Date post: | 29-Dec-2015 |
Category: |
Documents |
Upload: | margaret-shepherd |
View: | 221 times |
Download: | 2 times |
1
Ch 2
Financial Statements, Taxes, and Cash Flow
2
Issues in Ch.2 Three financial statements
Balance sheet Income statement Operating cash flow
The difference between accounting income and cash flow in financial decision-making process
The difference between accounting value (or book value) and market value of the firm
3
Three Financial Statements
Balance Sheet Income Statement Cash Flow Statement
4
Accounting identity
Assets = Liabilities + Shareholders’ equity
Or
Shareholders’ equity = Assets – Liabilities
Another name for Shareholders’ equity is “residual claim.”
5
Balance Sheet
The Balance Sheet is snap shot of the firm’s current condition
The asset side of the balance sheet reflects the investment decisions made by the firm
The liabilities and equity side reflect all of the financing decisions made over the same period
6
Balance Sheet
7
Balance Sheet of The firm (Snap Shot of the Firm) Current Assets have a
life of less than 1 year and include:
•Cash
•Account receivable
•Inventory
Current Liabilities have a life of less than 1 year and include:
•Short-term liability
•Accounts PayableCA - CL
Shareholders’ Equity = Assets - Liabilities
Assets = Liabilities + Shareholders’ Equity
•Bank loans
•Long-term borrowings
•Machine, Equipment
•Patents
8
Pop Quiz – Can you link them? Accounts
Receivable Long-term assets Patents Notes payable Accounts payable Long-term debt Common stock Retained earnings
Net income minus dividend
Intellectual property Loans the firm took and
must pay back within one year
Long-term borrowings Money owed to the firm
by its customers Money the firm owes to its
supplier Equipment, plant Amount of stock issued by
the firm
9
Please construct for Bobcats Co. the following statements using the information below:
Balance sheet Income statement Operating Cash Flow (OCF)
Accounts Payable = $70,000 Tax Rate = 34% Retained Earnings = $100,000 Interest Expense = $10,000 Inventory = $50,000 Depreciation Expense = $100,000 Notes Payable = $80,000 Sales = $800,000 Machinery, Buildings (net)= $400,000 Long-Term Debt = $200,000 Cash = $30,000 Cost of Goods Sold =$400,000 Patents, Trademarks =$150,000 Accounts Receivable = $20,000 Operating Expense = $100,000 Common Stock = ? Stock price = $20 per share Number of outstanding stocks = 20,000 shares
10
Put the balance sheet below.
Microsoft Excel Worksheet
11
Liquidity of Assets The order of assets on the balance sheet reflects
their liquidity. (decreasing order of liquidity) Liquidity is the speed at which the asset can be
converted to cash with little or no loss in value Liquid firms are less likely to experience financial
distress But, liquid assets earn a lower return Liquid Assets
Account receivable and possibly inventory Non-liquid Assets
specialized fixed asset (e.g., equipment) and intangible assets (e.g., patents and trademarks)
12
Net Working Capital Net Working Capital
Current Assets minus Current Liabilities Positive when the cash that will be
received over the next 12 months exceeds the cash that will be paid out
Usually positive in a healthy firm
13
Book Value vs. Market Value Find the book value of Bobcats.
Historical cost or the amount the investors originally paid for.
Recorded amount in financial statements GAAP says “You record historical cost!”
Simply the recorded value of stockholders’ equity or sum of retained earning and common stock items in balance sheet
14
Book Value vs. Market Value
Find the market value of Bobcats. Is NOT on the financial statements but
more important one True value of the firm or the value
observed in the marketplace. The amount of cash we would get if we
actually sell the firm now. Simply the current stock price * number of
outstanding stocks
Then, what is the intrinsic value? Intrinsic value
The present value of an asset’s expected future cash flows.
The fair value, given the amount, timing, and riskiness of future cash flows.
If MV > IV Overvalued If MV < IV Undervalued
15
16
Book Value vs. Market Value
Market value and book value are often very different. Why?
Which one is more important to the decision-making process?
The goal of the financial manager is to maximize the market value of the stock.
17
18
Income Statement
The income statement is the measurement of performance
You generally report revenues first and then deduct any expenses for the period
Income = Revenue - Expenses
19
Income Statement (Example)
2012 2013Sales 3,432,000 5,834,400 COGS 2,864,000 4,980,000 Other expenses 340,000 720,000 Deprec. 18,900 116,960 Tot. op. costs 3,222,900 5,816,960 EBIT 209,100 17,440 Int. expense 62,500 176,000 EBT 146,600 (158,560)Taxes (40%) 58,640 (63,424)Net income 87,960 (95,136)
20
Put the income statement for Bobcats Co. below.
Two Issues on Income Statement Non-cash item Realization principle
21
22
Noncash items A typical noncash item is depreciation
expense
Hypothetical number
Noncash items are irrelevant to firm valuation in general because they do not represent true cash inflow or outflow
However, noncash items are still important to understand the firm’s financial condition because they affect the firm's tax liability (and, therefore, cash flow)
23
GAAP Allows Accrual Basis Accounting!
Matching principle: GAAP says to show revenue when it accrues and match the expenses required to generate the revenue
Recognition Principle: GAAP says to recognize revenue when the earnings process is virtually complete and the value of an exchange of goods or services is known or can be reliably determined.
What does this mean? Records revenue when it is earned, whether or not the
revenue has been received in cash. Records expense when they are incurred, even if the
money has not actually been paid out.
Example Suppose DELL computer sold computers to the
University on credit at the beginning of the year. The University will pay cash at the end of the year.
Accounting journals
Now, Accounts Receivable XXXXRevenue XXXX
Expenses XXXXInventory XXXX
Later, Cash XXXXAR XXXX
24
25
Profits and cash flows are not the same thing! The potential problem with GAAP to
understand the firm’s financial condition
Mismatch between the time when the income (cost) is realized and the time when the revenue (cost) is collected
This is because GAAP requires that sales be recorded on the income statement when made, not when cash is received
GAAP also requires that we record cost of goods sold when the corresponding sales are made, regardless of whether we have actually paid our suppliers yet
26
GAAP versus Cash Flow Time Line
27
Profits and cash flows are not the same thing! In the earlier example, DELL will not receive
cash until the end of the year.There is an opportunity cost or timing
mismatch between the recognition of revenue and the receipt of cash flow in the DELL example.
As a result, net income is not equal to cash flow generated during the period.
In general, financial managers are more concerned with cash flow than accounting income.
28
So, what can we conclude? The accrual accounting and noncash items
results in inequality between cash flows and net income (or earnings).
Finance Emphasizes the Importance of Timing Timing of Cash Flow Matters Accrual Accounting May Obscure Timing “You Can’t Deposit Net Income, Only Cash”
Therefore, we must present cash flow statement to understand the firm’s financial condition better.
The Managerial Finance Function Relationship to Accounting
Finance and accounting differ with respect to decision-making.
While accounting is primarily concerned with the presentation of financial data, the financial manager is primarily concerned with analyzing and interpreting this information for decision-making purposes.
The financial manager uses this data as a vital tool for making decisions about the financial aspects of the firm.
The Managerial Finance Function Relationship to Accounting
One major difference in perspective and emphasis between finance and accounting is that accountants generally use the accrual method, while in finance the focus is on cash flows.
31
The Sources and Uses of Corporate Cash
Decrease in any asset
Increase in any liability
Net profits after taxes
Depreciation and other non-cash charges
Sale of stock
Increase in any asset Decrease in any liability Net loss Dividends paid Repurchase or
retirement of stock
SourcesSources UsesUses
32
Put the operating cash flow (OCF) for Bobcats Co. below.
OCF= EBIT + Depreciation Expense - Taxes
33
Cash Flows: Comprehensive View
34
Example: U.S. Corporation
CFFA = OCF – NCS - ΔNWCOCF = EBIT + depreciation – taxes
= $694 + 65 – 212 = $547NCS = ending net FA– beginning net FA + depreciation
= $1709 – 1644 + 65 = $130ΔNWC = ending NWC – beginning NWC
= ($1403 – 389) – ($1112 – 428) = $330 CFFA = 547 – 130 – 330 = $87
2009 2010 2009 2010Current Assets Current Liabilities Cash $104 $160 Accounts Payable $232 $266 Accounts Receivable 455 688 Notes Payable 196 123 Inventory 553 555 Total $428 $389 Total $1,112 $1,403Fixed Assets Net Fixed assets $1,644 $1,709 Long-term debt $408 $454
Owners' equity Common stock and paid-in surplus 600 640 Retained earnings 1,320 1,629 Total $1,920 $2,269
Total assets $2,756 $3,112Total Liabilties & Owners Equity $2,756 $3,112
Balance Sheet
Assets Liabiities & Owners' Equity
$1,509750
65$694
70$624
212$412
Dividends $103 Addition to retained earnings $309
TaxesNet Income
Depreciation
Interest PaidEarnings before interest and taxes
Taxable income
U.S. Corporation
Income Statement
Net salesCost of goods sold
35
Example: U.S. Corporation
CFFA = CF/CR + CF/SHCF/CR = interest paid – net new borrowing
= $70 – ($454 – 408) = $24CF/SH = dividends paid – net new equity
= $103 – ($640 – 600) = $63 CFFA = $24 + $63 = $87
2009 2010 2009 2010
Current Assets Current Liabilities
Cash $104 $160 Accounts Payable $232 $266
Accounts Receivable 455 688 Notes Payable 196 123
Inventory 553 555 Total $428 $389
Total $1,112 $1,403
Fixed Assets
Net Fixed assets $1,644 $1,709 Long-term debt $408 $454
Owners' equity
Common stock and
paid-in surplus 600 640
Retained earnings 1,320 1,629
Total $1,920 $2,269
Total assets $2,756 $3,112
Total Liabilties & Owners Equity $2,756 $3,112
U.S. Corporation
Balance Sheet
Assets Liabiities & Owners' Equity $1,50975065
$69470
$624212
$412 Dividends $103 Addition to retained earnings $309
TaxesNet Income
Depreciation
Interest PaidEarnings before interest and taxes
Taxable income
U.S. Corporation
Income Statement
Net salesCost of goods sold
36
37
Pop Quiz 1 Which one of the following assets is
generally the LEAST liquid?
A) plant and equipment B) inventory C) patents and goodwill D) cash E) accounts receivable
38
Pop Quiz 2 A firm's balance sheet shows current assets of
$95, net fixed assets of $250, long-term debt of $40, and owners equity of $200. What is the value of the firm's current liabilities if that is the only remaining balance sheet item? A) -$ 50 B) $ 50 C) $105 D) $145 E) $545
Pop Quiz 3Q: Explain why net income and operating
cash flow differ in amount.
A: Depreciation is a noncash expense and interest paid is a financing cash flow. While both of these affect operating cash flows indirectly through taxes, they do not directly affect the operating cash flows. They do directly reduce net income.
39
Pop Quiz 4Q:How is liquidity both beneficial and
harmful to a firm? A: Liquidity is beneficial because a firm
must have sufficient cash available to meet its obligations. Liquidity is harmful because liquid assets earn minimal rates of return as compared to less liquid assets.
40
Pop Quiz 5Which two of the following determine when revenue is recorded on the financial statements based on the GAAP?
I. when payment is collected for the sale of a good or serviceII. when the earnings process is virtually completedIII. when the value of a sale can be reliably determinedIV. when a product is physically delivered to the buyer’s location
a. I and II onlyb. I and IV onlyc. II and III onlyd. II and IV onlye. I and III only
41