li>Operating Expenses </li></ul><ul><li>(marketing, administrative) </li></ul><ul><li>Financing Costs </li></ul><ul><li>Taxes </li></ul>
    • 3. <ul><li>SALES </li></ul><ul><li>- Cost of Goods Sold </li></ul><ul><li>GROSS PROFIT </li></ul><ul><li>- Operating Expenses </li></ul><ul><li>OPERATING INCOME (EBIT) </li></ul><ul><li>- Interest Expense </li></ul><ul><li>EARNINGS BEFORE TAXES (EBT) </li></ul><ul><li>- Income Taxes </li></ul><ul><li>EARNINGS AFTER TAXES (EAT) </li></ul><ul><li>- Preferred Stock Dividends </li></ul><ul><li>- NET INCOME AVAILABLE </li></ul><ul><li>TO COMMON STOCKHOLDERS </li></ul>Income Statement Operating Activities
    • 4. <ul><li>SALES </li></ul><ul><li>- Cost of Goods Sold </li></ul><ul><li>GROSS PROFIT </li></ul><ul><li>- Operating Expenses </li></ul><ul><li>OPERATING INCOME (EBIT) </li></ul><ul><li>- Interest Expense </li></ul><ul><li>EARNINGS BEFORE TAXES (EBT) </li></ul><ul><li>- Income Taxes </li></ul><ul><li>EARNINGS AFTER TAXES (EAT) </li></ul><ul><li>- Preferred Stock Dividends </li></ul><ul><li>- NET INCOME AVAILABLE </li></ul><ul><li>TO COMMON STOCKHOLDERS </li></ul>Income Statement Financing Activities
    • 5. Balance Sheet <ul><li>Total Assets = </li></ul>Outstanding Debt + Shareholders’ Equity
    • 6. Balance Sheet <ul><li>Current Assets </li></ul><ul><li>Cash </li></ul><ul><li>Marketable Securities </li></ul><ul><li>Accounts Receivable </li></ul><ul><li>Inventories </li></ul><ul><li>Prepaid Expenses </li></ul><ul><li>Fixed Assets </li></ul><ul><li>Machinery & Equipment </li></ul><ul><li>Buildings and Land </li></ul><ul><li>Other Assets </li></ul><ul><li>Investments & patents </li></ul>Assets Liabilities (Debt) & Equity 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
    • 7. Assets <ul><li>Current Assets : assets that are relatively liquid, and are expected to be converted to cash within a year. </li></ul><ul><ul><li>Cash, marketable securities, accounts receivable, inventories, prepaid expenses. </li></ul></ul>
    • 8. Assets <ul><li>Current Assets : assets that are relatively liquid, and are expected to be converted to cash within a year. </li></ul><ul><ul><li>Cash, marketable securities, accounts receivable, inventories, prepaid expenses. </li></ul></ul><ul><li>Fixed Assets : machinery </li></ul><ul><li>and equipment, buildings, </li></ul><ul><li>and land. </li></ul>
    • 9. Assets <ul><li>Current Assets : assets that are relatively liquid, and are expected to be converted to cash within a year. </li></ul><ul><ul><li>Cash, marketable securities, accounts receivable, inventories, prepaid expenses. </li></ul></ul><ul><li>Fixed Assets : machinery and equipment, buildings, and land. </li></ul><ul><li>Other Assets : any asset that is not a current asset or fixed asset. </li></ul><ul><ul><li>Intangible assets, such as patents and copyrights. </li></ul></ul>
    • 10. Financing <ul><li>Debt Capital : financing provided by a creditor. </li></ul><ul><li>Short-term debt : borrowed money that must be repaid within the next 12 months. </li></ul><ul><ul><li>Accounts payable, other payables such as interest or taxes payable, accrued expenses, short-term notes. </li></ul></ul><ul><li>Long-term debt : loans from banks or other sources that lend money for longer than 12 months. </li></ul>
    • 11. Financing <ul><li>Equity Capital : shareholders’ investment in the firm. </li></ul><ul><li>Preferred Stockholders : receive fixed dividends, and have higher priority than common stockholders in event of liquidation of the firm. </li></ul><ul><li>Common Stockholders : residual owners of a business. They receive whatever is left after creditors and preferred stockholders are paid. </li></ul>
    • 12. Corporate Income Tax Rates Since 1993 <ul><li>Taxable Income Corporate Tax Rate </li></ul><ul><li>$1 - $50,000 15% </li></ul><ul><li>$50,001 - $75,000 25% </li></ul><ul><li>$75,001 - $100,000 34% </li></ul><ul><li>$100,001 - $335,000 39% </li></ul><ul><li>$335,001 - $10,000,000 34% </li></ul><ul><li>$10,000,001 - $15,000,000 35% </li></ul><ul><li>$15,000,001 - $18,333,333 38% </li></ul><ul><li>over $18,333,333 35% </li></ul>
    • 13. Free Cash Flows <ul><li>Free cash flow: cash flow that is free and available to be distributed to the firm’s investors (both debt and equity investors). </li></ul>
    • 14. Free Cash Flows <ul><li>Cash Flows from Assets </li></ul>= Cash Flows from Financing Cash flows generated through the firm’s assets = Cash flows paid to - or received from - the firm’s investors (creditors & stockholders)
    • 15. Calculating Free Cash Flows: An Asset Perspective <ul><li>After-tax cash flow from operations </li></ul><ul><li>less </li></ul><ul><li>investment in net operating working capital </li></ul><ul><li>less </li></ul><ul><li>investments in fixed and other assets </li></ul>
    • 16. Calculating Free Cash Flows: An Asset Perspective <ul><li>After-tax cash flow from operations </li></ul><ul><li>less </li></ul><ul><li>investment in net operating working capital </li></ul><ul><li>less </li></ul><ul><li>investments in fixed and other assets </li></ul>Operating income + depreciation - cash tax payments
    • 17. Calculating Free Cash Flows: An Asset Perspective <ul><li>After-tax cash flow from operations </li></ul><ul><li>less </li></ul><ul><li>investment in net operating working capital </li></ul><ul><li>less </li></ul><ul><li>investments in fixed and other assets </li></ul>[Change in current assets] - [change in non-interest bearing current liabilities]
    • 18. Calculating Free Cash Flows: An Asset Perspective <ul><li>After-tax cash flow from operations </li></ul><ul><li>less </li></ul><ul><li>investment in net operating working capital </li></ul><ul><li>less </li></ul><ul><li>investments in fixed and other assets </li></ul>Change in gross fixed assets, and any other assets that are on the balance sheet.
    • 19. Calculating Free Cash Flows: A Financing Perspective <ul><li>Interest payments to creditors </li></ul><ul><li>- change in debt principal </li></ul><ul><li>- dividends paid to stockholders </li></ul><ul><li>- change in stock </li></ul><ul><li>= Financing Free Cash Flows </li></ul>
    • 20. Tax Example:
    • 21. <ul><li>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. </li></ul><ul><li>Calculate the firm’s tax liability. </li></ul>
    • 22. <ul><li>Sales $32,000,000 </li></ul><ul><li>Cost of Goods Sold (19,200,000) </li></ul><ul><li>Operating Expenses (2,400,000) </li></ul><ul><li>Depreciation Expense (1,400,000) </li></ul><ul><li>EBIT or NOI 9,000,000 </li></ul><ul><li>Interest Expense (1,140,000) </li></ul><ul><li>Taxable Income 7,860,000 </li></ul>
    • 23. <ul><li>Income tax rate tax payment </li></ul><ul><li>$50,000 x .15 = $ 7,500 </li></ul><ul><li>$25,000 x .25 = 6,250 </li></ul><ul><li>$25,000 x .34 = 8,500 </li></ul><ul><li>$235,000 x .39 = 91,650 </li></ul><ul><li>$7,525,000 x .34 = 2,558,500 </li></ul><ul><li>Total Tax payment $2,672,400 </li></ul><ul><li>short cut: $7,860,000 x .34 = $2,672,400 </li></ul>

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