1. GBUS502 Vicentiu Covrig 1 Financial statements and cash flow (chapter 3)

2. GBUS502 Vicentiu Covrig 2 Sources of Information Annual reports Wall Street Journal Internet - www.yahoo.com www.yahoo.com - www.smartmoney.com Mergent online SEC - EDGAR - 10K & 10Q reports

3. GBUS502 Vicentiu Covrig 3 Financial statements 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 I’ll review most of the concepts for this chapter using the integrated case D’Leon from page 80 in your text

4. GBUS502 Vicentiu Covrig 4 Balance Sheet: Assets Cash A/R Inventories Total CA Gross FA Less: Dep. Net FA Total Assets 2008 7,282 632,160 1,287,360 1,926,802 1,202,950 263,160 939,790 2,866,592 2007 57,600 351,200 715,200 1,124,000 491,000 146,200 344,800 1,468,800

5. GBUS502 Vicentiu Covrig 5 Balance sheet: Liabilities and Equity Accts payable Notes payable Accruals Total CL Long-term debt Common stock Retained earnings Total Equity Total L & E 2008 524,160 636,808 489,600 1,650,568 723,432 460,000 32,592 492,592 2,866,592 2007 145,600 200,000 136,000 481,600 323,432 460,000 203,768 663,768 1,468,800

6. GBUS502 Vicentiu Covrig 6 Income statement Sales COGS Other expenses EBITDA Depr. & Amort. EBIT Interest Exp. EBT Taxes Net income 2008 6,034,000 5,528,000 519,988 (13,988) 116,960 (130,948) 136,012 (266,960) (106,784) (160,176) 2007 3,432,000 2,864,000 358,672 209,328 18,900 190,428 43,828 146,600 58,640 87,960

7. GBUS502 Vicentiu Covrig 7 Other data No. of shares EPS DPS Stock price Lease pmts 2008 100,000 -$1.602 $0.11 $2.25 $40,000 2007 100,000 $0.88 $0.22 $8.50 $40,000

8. GBUS502 Vicentiu Covrig 8 Statement of Retained Earnings (2008) Balance of retained earnings, 12/31/07 Add: Net income, 2008 Less: Dividends paid Balance of retained earnings, 12/31/08 $203,768 (160,176) (11,000) $32,592

9. GBUS502 Vicentiu Covrig 9 What effect did the expansion have on net and total operating working capital? Net operating working capital (NOWC) = All current assets – All current liabilities that do not charge interest = (Cash and marketable securities + Accounts receivable + Inventories) – - (Account payable +Accruals) NOWC 2008 = $913,042 NOWC 2007 = $842,400 Total Operating capital = NOWC + Net Fixed Assets Total Operating Capital 2008 = $1,852,832 Total Operating Capital 2007 = $1,187,200

10. GBUS502 Vicentiu Covrig 10 Did the expansion create additional net operating after taxes (NOPAT)? NOPAT = EBIT (1 – Tax rate) NOPAT 08 = -$130,948(1 – 0.4) = -$130,948(0.6) = -$78,569 NOPAT 07 = $114,257

11. GBUS502 Vicentiu Covrig 11 What is your assessment of the expansion’s effect on operations? Sales NOPAT NOWC Operating capital Net Income 2008 $6,034,000 -$78,569 $913,042 $1,852,832 -$160,176 2007 $3,432,000 $114,257 $842,400 $1,187,200 $87,960

12. GBUS502 Vicentiu Covrig 12 What effect did the expansion have on operating cash flow? OCF 08 = NOPAT + Dep = ($78,569) + $116,960 = $38,391 OCF 07 = $114,257 + $18,900 = $133,157

13. GBUS502 Vicentiu Covrig 13 What was the free cash flow (FCF) for 2008? FCF = the cash flow available for distribution to all investors after the company has made all investments in fixed assets, new products, working capital necessary to sustain the ongoing operations FCF = OCF – Gross capital investment - OR - FCF 08 = NOPAT – Net capital investment = NOPAT – ( Total Operating Capital 08 - Total Operating Capital 07 ) = -$78,569 – ($1,852,832 - $1,187,200) = -$744,201 Is negative free cash flow always a bad sign?

14. GBUS502 Vicentiu Covrig 14 Does D’Leon pay its suppliers on time? Probably not. A/P increased 260%, over the past year, while sales increased by only 76%. If this continues, suppliers may cut off D’Leon’s trade credit. Does it appear that D’Leon’s sales price exceeds its cost per unit sold?

15. GBUS502 Vicentiu Covrig 15 What if D’Leon’s sales manager decided to offer 60-day credit terms to customers, rather than 30-day credit terms? If competitors match terms, and sales remain constant … - A/R would  - Cash would  If competitors don’t match, and sales double … - Short-run: Inventory and fixed assets  to meet increased sales. A/R , Cash . Company may have to seek additional financing. - Long-run: Collections increase and the company’s cash position would improve.

16. GBUS502 Vicentiu Covrig 16 How did D’Leon finance its expansion? D’Leon financed its expansion with external capital. D’Leon issued long-term debt which reduced its financial strength and flexibility.

17. GBUS502 Vicentiu Covrig 17 What happens if D’Leon depreciates fixed assets over 7 years (as opposed to the current 10 years)? No effect on physical assets. Fixed assets on the balance sheet would decline. Net income would decline. Tax payments would decline.

18. GBUS502 Vicentiu Covrig 18 Federal Income Tax System

19. GBUS502 Vicentiu Covrig 19 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%). Individuals - Rates begin at 10% and rise to 35% for individuals with income over $349,700. - May be subject to state tax.

20. GBUS502 Vicentiu Covrig 20 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). Interest earned – usually fully taxable (an exception being interest from a (muni”). Dividends paid – paid out of after-tax income. Dividends received – taxed as ordinary income for individuals (“double taxation”). A portion of dividends received by corporations is tax excludable, in order to avoid “triple taxation”.

21. GBUS502 Vicentiu Covrig 21 More tax issues Tax Loss Carry-Back and Carry-Forward – since corporate incomes can fluctuate widely, the tax code allows firms to carry losses back to offset profits in previous years or forward to offset profits in the future. Capital gains – defined as the profits from the sale of assets not normally transacted in the normal course of business, capital gains for individuals are generally taxed as ordinary income if held for less than a year, and at the capital gains rate if held for more than a year. Corporations face somewhat different rules.