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CHAPTER 3 Financial Statements, Cash Flow, and Taxes
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  1. CHAPTER 3Financial Statements, Cash Flow, and Taxes The Annual Report Balance Sheet Income statement Statement of cash flows Statement of Stockholder’s Equity Free Cash Flow Income Taxes

  2. The Annual Report • A report issued annually by a corporation to its stockholders. It contains basic financial statements as well as management’s analysis of the firm’s past operations and future prospects.

  3. The Annual Report • Balance sheet – shows what assets company owns and who has claims on those assets as of a given date. • Income statement – shows firm’s sales and costs (and thus profit) during some past period. • Statement of stockholder’s equity – shows how the amount of equity changed during the period. • Statement of cash flows – shows what affected the change in the amount of cash.

  4. Net Working Capital • Current Assets are often called working capital because they are used and replaced (“turned over”) throughout the year. • Net working capital = Current assets – (Payables + Accruals) • Payables and Accruals are like “free” loans since they don’t bear any interest. • NWC is the amount of money company must obtain from non-free sources to fund its current assets. • Allied Food: $1000 - ($60 + $140) = $800

  5. Market Value VS Book Value • Book Valuesare the values of assets calculated using methods of GAAP and put in the balance sheet. • Market Values are the current price of an asset in the market if it were to put up for sale.

  6. Sources of Funds • Debt or Liabilities: • Long-term debt – Interest bearing. Ex: bonds, loans • Current debt – Non-interest bearing. Ex: payables, accruals • Preferred Stock - Part of equity that is a hybrid of debt and common stock • Common Stock – Portions of ownership of a company • In the event of bankruptcy priority of payback are as follows: debt-preferred stocks-common stocks

  7. Income at different stages • Operating Income: Income from firm’s regular core business. It is also called Earnings Before Interest and Tax (EBIT). • Companies can have same EBIT but different Net Income because of different Interest amount. The more debt a firm has the more interest they have to pay which changes the Net Income.

  8. Income at different stages • Depreciation: The charge to reflect the cost of assets used up in the production process. Depreciation is not a cash outflow. • Amortization: A noncash charge similar to depreciation except that it is used to write off the costs of intangible assets. • Since these are non-cash so Earnings Before Interest Tax Depreciation and Amortization (EBITDA) is also an important indicator of firm performance

  9. Statement of Cash Flows • Operating Activities: Deals with items that occur as part of normal ongoing operation. • Investing Activities: Activities involving long-term assets. • Financing Activities: Activities involving long-term debt or equity financing.

  10. Statement of Stockholder’s Equity • Retained Earnings represent a claim against assets. It does not represent cash and are not available for dividends or anything else, only for investing activities

  11. Free Cash Flow (FCF) • FCF is the amount of cash that could be withdrawn from a firm without harming it’s ability to operate and to produce future cash flow. • FCF = EBIT(1-T) + Depreciation – (Capital expenditure + Increase in NWC)

  12. Free Cash Flow • EBIT(1-T) = Net Operating Profit After Tax (NOPAT) • Capital Expenditure = Change in Long-term assets • Increase in NWC = Change in current assets – Change in payables and accruals • FCF = $283.8(1-0.4) + $100 – ([$1000 - $870] + [($1000 - $810) – ($200 - $160)]) = -$9.72 • Negative FCF means Operating Income is not enough to cover for the new ventures and the working capital

  13. Income Taxes • Individuals are taxed on wages, salaries, and on investment income like dividends, interest, and capital gains. • Capital Gain or Loss is the profit/loss from the sale of a capital asset (stocks, bonds, and real estates) for more/less than it’s purchase price. • The tax rates are progressive meaning the higher one’s income the larger the percentage paid in taxes.

  14. Income Taxes • Corporations also have to pay taxes on their income at a progressive rate. • Interest and dividends received on bonds and stocks are taxed. But for dividends the rule is more relaxed and only 30% is taxed. • Interest paid are deducted from taxable income but dividends paid are not. • Corporate capital gains are also taxed.