2. Chapter 3 Accounting and Finance

3. Learning Objectives  Interpret information contained in the balance sheet, income statement, and statement of cash flows.  Distinguish between market and book value.  Explain why income differs from cash flow.  Understand the essential features of the taxation of corporate and personal income.

4. Topics Covered  The Balance Sheet  The Income Statement  The Statement of Cash Flows  Taxes

5. 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).  Refer to Intel’s balance sheet

6. 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 =

7. Important Balance Sheet Relationships  Net Working Capital = Current Assets minus Current Liabilities  Shareholders’ Equity = Total Assets minus Total Liabilities  Book Value = Historical accounting value of assets and equity found on balance sheet.  Market Value = current value of assets and equity Recent market value of Intel stock = $184.49 billion vs. latest quarterly balance sheet equity of $35.49. Market Value of Intel’s Assets = Market Value of Liabilities ($8.75 billion) + Market Value of Equity ($184.49 billion) = $193.24 billion vs. latest quarterly balance sheet assets of $44.47 billion

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). Refer to Intel’s Income Statement

9. The Income Statement Earnings Before Income & Taxes (EBIT) EBIT = - total Revenues - costs - deprecation

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. 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

12. Statement of Cash Flows: General Concepts Overall:  Inflows(or sources) of cash are net income, depreciation, decreases in assets, and increases in liabilities  Outflows(or uses) of cash are increases in assets, decreases in liabilities, and dividends

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

14. Intel’s Cash Flows 1998-2002 (millions of $)

15. INCOME TAXES

16. 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).

17. Corporate Tax Rates (2002)

18. Corporate Tax Example  Kramerica has taxable income of $80,000. 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.  In 34% bracket = marginal tax rate.  Tax Liability =.15($50,000) +.25($25,000) +.34($80,000 - $75,000) = $15,450  Average Tax Rate = $15,450/$80,000 =19.3%

19. Personal Income Taxes  Marginal tax rate = the tax rate on the next dollar of income.  Average Tax Rate = taxes paid divided by taxable income.  Wages, tips, and interest income are considered ordinary taxable income.  Deductions: charitable donations, mortgage interest, personal exemptions, medical expenses to an extent(> 7.5% of gross income), and a portion of student loan interest is tax deductible.

20. New 2003 Personal Tax Rates Marginal RateSingleMarried File Jointly 10%0-$7,0000-$14,000 15%$7,001-$28,400$14,001-$56,800 25%$28,401-$68,800$56,801-$114,650 28%$68,801-$143,500$114,651-$174,700 33%$143,501-$311,950$174,701-$311,950 35%Over $311,950

21. Recent Changes in Personal Investment Income Taxes  Financial and Real assets held for less than 12 MONTHS and then sold are considered short-term capital gains and taxed as ordinary income at the taxpayer’s marginal tax rate.  Long-term (held more than 12 months) capital gains and dividend income are now taxed at a maximum rate of 15% (25% tax bracket and above) or 5%(10% & 15% tax bracket).