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CHAPTER 3Financial Statements, Cash Flow, and Taxes

Balance sheet Income statement Statement of cash flows Accounting income vs. cash

flow EVA Federal tax system

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Tutor hours

FIN 350 (BUS 137)

Mon.    5:00 - 7:00pmWed.   12:00 - 2:00pm

& 5:00 - 7:00pmThurs.  11:00 - 1:00pm

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The Annual Report– a review of acct 101

Balance sheet – provides a snapshot of a firm’s financial position at one point in time.

Income statement – summarizes a firm’s revenues and expenses over a given period of time.

Statement of retained earnings – shows how much of the firm’s earnings were retained, rather than paid out as dividends.

Statement of cash flows – reports the impact of a firm’s activities on cash flows over a given period of time.

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Balance Sheet: Assets

CashA/RInventories

Total CAGross FALess: Dep.

Net FATotal Assets

20027,282

632,1601,287,3601,926,8021,202,950 263,160 939,7902,866,592

200157,600

351,200 715,2001,124,000

491,000 146,200 344,8001,468,800

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Balance sheet: Liabilities and Equity

Accts payableNotes payableAccruals

Total CLLong-term debtCommon stockRetained earnings

Total EquityTotal L & E

2002524,160

636,808 489,6001,650,568

723,432460,000

32,592 492,5922,866,592

2001145,600200,000

136,000481,600323,432460,000

203,768 663,7681,468,800

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Income statement

SalesCOGSOther expenses

EBITDADepr. & Amort.

EBITInterest Exp.EBTTaxesNet income

20026,034,000

5,528,000 519,988

(13,988) 116,960(130,948) 136,012(266,960) (106,784) (160,176)

20013,432,0002,864,000 358,672

209,328 18,900

190,428 43,828

146,600 58,640

87,960

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Other data

No. of sharesEPSDPSStock price

2002100,000-$1.602

$0.11$2.25

2001100,000

$0.88$0.22$8.50

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Statement of Retained Earnings (2002)

Balance of retainedearnings, 12/31/01

Add: Net income, 2002

Less: Dividends paid

Balance of retained earnings, 12/31/02

$203,768

(160,176)

(11,00

0)

$32,592

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Statement of Cash Flows (2002)

OPERATING ACTIVITIESNet income

Add (Sources of cash):DepreciationIncrease in A/PIncrease in accruals

Subtract (Uses of cash):Increase in A/RIncrease in inventories

Net cash provided by ops.

(160,176)

116,960378,560353,600

(280,960)(572,160)(164,176)

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Statement of Cash Flows (2002)L-T INVESTING ACTIVITIES

Investment in fixed assets

FINANCING ACTIVITIESIncrease in notes payableIncrease in long-term debtPayment of cash dividendNet cash from financing

NET CHANGE IN CASH

Plus: Cash at beginning of year

Cash at end of year

(711,950)

436,808400,000

(11,000)825,808

(50,318)

57,6007,282

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What can you conclude about the company' financial condition from its statement of CFs?

Net cash from operations = -$164,176, mainly because of negative NI.

The firm borrowed $825,808 to meet its cash requirements.

Even after borrowing, the cash account fell by $50,318.

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How much is net operating after taxes (NOPAT)?

NOPAT = EBIT (1 – Tax rate)

NOPAT02 = -$130,948(1 – 0.4)

= -$130,948(0.6)= -$78,569

NOPAT01 = $114,257

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What effect did the expansion have on net operating working capital (NOWC)?

NOWC = Current - Non-interest

assets bearing CL

Examples of Non-interest bearing current liability: account payable, unearned revenue, etc.

Example of interest bearing current liability: note payable

NOWC02 = ($7,282 + $632,160 + $1,287,360) – ( $524,160 + $489,600) = $913,042

NOWC01 = $842,400

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Net fixed AssetsNet fixed assets mean long term assets after

depreciation and amortization At end of 2002 net fixed assets=$939,790 At the end of 2001 net fixed assets=$344,800

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How much is the operating capital?

Operating capital = NOWC + Net Fixed Assets

Operating Capital02 = $913,042 + $939,790 = $1,852,832

Operating Capital01 =$842,400+$344,800 =1,187,200

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What effect did the expansion have on operating cash flow (OCF)?

OCF02 = NOPAT + Dep

= ($78,569) + $116,960 = $38,391

OCF01 = $114,257 + $18,900

= $133,157

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What is your assessment of the expansion’s effect on operations?

SalesNOPATNOWCOperating

capitalNet Income

2002 $6,034,000

-$78,569$913,042

$1,852,832-$160,176

2001 $3,432,00

0$114,257$842,400$1,187,20

0$87,960

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What was the free cash flow (FCF) for 2002?

FCF = Operating Cash Flow (OCF) – Gross capital investment- OR -

FCF = NOPAT – Net Investment (change) in Operating Capital= -$78,569 – ($1,852,832 - $1,187,200)= -$744,201 (year 2002)

Remember: OCF=NOPAT+DEP, Gross Capital investment=Net Investment in Operating Capital + DEPIs negative free cash flow always a bad sign?

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Economic Value Added (EVA)

EVA = After-tax __ After-tax

Operating Income Capital costs

= NOPAT – After-tax Cost of Capital

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EVA Concepts In order to generate positive EVA,

a firm has to more than just make a profit. It must also provide a return to those who have provided the firm with capital.

EVA takes into account the total cost of capital.

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What is the firm’s EVA? Assume the firm’s after-tax percentage cost of capital was 10% in 2000 and 13% in 2001.

EVA02 = NOPAT – (After tax cost of capital) (Capital)

= -$78,569 – (0.13)($1,852,832)= -$78,569 - $240,868= -$319,437

EVA01 = $114,257 – (0.10)($1,187,200)= $114,257 - $118,720= -$4,463

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Federal Income Tax System

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Corporate and Personal Taxes

Both have a progressive structure (the higher the income, the higher the marginal tax rate).

Corporations Rates begin at 15% and rise to 35% for

corporations with income over $10 million. Also subject to state tax (around 5%). In most problems, we will assume 40%

Individuals Rates begin at 10% and rise to 35% for

individuals with income over $319,100. May be subject to state tax.

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Tax treatment of various uses and sources of funds Interest paid – tax deductible for

corporations (paid out of pre-tax income), but usually not for individuals (interest on home loans being the exception).

Dividends paid – not tax deductible. Dividends received – taxed as ordinary

income for individuals (“double taxation”). Interest earned – usually fully taxable (an

exception being interest from a “muni”).