1 Chapter 2 Financial Statement and Cash Flow Analysis

2 Learning Objectives  Interpret information contained in the balance sheet, income statement, and statement of cash flows.  Explain why income differs from cash flow.  Measure and interpret financial ratios.  Understand the essential features of the taxation of corporate income.

3 Topics Covered  The Balance Sheet  The Income Statement  Measuring Cash Flow & The Statement of Cash Flows  Corporate Taxes  Financial Ratio Analysis

4 The Balance Sheet Definition  Financial statements that show the value of the firm’s assets and liabilities at a particular point in time (from an accounting perspective).  A “snapshot” of a company’s financial position.

5 The Balance Sheet The Main Balance Sheet Items Current Assets Cash & Securities Receivables Inventories + Fixed Assets Tangible Assets Intangible Assets Current Liabilities Payables Short-term Debt + Long-term Liabilities + Shareholders’ Equity =

6 Target Balance Sheet ($ Thousands) PERIOD ENDING29-Jan-0531-Jan-04 Current Assets Cash And Cash Equivalents2,245,000716,000 Net Receivables5,069,0005,776,000 Inventory5,384,0005,343,000 Other Current Assets1,224,0001,093,000 Total Current Assets13,922,00012,928,000 Fixed Assets Gross Property Plant and Equipment22,272,00019,880,000 Accumulated Depreciation-5,412,000-4,727,000 Net Property Plant and Equipment16,860,00016,969,000 Goodwill60,000 Intangible Assets146,000 Other Assets1,305,0001,495,000 Total non-current assets18,371,00018,464,000 Total Assets32,293,00031,392,000

Target Liabilities & Stockholders’ Equity ($ Thousands) PERIOD ENDING29-Jan-0531-Jan-04 Current Liabilities Accounts Payable7,716,0007,448,000 Short/Current Long Term Debt504,000866,000 Total Current Liabilities8,220,0008,314,000 Long Term Debt9,034,00010,217,000 Other Liabilities1,037,000 Deferred Long Term Liability Charges973,0001,796,000 Total Liabilities19,264,00020,327,000 Stockholders' Equity Common Stock74,00076,000 Retained Earnings11,148,0009,645,000 Capital Surplus1,810,0001,341,000 Other Stockholder Equity-3,0003,000 Total Stockholder Equity13,029,00011,065,000 Total Liabilities & Equity32,293,00031,392,000

8 The Income Statement Definition Financial statement that shows the revenues, expenses, and net income of a firm over a period of time (from an accounting perspective).

9 Target’s Income Statement (thousands of $) PERIOD ENDING29-Jan-0531-Jan-04 Total Revenue46,839,00048,163,000 Cost of Revenue31,445,00031,790,000 Gross Profit15,394,00016,373,000 Selling General and Administrative10,534,00011,534,000 Other Operating Expenses1,259,0001,320,000 Operating Income or Loss3,601,0003,519,000 Earnings Before Interest And Taxes3,601,0003,519,000 Interest Expense570,000559,000 Income Before Tax3,031,0002,960,000 Income Tax Expense1,146,0001,119,000 Net Income From Continuing Ops1,885,0001,841,000 Discontinued Operations1,313,000- Net Income3,198,0001,841,000

10 Accounting Income vs. Cash Flow An Income Statement  Sales  Cost of Goods Sold  Selling & Gen. Adm. Exp  Depreciation  Interest Exp  Taxable Income  Taxes  Net Income  Do all items reflect all cash collected and paid?  NO!!! Income statement is on an accrued basis.  What is and who is depreciation?

11 Sources and Uses of Corporate Cash Sources Decrease in any asset Increase in any liability Net profits after taxes Depreciation and other non-cash charges Sale of stock Uses Increase in any asset Decrease in any liability Net loss Dividends paid Stock repurchase or retirement

12 Statement of Cash Flows  Shows how the firm used and raised cash during the year.  Reconciles the Income Statement by the changes in the Balance Sheet from the beginning of the year to the end of the year

13 Parts of Statement of Cash Flows  Cash Flow from Operations = net cash income from income statement: net income, Depreciation,change in A/R, Inv, Other CA, A/P, Accruals (Wages & Taxes), Other CL  Cash Flow from Investments = Purchases and Sales of long-term real assets & investments and short-term investments  Cash Flow from Financing = issuances and payments of debt and stock: L-T Debt, Common and Preferred Stock, Notes Payable & Dividends Paid

14 Target’s Statement Of Cash Flows ($ Thousands) PERIOD ENDING29-Jan-0531-Jan-04 Net Income3,198,0001,841,000 Depreciation1,259,0001,320,000 Adjustments To Net Income-437,000846,000 Changes In Accounts Receivables-209, ,000 Changes In Liabilities1,064,000912,000 Changes In Inventories-853, ,000 Changes In Other Operating Activities-827, ,000 Total Cash Flow From Operating Activities3,195,0003,160,000 Investing Activities, Cash Flows Provided By or Used In Capital Expenditures-3,068,000-3,004,000 Other Cashflows from Investing Activities4,247,00085,000 Total Cash Flows From Investing Activities1,179,000-2,919,000

15 Target’s Statement Of Cash Flows ($Thousands) PERIOD ENDING29-Jan-0531-Jan-04 Financing Activities, Cash Flows Provided By or Used In Dividends Paid-272, ,000 Sale Purchase of Stock-1,144,000 Net Borrowings-1,477,000-72,000 Other Cash Flows from Financing Activities56,00026,000 Total Cash Flows From Financing Activities-2,837, ,000 Change In Cash and Cash Equivalents$1,537,000($42,000)

16 Target’s Cash Flows Fiscal ($Thousands)

17 Key Measures of Cash Flow Cash Flow from Operations Total cash generated Operating Cash Flow Cash flow before repaying lenders Free Cash Flow Cash flow that firm could distribute to investors.

18 Specific Cash Flow Definitions  Operating Cash Flow (OCF) = cash generated from the firm’s operations OCF = Earnings Before Interest and Taxes (EBIT) – Taxes + Depreciation Target 2005 OCF = 3,601,000 – 1,146, ,259,000 = 3,714,000  Free Cash Flow (FCF) = Cash available to the firm’s investors after firm meets operating and investment needs FCF = OCF – FA(gross) – (CA – A/P – Accruals) Target 2005 FCF = 3,714,000 – 2,408,000 – (994,000 – 268,000) = 580,000

19 Corporate Income Taxes  Corporate deductions from income: operating expenses, depreciation, interest expense.  Dividends paid are NOT deductible.  Interest and capital gain income is fully taxable.  30% (in general) of Dividend income is taxable.  Losses can be carried back (for refund of past taxes paid) and carried forward (to reduce future taxable income & taxes).

20 Corporate Tax Rates (2002)

21 Corporate Tax Example  Kramerica has taxable income of $90,000. What is their tax liability, marginal and average tax rates? Marginal tax rate = the tax rate on the next dollar of income. Average Tax Rate = taxes paid divided by taxable income.

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