Presentation on theme: "Financial Statements, Cash Flow, and Taxes"— Presentation transcript:
1 Financial Statements, Cash Flow, and Taxes Chapter 2Financial Statements, Cash Flow, and Taxes
2 Topics in Chapter Balance sheet Income statement Statement of cash flowsFree cash flowMVA and EVACorporate taxes
3 Importance of Financial Statements Form the basis for understanding the financial position of a businessProvide information regarding the financial policies and strategies and insight into future performance10-K and 10-Q
7 Changes on liabilities & equity CL increased as creditors and suppliers “financed” part of the expansion.Long-term debt increased to help finance the expansion.The company didn’t issue any stock.Retained earnings fell, due to the year’s negative net income and dividend payment.
9 Balance Sheet highlights Net plant and equipment= gross plant and equipment– accumulated depreciationCommon stock at par and additional paid-in (capital surplus)Retained earningsAnnual addition to retained earnings = net income – dividends paidNet worth – common equity
10 Income Statement Net Sales Less Cost of Goods Sold (COGS) Less Operating expensesEBITDALess DepreciationLess AmortizationsEBITLess InterestEBTLess TaxesNet income
11 Income Statement Example 20092010Sales$3,432,000$5,834,400COGS2,864,0004,980,000Other expenses340,000720,000Deprec.18,900116,960Tot. op. costs3,222,9005,816,960EBIT209,10017,440Int. expense62,500176,000EBT146,600(158,560)Taxes (40%)58,640(63,424)Net income$ 87,960($ 95,136)
13 MicroDrive Income Statement Table 2-2MicroDrive Income Statements for Years Ending December 31(in millions of dollars)20102009INCOME STATEMENTNet sales$3,000.0$2,850.0Operating costs except depreciation$2,616.2$2,497.0Earnings before interest, taxes, deprn., and amortization (EBITDA)*$383.8$353.0Depreciation$100.0$90.0Amortization$0.0Depreciation and amortizationEarnings before interest and taxes (EBIT)$283.8$263.0Less interest$88.0$60.0Earnings before taxes (EBT)$195.8$203.0Taxes$78.3$81.2Net Income before preferred dividends$117.5$121.8Preferred dividends$4.0Net Income available to common stockholders$113.5$117.8Common dividends$57.5$53.0Addition to retained earnings$56.0$64.8*MicroDrive has no amortization charges.
14 Income Statement Highlight Operating expensesInclude management salaries, advertising expenditures, repairs & maintenance, R&D, general & administrative expenses, lease payments, etc.Earnings per common share (EPS)Companies that issued convertible securities (such as bonds convertible into common stock) and stock options, must calculate two types of earnings per share: basic and diluted.
15 Statement of Cash Flows FI Corporate Finance Leng LingStatement of Cash FlowsProvides information about cash inflows and outflows during an accounting periodFocuses on CASH.Has THREE sections:Cash flow from Operating Activities (OCF)Cash flow from Investing Activities (ICF)Cash flow from Financing Activities (FCF )
16 Compute the changes in some accounts over two periods Accounts receivablesNotes payableDepreciationFixed assetsAccruals etc …Which account itemgoes toWhich section ?OperatingInvestingFinancing
17 Useful Tip 1No matter which section you are doing (operating, investing or financing),IF the change of an account leads to a cash INFLOW, you add that change (+); IF the change leads to a cash OUTFLOW, you subtract that change (-)inflow: decreases in assets or increases in liabilities or equity.outflow: increases in assets or decreases in liabilities or equity.
18 FI 3300 - Corporate Finance Leng Ling Useful Tip 2Cash flow from Operating Activities+ Cash flow from Investing Activities+ Cash flow from Financing Activities= CHANGE in cash account
19 Cash flows from operating activities 1 Net income+ depreciation+/- change in A/R+/- change in Inv.+/- change in A/P+/- change in Accruals
20 Cash flows from operating activities 2 FI Corporate Finance Leng LingCash flows from operating activities 2AssetLiabilityDecreasesAdd +(cash inflow)Subtract -(cash outflow)Increases
21 Cash flows from investing activities 1 Buying or selling productive assets (plant & equipment)Buying or selling financial securities (e.g., stocks and bonds of other companies,)
22 Cash flows from investing activities 2 FI Corporate Finance Leng LingCash flows from investing activities 2Inflows:Means:Decrease in gross fixed assetsFirm sells long-lived assets such as gross property, plant and equipmentDecrease in long-term investmentsFirm sells debt or equity securities of other firmsOutflows:Increase in gross fixed assetsFirm buys long-lived assets such as gross property, plant and equipmentIncrease in long-term investmentsFirm buys debt or equity securities of other firms
23 Cash flows from investing activities 3 FI Corporate Finance Leng LingCash flows from investing activities 3Warning: we want changes in GROSS fixed assets. We don’t want the changes in net fixed assets!BUT, if gross fixed assets are not reported in balance sheet …
24 Cash flows from investing activities 4 FI Corporate Finance Leng LingCash flows from investing activities 4change in gross fixed assets= change in net fixed assets + depreciation
25 Cash flows from financing activities 1 +/- changes in N/P+/- changes in current long-term debt+/- changes in long-term debt+/- changes in common and preferred stock+/- changes in capital surplus- Payment of dividends
26 Cash flows from financing activities 2 FI Corporate Finance Leng LingCash flows from financing activities 2Inflows:Means:increase in notes payableincrease in long-term debtFirm borrows moneyincrease in common stockFirm sells equity securitiesOutflows:decrease in notes payabledecrease in long-term debtFirm repays debtdecrease in common stockFirm buys back sharesPayment of dividendsFirm pays cash to shareholders
29 Analyzing Statement of Cash Flows 1 FI Corporate Finance Leng LingAnalyzing Statement of Cash Flows 1Statement of CF can help you analyze a company:1) Relationship between net income and net cash flow from operations (OCF)If net income positive, but OCF is negative, could mean:Company is growing rapidlyFinancial mis-management
30 Analyzing Statement of Cash Flows 2 2) Net cash flow from investing activities (ICF)If negative, company is making investmentsBuying plant & equipment (improve efficiencies)Buying another company’s stock (strategic reasons, e.g., joint venture)If positive, company is liquidating assets. Why? Financial distress?
31 Analyzing Statement of Cash Flows 3 3) Does company have sufficient cash to pay dividends?OCF should exceed dividends.If dividends exceed OCF, why?Company liquidated assets to pay dividends?Company issued equity or borrow to pay dividends?Neither situation is good.
32 Analyzing Statement of Cash Flows 4 FI Corporate Finance Leng LingAnalyzing Statement of Cash Flows 44) Changes in debtLook at cash flow from financing activitiessubstantial increases in debt (either short-term or long-term)Substituting short-term debt for long-term debt may indicate worsening financial health.
33 What is free cash flow (FCF)? Why is it important? FCF is the amount of cash available from operations for distribution to all investors (including stockholders and debtholders) after making the necessary investments to support operations.A company’s value depends on the future FCF it can generate.
34 What are the five uses of FCF? 1. Pay interest on debt.2. Pay back principal on debt.3. Pay dividends.4. Buy back stock (repurchase).5. Buy nonoperating assets (e.g., marketable securities, investments in other companies, etc.)
35 Calculating Free Cash Flow in 5 Easy Steps Earning before interest and taxesOperating current assetsX(1 − Tax rate)−Operating current liabilitiesNet operating profit after taxesNet operating working capitalStep 3Net operating working capital+Operating long-term assetsTotal net operating capitalStep 5Figure 2-1 in FM13Step 4Net operating profit after taxesTotal net operating capital this year−Net investment in operating capital−Total net operating capital last yearNet investment in operating capitalFree cash flow
36 Step1: Net Operating Profit after Taxes (NOPAT) NOPAT = EBIT(1 - Tax rate)=EBIT - Tax
37 Step2: Net Operating Working Capital (NOWC) =OperatingCACLNOWCOperating CA = cash and equivalent + inventory + accounts receivables.Operating CL = accounts payable + accruals
38 Step 3: Total net operating capital (or operating capital) = NOWC + Net fixed assets.
39 Step 4: net investment in operating capital Net investment in operating capital = operating capital this year - operating capital last year
40 Step 5: Free Cash Flow (FCF) = NOPAT - Net investment in operating capitalEquation (2-6)
41 Alternative FCF equation (2-9) operating cash flow- gross investment in long-term operating assetinvestment in NOWCEquation (2-9)
42 Is a negative FCF bad? If –NOPAT leads to a –FCF, then bad. High growth usually causes negative FCF (due to investment in capital), but that’s ok if ROIC > WACC.ROIC: return on invested capitalROIC = NOPAT / operating capital
43 Market Value Added (MVA) MVA = Market Value of the Firm - Book Value of the FirmMarket Value = (# shares of stock)(price per share) + Value of debtBook Value = Total common equity + Value of debt
44 MVA (Continued)If the market value of debt is close to the book value of debt, thenMVA = Market value of equity – book value of equityThis applies when it is hard to find the market value of debt.
45 MVA (Assume market value of debt = book value of debt.) Market Value of Equity 2010:(100,000)($6.00) = $600,000.Book Value of Equity 2010:$557,632.MVA = $600,000 - $557,632 = $42,368.
46 Economic Value Added (EVA) = NOPAT – Operating capital x WACC= Operating capital x ROIC –Operating capital x WACC= Operating capital (ROIC-WACC)
47 MVA and EVA (Table 2-5) Table 2-5 MVA and EVA for MicroDrive (Millions of Dollars)20102009MVA CalculationPrice per share$23.0$26.0Number of shares (millions)50.0Market value of equity = Share price (number of shares)$1,150.0$1,300.0Book value of equity$896.0$840.0MVA = Market value - Book value$254.0$460.0EVA CalculationEBIT$283.8$263.0Tax rate40%NOPAT = EBIT (1-T)$170.3$157.8Total investor-supplied operating capitala$1,800.0$1,455.0Weighted average cost of capital, WACC (%)11.0%10.8%Dollar cost of capital = Operating capital (WACC)$198.0$157.1EVA = NOPAT – Capital cost-$27.7$0.7ROIC = NOPAT/Operating capital9.46%10.85%ROIC – Cost of capital = ROIC – WACC-1.54%0.05%EVA = (Operating capital)(ROIC – WACC)
48 2009 Corporate Tax Rates Taxable Income Tax on Base Rate on amount above base0 -50,00015%50, ,0007,50025%75, ,00013,75034%100, ,00022,25039%335, M113,90010M - 15M3,400,00035%15M M5,150,00038%18.3M and up6,416,667
49 Features of Corporate Taxation Progressive rate up until $18.3 million taxable income.Below $18.3 million, the marginal rate is not equal to the average rate.Above $18.3 million, the marginal rate and the average rate are 35%.
50 After Chapter Homework Problems: (2-3), (2-4), (2-5), (2-10), (2-12 abcde), mini case d,e,f,g,h.Course website: Statement of Cash Flow assignment 3.2, 3.3.