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Corporate Finance Ronald F. Singer FINA 4330. Finance and Accounting Lecture 2 . Fall, 2010. Financial Statements . Generally Finance Professionals get their information from Financial Statements prepared by accountants.

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financial statements
Financial Statements
  • Generally Finance Professionals get their information from Financial Statements prepared by accountants.
  • In general, Financial Statements are used to determine how the firm “is doing,” in particular, how it has done over some period of time.

FINA4330 Corporate Finance

financial statements3
Financial Statements
  • Although we are also interested in the financial health of companies; generally, financial statements have to be modified in order to focus on our objective.
  • In general, the “focus of our objective” is cash flow
  • Most corporations prepare three basic financial statements:

Income Statement

Balance Sheet

Cash Flow Statements

FINA4330 Corporate Finance

focus of finance
Focus of Finance
  • Cash Flow!!!
  • What is Cash Flow?
  • It is the amount of cash generated and available to security holders.

FINA4330 Corporate Finance

financial statements5
Financial Statements
  • Income Statement:
    • A Listing of Revenue, Expenses, and Profits over a period of time
  • Balance sheet
    • A listing of Assets, Liabilities, and Net Worth at a single point in time. Generally in terms of Book Value.
  • Cash Flow Statement
    • The Flow of Cash over a period of time

FINA4330 Corporate Finance

macintosh enterprises
Macintosh Enterprises

Balance Sheet

December 31, 2008

(BV $ thousands)

AssetsLiabilities and Stockholders Equity

Current Assets Current Liabilities

Cash 1,000 Accounts payable 500

Accounts Receivable 1,000 Notes payable 75

Inventory 450 Accrued expenses 75

Other 50 Total Current Liabilities 650

Total Current Assets $2,500 Long term Liabilities

Fixed Assets Deferred Taxes 1,000

Property, Plant & equip. 4,600 Long term debt 2,000

Less Accumulated Dep. 600 Total long term liability 3,000

Net PP&E 4,000

Intangible & Other assets 1,000 Stockholders’ Equity ???

Total Assets $7,500 Total Liabilities and Stockholders’ Equity ???

FINA4330 Corporate Finance

macintosh enterprises7
Macintosh Enterprises

Balance Sheet

December 31, 2009

(BV $ thousands)

AssetsLiabilities and Stockholders Equity

Current Assets Current Liabilities

Cash 800 Accounts payable 650

Accounts Receivable 1,200 Notes payable 25

Inventory 550 Accrued expenses 75

Other 150 Total Current Liabilities 750

Total Current Assets $2,700 Long term Liabilities

Fixed Assets Deferred Taxes 1,000

Property, Plant & equip. 4,600 Long term debt 2,000

Less Accumulated Dep. 600 Total long term liability 3,000

Net PP&E 4,000

Intangible & Other assets 1,000 Stockholders’ Equity ???

Total Assets $7,500 Total Liabilities and Stockholders’ Equity ???

FINA4330 Corporate Finance

macintosh enterprises8
Macintosh Enterprises

Pro-Forma Income Statement

(Year ending December 31, 2009)

($ thousand)

Sales $5,000

Less: Operating Expenses (COGS) 2,000

Depreciation & Amortization 600

Selling, general and administrative exp. 300

Operating Income $2,100

Other income 100

Earnings Before Interest and Taxes (EBIT) 2,200

Less: Interest Expense 770

Pretax (Taxable) Income 1,430

Less Tax (@ 40%) 572

Net Income (Earnings after Tax) $858

Addition to retained earnings 58

Dividends 800

Earnings per Share (EPS) = Net Income/Shares = $0.858

Dividends per share (DPS) = $0.80

FINA4330 Corporate Finance

transform income statement into cash flow
Transform income statement into Cash Flow

Now we are ready to transform this income statement into Cash Flow

Adjustments Necessary:

1. Changes in Fixed Assets: Depreciation and Amortization is not a cash expense and thus should not be subtracted from Cash Flow. But, New Investment is a cash expense (when paid for) and should be subtracted.

FINA4330 Corporate Finance

transform income statement into cash flow10
Transform income statement into Cash Flow

2. Cost of Goods Sold (COGS) is the DIRECT expense associated with producing the goods that are sold in the period.

Costs associated with goods that are produced but will be sold in future periods are not counted.

If the firm pays for goods THAT ARE NOT SOLD, there is a cash flow out which must be accounted for.

In order to account for this, we include changes in Inventory in the Cash Flow statement.

FINA4330 Corporate Finance

transform income statement into cash flow11
Transform income statement into Cash Flow
  • In general: Increases in Working Capital must be subtracted from Earning to get Cash Flow
  • In this case suppose:

Changes in Working Capital (+100)

Change in cash -200

a/c receivable +200 a/c payable +150

Inventory +100 Notes payable -50

Other S.T.A +100

Total change 200 100

FINA4330 Corporate Finance

macintosh enterprises12
Macintosh Enterprises

Pro-Forma Cash Flow Statement

(Year ending December 31, 2006)

($ thousand)

Earnings Before Interest and Taxes (from Income Statement) $2,200

Less: Tax on Operations (@ 40% (Note: tax rate times EBIT not $572) 880

Operating Income after Tax (EBIT(1-t)) 1,320

Plus: Non-Cash Expenses (Depreciation & Amortization) 500 1,820

Increase (decrease) in cash holdings -200

increase (decrease) in accounts receivable 200

increase (decrease) in Inventory 100

increase (decrease) in other Short Term Assets 100

Change in Short Term Assets 200

Less: increase (decrease) in accounts payable 150

increase (decrease) in Short Term Liabilities (50)

Changer in Short Term Liabilities 100

Less: Net Change in Working Capital 300 300

Free Cash Flow from Operations $1,520

Less: “After Tax” interest payments I(1-t) (note: = 770 (1-.40)) 462

Less: Dividends to preferred stockholders 100

Less: Investment (net of capital gains tax) 400

Free Cash Flow to Common Stockholders 558

EBITDA (2,200 + 500) $2,700