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Financial statements and cash flow

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Financial statements and cash flow

  1. 1. Financial Statements and Cash Flow 2-1
  2. 2. Chapter Outline2.1 The Balance Sheet2.2 The Income Statement2.3 Taxes2.4 Net Working Capital2.5 Financial Cash Flow2.6 The Accounting Statement of Cash Flows2.7 Cash Flow Management 2-2
  3. 3. 2.1 The Balance Sheet An accountant’s snapshot of the firm’s accounting value at a specific point in time The Balance Sheet Identity is: Assets ≡ Liabilities + Stockholder’s Equity 2-3
  4. 4. U.S. Composite Corporation Balance Sheet 2010 2009 The assets are listed in2010 2009 order by Current assets: Current Liabilities: Cash and equivalents $140 $107 the length of time it would $197 Accounts payable $213 Accounts receivable Inventories 294 269 270 280 normally take a firm with 205 Notes payable Accrued expenses 50 223 53 Other Total current assets 58 $761 50 $707 ongoing operations to convert Total current liabilities $486 $455 Long-term into cash. them liabilities: Fixed assets: Deferred taxes $117 $104 Property, plant, and equipment $1,423 $1,274 Long-term debt 471 458 Less accumulated depreciation (550) (460) Total long-term liabilities $588 $562 Net property, plant, and equipment 873 814 Intangible assets and other 245 221 Stockholders equity: Total fixed assets $1,118 $1,035 Preferred stock $39 $39 Clearly, cash is much more Common stock ($1 par value) 55 32 Capital surplus 347 327 liquid than property, plant, and Accumulated retained earnings 390 347 equipment. Less treasury stock Total equity (26) $805 (20) $725 Total assets $1,879 $1,742 Total liabilities and stockholders equity $1,879 $1,742 2-4
  5. 5. Balance Sheet Analysis• When analyzing a balance sheet, the Finance Manager should be aware of three concerns: 1. Liquidity 2. Debt versus equity 3. Value versus cost 2-5
  6. 6. Liquidity• Refers to the ease and quickness with which assets can be converted to cash—without a significant loss in value• Current assets are the most liquid.• Some fixed assets are intangible.• The more liquid a firm’s assets, the less likely the firm is to experience problems meeting short-term obligations.• Liquid assets frequently have lower rates of return than fixed assets. 2-6
  7. 7. Debt versus Equity• Creditors generally receive the first claim on the firm’s cash flow.• Shareholder’s equity is the residual difference between assets and liabilities. 2-7
  8. 8. Value versus Cost• Under Generally Accepted Accounting Principles (GAAP), audited financial statements of firms in the U.S. carry assets at cost.• Market value is the price at which the assets, liabilities, and equity could actually be bought or sold, which is a completely different concept from historical cost. 2-8
  9. 9. 2.2 The Income Statement• Measures financial performance over a specific period of time• The accounting definition of income is: Revenue – Expenses ≡ Income 2-9
  10. 10. U.S.C.C. Income Statement Total operating revenues $2,262The operations Cost of goods sold 1,655section of the Selling, general, and administrative expenses 327 Depreciation 90income statement Operating income $190reports the firm’s Other income 29revenues and Earnings before interest and taxes $219 Interest expense 49expenses from Pretax income $170principal Taxes 84operations. Current: $71 Deferred: $13 Net income $86 Addition to retained earnings $43 Dividends: $43 2-10
  11. 11. U.S.C.C. Income Statement Total operating revenues $2,262The non-operating Cost of goods sold 1,655section of the Selling, general, and administrative expenses 327 Depreciation 90income statement Operating income $190includes all Other income 29financing costs, Earnings before interest and taxes $219 Interest expense 49such as interest Pretax income $170expense. Taxes 84 Current: $71 Deferred: $13 Net income $86 Addition to retained earnings: $43 Dividends: $43 2-11
  12. 12. U.S.C.C. Income Statement Total operating revenues $2,262 Cost of goods sold 1,655 Selling, general, and administrative expenses 327 Depreciation 90 Operating income $190 Other income 29 Earnings before interest and taxes $219Usually a separate Interest expense 49section reports the Pretax income $170 Taxes 84amount of taxes Current: $71levied on income. Deferred: $13 Net income $86 Addition to retained earnings: $43 Dividends: $43 2-12
  13. 13. U.S.C.C. Income Statement Total operating revenues $2,262 Cost of goods sold 1,655 Selling, general, and administrative expenses 327 Depreciation 90 Operating income $190 Other income 29 Earnings before interest and taxes $219 Interest expense 49Net income is the Pretax income $170“bottom line.” Taxes 84 Current: $71 Deferred: $13 Net income $86 Retained earnings: $43 Dividends: $43 2-13
  14. 14. Income Statement Analysis• There are three things to keep in mind when analyzing an income statement: 1. Generally Accepted Accounting Principles (GAAP) 2. Non-Cash Items 3. Time and Costs 2-14
  15. 15. GAAP The matching principle of GAAP dictates that revenues be matched with expenses. Thus, income is reported when it is earned, even though no cash flow may have occurred. 2-15
  16. 16. Non-Cash Items Depreciation is the most apparent. No firm ever writes a check for “depreciation.” Another non-cash item is deferred taxes, which does not represent a cash flow. Thus, net income is not cash. 2-16
  17. 17. Time and Costs In the short-run, certain equipment, resources, and commitments of the firm are fixed, but the firm can vary such inputs as labor and raw materials. In the long-run, all inputs of production (and hence costs) are variable. Financial accountants do not distinguish between variable costs and fixed costs. Instead, accounting costs usually fit into a classification that distinguishes product costs from period costs. 2-17
  18. 18. 2.3 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• Other taxes 2-18
  19. 19. Marginal versus 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? 2-19
  20. 20. 2.4 Net Working CapitalNet Working Capital ≡ Current Assets – Current Liabilities• NWC usually grows with the firm 2-20
  21. 21. U.S.C.C. Balance Sheet $252m = $707- $455 2010 2009 2010 2009 Current assets: Current Liabilities: Cash and equivalents $140 $107 Accounts payable $213 $197 Accounts receivable 294 270 Notes payable 50 53 Inventories 269 280 Accrued expenses 223 205 Other 58 50 Total current liabilities $486 $455 Total current assets $761 $707 Long-term liabilities: Fixed assets: Here we see NWC grow to $104 Deferred taxes $117 Property, plant, and equipment $1,423 $1,274 Long-term debt 471 458 Less accumulated depreciation (550) (460 $275 million in 2010 from $562 Total long-term liabilities $588 Net property, plant, and equipment 873 814 Intangible assets and other 245 221 $252 million in 2009. Stockholders equity: Total fixed assets $1,118 $1,035 Preferred stock $39 $39 $23 million value) Common stock ($1 par 55 32 Capital surplus 347 327$275m = $761m- $486m This increase of $23 million 347 Accumulated retained earnings 390 Less treasury stock (26) (20) isTotal equity an investment of the$805 $725firm. Total assets $1,879 $1,742 Total liabilities and stockholders equity $1,879 $1,742 2-21
  22. 22. 2.5 Financial Cash Flow• In finance, the most important item that can be extracted from financial statements is the actual cash flow of the firm.• Since there is no magic in finance, it must be the case that the cash flow received from the firm’s assets must equal the cash flows to the firm’s creditors and stockholders. CF(A)≡ CF(B) + CF(S) 2-22
  23. 23. U.S.C.C. Financial Cash FlowCash Flow of the Firm Operating Cash Flow:Operating cash flow $238 (Earnings before interest and taxes plus depreciation minus taxes) EBIT $219Capital spending -173 (Acquisitions of fixed assets Depreciation $90 minus sales of fixed assets)Additions to net working capital Total -23 $42 Current Taxes -$71Cash Flow of Investors in the Firm OCF $238Debt $36 (Interest plus retirement of debt minus long-term debt financing)Equity 6 (Dividends plus repurchase of equity minus new equity financing) Total $42 2-23
  24. 24. U.S.C.C. Financial Cash FlowCash Flow of the FirmOperating cash flow $238 (Earnings before interest and taxes plus depreciation minus taxes) Capital SpendingCapital spending -173 Purchase of fixed assets $198 (Acquisitions of fixed assets minus sales of fixed assets) Sales of fixed assets -$25Additions to net working capital -23 Total $42 Capital Spending $173Cash Flow of Investors in the FirmDebt $36 (Interest plus retirement of debt minus long-term debt financing)Equity 6 (Dividends plus repurchase of equity minus new equity financing) Total $42 2-24
  25. 25. U.S.C.C. Financial Cash FlowCash Flow of the FirmOperating cash flow $238 (Earnings before interest and taxes plus depreciation minus taxes) NWC grew from $275Capital spending -173 million in 2010 from $252 (Acquisitions of fixed assets minus sales of fixed assets) million in 2009.Additions to net working capital -23 Total $42 This increase of $23Cash Flow of Investors in the Firm million is the addition toDebt $36 (Interest plus retirement of debt NWC. minus long-term debt financing)Equity 6 (Dividends plus repurchase of equity minus new equity financing) Total $42 2-25
  26. 26. U.S.C.C. Financial Cash FlowCash Flow of the FirmOperating cash flow $238 (Earnings before interest and taxes plus depreciation minus taxes)Capital spending -173 (Acquisitions of fixed assets minus sales of fixed assets)Additions to net working capital -23 Total $42Cash Flow of Investors in the FirmDebt $36 (Interest plus retirement of debt minus long-term debt financing)Equity 6 (Dividends plus repurchase of equity minus new equity financing) Total $42 2-26
  27. 27. U.S.C.C. Financial Cash FlowCash Flow of the FirmOperating cash flow $238 (Earnings before interest and taxes plus depreciation minus taxes) Cash Flow to CreditorsCapital spending -173 (Acquisitions of fixed assets Interest minus sales of fixed assets)Additions to net working capital -23 $49 Total $42 Retirement of debt 73Cash Flow of Investors in the FirmDebt $36 (Interest plus retirement of debt Debt service 122 minus long-term debt financing)Equity 6 Proceeds from new debt (Dividends plus repurchase of equity minus new equity financing) sales -86 Total $42 Total $36 2-27
  28. 28. U.S.C.C. Financial Cash FlowCash Flow of the FirmOperating cash flow $238 (Earnings before interest and taxes Cash Flow to Stockholders plus depreciation minus taxes)Capital spending -173 Dividends $43 (Acquisitions of fixed assets minus sales of fixed assets) Repurchase of stock 6Additions to net working capital -23 Total $42 Cash to Stockholders 49Cash Flow of Investors in the Firm Proceeds from new stock issueDebt $36 -43 (Interest plus retirement of debt minus long-term debt financing) Total $6Equity 6 (Dividends plus repurchase of equity minus new equity financing) Total $42 2-28
  29. 29. U.S.C.C. Financial Cash FlowCash Flow of the FirmOperating cash flow $238 The cash flow received (Earnings before interest and taxes plus depreciation minus taxes) from the firm’s assetsCapital spending -173 must equal the cash flows (Acquisitions of fixed assets minus sales of fixed assets) to the firm’s creditors andAdditions to net working capital -23 stockholders: Total $42Cash Flow of Investors in the Firm CF ( A) ≡Debt $36 (Interest plus retirement of debt CF ( B ) +CF ( S ) minus long-term debt financing)Equity 6 (Dividends plus repurchase of equity minus new equity financing) Total $42 2-29
  30. 30. 2.5 The Statement of Cash Flows• There is an official accounting statement called the statement of cash flows.• This helps explain the change in accounting cash, which for U.S. Composite is $33 million in 2010.• The three components of the statement of cash flows are: – Cash flow from operating activities – Cash flow from investing activities – Cash flow from financing activities 2-30
  31. 31. U.S.C.C. Cash Flow from Operations OperationsTo calculate cash Net Income $86flow from operations, Depreciation 90 Deferred Taxes 13start with net income, Changes in Assets and Liabilitiesadd back non-cash Accounts Receivable -24items like Inventories 11 Accounts Payable 16depreciation and Accrued Expenses 18adjust for changes in Other -8current assets and Total Cash Flow from Operations $202liabilities (other thancash). 2-31
  32. 32. U.S.C.C. Cash Flow from InvestingCash flow from Acquisition of fixed assets -$198investing activities Sales of fixed assets 25 Total Cash Flow from Investing Activities -$173involves changes incapital assets:acquisition of fixedassets and sales offixed assets (i.e., netcapital expenditures). 2-32
  33. 33. U.S.C.C. Cash Flow from FinancingCash flows to and Retirement of debt (includes notes) -$73from creditors and Proceeds from long-term debt sales 86 Change in notes payable -3owners include Dividends -43changes in equity and Repurchase of stock -6debt. Proceeds from new stock issue 43 Total Cash Flow from Financing $4 2-33
  34. 34. U.S.C.C. Statement of Cash Flows Operations Net Income $86 The statement of Depreciation 90 Deferred Taxes 13 cash flows is the Changes in Assets and Liabilities Accounts Receivable -24 addition of cash Inventories Accounts Payable 11 16 flows from Accrued Expenses Other 18 -8 Total Cash Flow from Operations $202 operations, Investing Activities Acquisition of fixed assets -$198 investing, and Sales of fixed assets Total Cash Flow from Investing Activities 25 -$173 Financing Activities financing. Retirement of debt (includes notes) -$73 Proceeds from long-term debt sales 86 Notes Payable -3 Dividends -43 Repurchase of stock -6 Proceeds from new stock issue 43 Total Cash Flow from Financing $4 Change in Cash (on the balance sheet) $33 2-34
  35. 35. 2.7 Cash Flow Management• Earnings can be manipulated using subjective decisions required under GAAP• Total cash flow is more objective, but the underlying components may also be “managed” – Moving cash flow from the investing section to the operating section may make the firm’s business appear more stable 2-35

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