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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
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.
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.
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
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.
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
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.
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
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.
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
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)
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
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.
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.