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Wal*Mart. Wal*Mart had a Market to Book ratio of 7.6 Market Capitalization (price x # of shares) is 7.6 times its book value (assets-liabilities). Why? The Gap had a Market to Book ratio of 4.0 in February 2001 down from 9.5 in February 2000! Why?
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Wal*Mart • Wal*Mart had a Market to Book ratio of 7.6 • Market Capitalization (price x # of shares) is 7.6 times its book value (assets-liabilities). • Why? • The Gap had a Market to Book ratio of 4.0 in February 2001 down from 9.5 in February 2000! • Why? • Wal*Mart had Net Income of $6,671 before extraordinary items in FY2002 (1/31/02). • It used $8,383 to purchase new plant and equipment. • It also had a net outflow of investing activity and a net outflow from financing activity F305 - Review Financial Reporting
Review Financial Reporting • How are finance and accounting different? • Book Value does not equal Market Value • Net Income does not equal Cash Flow F305 - Review Financial Reporting
The Wal*Mart Income Statement Total Revenues Less: Costs of sales Operating, selling, general and admin costs Interest costs ___________ Earnings before tax and minority interest Provision for income taxes Minority interest ___________ Net income F305 - Review Financial Reporting
Wal*Mart Cash Flow • In 2002, Wal*Mart had Net Income before extraordinary items of $6,671. • The Statement of Cash flows shows the firm had a net cash inflow of $107 for the year. • Why is cash flow so different from net income? F305 - Review Financial Reporting
Review Financial Reporting • What is the difference in the income and cash flow? • Net income must be increased by all non-cash items, such as depreciation and amortization, as well as changes to deferred taxes • The increase or decrease in operating assets will either increase or decrease net income to arrive at the net change in cash. Think of the effect on cash as the other side of a T-account entry: • Increases in assets reduce cash • Decreases in assets increase cash • Increases in liabilities increase cash • Decreases in liabilities decrease cash • Net Investing activities will typically decrease cash F305 - Review Financial Reporting
Free Cash Flow • Free cash flow (FCF) is cash from business activities. • It tells your cash over and above your normal investments. • It does not consider cash distributed, used to retire debt or received from borrowings or security issuances. • Rather, it is used to determine how much you have to distribute and repay debt or how much you need from financing. [Recall: investment and financing decisions are separate] • FCF = operating cash flow in excess of investments needed for business activity. • Free Cash Flow = Cash flow from operations – Cash used for investments in PP&E and other operating investments F305 - Review Financial Reporting
Free Cash Flow • What is cash flow from operations? • Cash flow related to the investment side (ongoing business activity) rather than financing side of the business. • Does income = operating cash flow? • NO! • Non-cash expenses and revenues • Non-operating expenses and income (ex. Interest) F305 - Review Financial Reporting
Free Cash Flow • Income does NOT = operating cash flow? • The typical Cash Flow has the following adjustments to Net Income • Non-cash expenses: Depreciation, amortization • Income not yet collected: Accounts Receivables • Operating Items paid for but not expensed: Inventory • Expenses not yet paid: Accounts and Taxes Payable • Non-operating income / expenses: Interest (after tax) = Cash from operations • This is not an exhaustive list, but used only to provide examples! • Note: Increases in assets are cash outflows and increases in liabilities are cash inflows F305 - Review Financial Reporting
Free Cash Flow • Methods of calculating – focus on indirect (Exhibit 2.3) • Direct and Indirect get to same free cash flow • Direct restates Income Statement • Indirect starts with Net Income and adjusts for non-cash items • How does free cash flow differ from the firm’s statement of cash flow? • A Statement of Cash Flow is like a bank reconciliation. It shows where the funds came from and went. It ties last year’s and this year’s cash balance. • Free Cash Flow tells you what cash is available from your business activities. F305 - Review Financial Reporting
Wal*Mart Free Cash Flow – 2002(Do in Class) F305 - Review Financial Reporting
Review Financial Reporting • Is one cash flow more important than the other in determining the value of the business? • No, both are vital to business operations • Accounting provides most of the information we have about a firm • Do you really need to know how to be an accountant to be a good financial analyst? • Definitely! F305 - Review Financial Reporting
Key Points • Financial Analysis relies on Accounting information • Accounting information must be adjusted to use in financial analysis • Accountants record the value of the firm. However, often the market value is not clear so the accountants so rely on historical cost accounting. • Accountants use accrual accounting – In finance, we are concerned with cash flow. • Specifically, we want to value the free cash flow of the company, i.e. the cash flow related to operations. F305 - Review Financial Reporting