Ch. 2 - Understanding Financial Statements, Taxes, and Cash Flows, Prentice Hall, Inc.

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Ch. 2 - Understanding Financial Statements, Taxes, and Cash Flows

, Prentice Hall, Inc.

- EXPENSES

= PROFIT

Income Statement

- EXPENSES

= PROFIT

Income Statement

Revenue

Income Statement

- EXPENSES

= PROFIT

Income Statement

- EXPENSES

= PROFIT

•Cost of Goods Sold

Income Statement

- EXPENSES

= PROFIT

•Cost of Goods Sold•Operating Expenses

Income Statement

- EXPENSES

= PROFIT

•Cost of Goods Sold•Operating Expenses (marketing, administrative)

Income Statement

- EXPENSES

= PROFIT

•Cost of Goods Sold•Operating Expenses (marketing, administrative)•Financing Costs

Income Statement

- EXPENSES

= PROFIT

•Cost of Goods Sold•Operating Expenses (marketing, administrative)•Financing Costs•Taxes

- Cost of Goods Sold

GROSS PROFIT

- Operating Expenses

OPERATING INCOME (EBIT)

- Interest Expense

EARNINGS BEFORE TAXES (EBT)

- Income Taxes

EARNINGS AFTER TAXES (EAT)

- Preferred Stock Dividends

- NET INCOME AVAILABLE

TO COMMON STOCKHOLDERS

Income Statement

GROSS PROFIT

- Interest Expense

- Income Taxes

Income Statement

GROSS PROFIT

- Interest Expense

- Income Taxes

Income Statement

Balance Sheet

Total Assets =

OutstandingDebt

+Shareholders’

Equity

Balance Sheet

Balance SheetAssets

Balance SheetAssets Liabilities (Debt) & Equity

Current Assets Cash

Marketable Securities

Accounts Receivable

Inventories

Prepaid Expenses

Fixed Assets Machinery & Equipment

Buildings and Land

Other AssetsInvestments & patents

Current Liabilities Accounts Payable Accrued Expenses Short-term notesLong-Term Liabilities Long-term notes MortgagesEquity Preferred Stock Common Stock (Par value) Paid in Capital Retained Earnings

Assets• Current Assets:

Assets• Current Assets: assets that are relatively

liquid, and are expected to be converted to cash within a year.

liquid, and are expected to be converted to cash within a year.– Cash, marketable securities, accounts

receivable, inventories, prepaid expenses.

• Fixed Assets:

• Fixed Assets: machinery

and equipment, buildings,

and land.

• Fixed Assets: machinery and equipment, buildings, and land.

• Other Assets:

• Other Assets: any asset that is not a current asset or fixed asset.

• Other Assets: any asset that is not a current asset or fixed asset.– Intangible assets such as patents and copyrights.

Financing• Debt Capital:

Financing• Debt Capital: financing provided by a

creditor.

• Short-term debt:

creditor.

• Short-term debt: borrowed money that must be repaid within the next 12 months.

creditor.

• Short-term debt: borrowed money that must be repaid within the next 12 months. – Accounts payable, other payables such as

interest or taxes payable, accrued expenses, short-term notes.

creditor.

• Long-term debt:

creditor.

• Long-term debt: loans from banks or other sources that lend money for longer than 12 months.

Financing• Equity Capital:

Financing• Equity Capital: shareholders’ investment in

the firm.

• Preferred Stockholders:

the firm.

• Preferred Stockholders: receive fixed dividends, and have higher priority than common stockholders in event of liquidation of the firm.

the firm.

• Preferred Stockholders: received fixed dividends, and have higher priority than common stockholders in event of liquidation of the firm.

• Common Stockholders:

the firm.

• Preferred Stockholders: received fixed dividends, and have higher priority than common stockholders in event of liquidation of the firm.

• Common Stockholders: residual owners of a business. They receive whatever is left after creditors and preferred stockholders are paid.

Corporate Income Tax RatesSince 1993

Taxable Income Corporate Tax Rate

$1 - $50,000 15%$50,001 - $75,000 25%$75,001 - $100,000 34%$100,001 - $335,000 39%$335,001 - $10,000,000 34%$10,000,001 - $15,000,000 35%$15,000,001 - $18,333,333 38%over $18,333,333 35%

Free Cash Flows

Free cash flow: cash flow that is free and available to be distributed to the firm’s investors (both debt and equity investors)

Free Cash Flows

Firm’s Operating Free cash flows = Firm’s Financing

Free cash flows

Cash flows generated through the firm’s

operations and investments in assets

=Cash flows paid to - or

received by - the firm’s investors

(creditors & stockholders)

Calculating Free Cash Flows:An Operating Perspective

After-tax cash flow from operations

investment in net operating working capital

investments in fixed and other assets

Operating income + depreciation - cash tax payments

[Change in current assets]-

[change in non-interest bearing current liabilities]

Change in gross fixed assets, and any other assets that are on the

balance sheet.

Calculating Free Cash Flows:A Financing Perspective

Interest payments to creditors

- change in debt principal

- dividends paid to stockholders

- change in stock

= Financing Free Cash Flows

Tax Example:

• Space Cow Computer has sales of $32 million, cost of goods sold at 60% of sales, cash operating expenses of $2.4 million, and $1.4 million in depreciation expense. The firm has $12 million in 9.5% bonds outstanding. The firm will pay $500,000 in dividends to its common stock holders.

• Calculate the firm’s tax liability.

Sales $32,000,000

Cost of Goods Sold (19,200,000)

Operating Expenses (2,400,000)

Depreciation Expense (1,400,000)

EBIT or NOI 9,000,000

Interest Expense (1,140,000)

Taxable Income 7,860,000

Income tax rate tax payment

$50,000 x .15 = $ 7,500

$25,000 x .25 = 6,250

$25,000 x .34 = 8,500

$235,000 x .39 = 91,650

$7,525,000 x .34 = 2,558,500

Total Tax payment $2,672,400

short cut: $7,860,000 x .34 = $2,672,400

Ch. 2 - Understanding Financial Statements, Taxes, and Cash Flows, Prentice Hall, Inc.

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