Financial Statement, Cash Flows, And Taxes

7/30/2019 Financial Statement, Cash Flows, And Taxes

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FINANCIAL STATEMENTS, CASH

FLOW, AND TAXES

Financial Management


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Financial Statements, Cash Flow and

Taxes

Income statement

Balance sheet

Statement of cash flows Free cash flow

MVA and EVA

Corporate taxes

Personal taxes


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The Annual Report

Balance sheetprovides a snapshot of a firmsfinancial position at one point in time.

Income statementsummarizes a firmsrevenues and expenses over a given period oftime.

Statement of retained earnings shows howmuch of the firms earnings were retained,rather than paid out as dividends.

Statement of cash flows reports the impact ofa firms activities on cash flows over a givenperiod of time.


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How can Financial Statements be used to

increase value or make money in Business

Use to evaluate investment opportunities

1. Internal - From within company

i.e.: investments in fixed assets to increase FCFs &

value

2. External:

To make informed investment decisions into specific

companies

4


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5

Value = + + +FCF1 FCF2 FCF

(1 + WACC)1 (1 + WACC)(1 + WACC)2

Free cash flow(FCF)

Market interest rates

Firms business riskMarket risk aversion

Firms debt/equity mixCost of debt

Cost of equity

Weighted average

cost of capital(WACC)

Sales revenues

Operating costs and taxes

Required investments in operating capital

=

Determinants of Intrinsic Value: Calculating FCF

...


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6

Income Statement

Revenue (Sales)

-Costs (COGS)

-Operating exp

- Deprec. exp=EBIT Earnings b/4 interest & Taxes Op Income b/4 taxes

-Int. expense

=EBT Earnings b/4 taxes Taxable Income

-Taxes Tax Expense= Net Income Profit

NI / #shs c. stk =EPS Earning per share


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Statement of Retained Earnings

Beginning RE

+ NI

-Divids

Ending RE

Divids / #shs c. stk =DPS


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Balance Sheet

ASSETS= LIABILITIES + OWNERS EQUITY

Current Assets Current Liabilities

Cash

Accounts Receivable Accounts Payable Common Stock

Inventory Accruals (other s/t payables) Addtl Paid-in-Cap

Prepaids S/T Notes Payable Prfd. Stock

Marketable Securities Retained Earnings

Non-Current Assets Non-Current Liabilities

Property N/P

Plant Mortgage Payable

Equipment Bonds Payable

-Accum Deprec


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The Balance Sheet


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Statement of Cash Flows

Is used to help answer questions such as:

Is the firm generating enough cash to purchasethe additional assets required for growth?

Is the firm generating any extra cash that can beused to repay debt or to invest in newproducts?

Such information is useful both for

managers and investors


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Sources of cash Uses of cash

Net income + depreciation

Increase in long-term debt

Increase in equity

Increases in current liabilities

Decreases in fixed assets

Decreases in current assets

other than cash

Dividend payments

Increases in current assets

other than cash

Decrease in long-term debt

Decrease in equity

Increases in fixed assets

Cash and

cash

equivalents


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Statement of Cash Flows

Summarizes the changes in a companys

cash position

The statement separates activities into

three categories, plus a summary section:

Operating activities

Investment activities

Financing activities


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Operating activities

Includes:

net income,

depreciation,

changes in current assets and liabilities other than

cash,

short-term investments and

short term debt


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Investing activities

Includes:

investments in fixed assets

or sales of fixed assets


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Financing activities

Includes:

Raising cash by selling short-term investments or

by issuing short-term debt

Long term debt, or stock

Also because both dividends paid and cash used to

buy back outstanding stock or bonds reduce the

companys cash, such transactions are includedhere


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Modifying Accounting Data for

Managerial Decisions We have to divide total assets in twocategories

Operating assets which consist of the assets

necessary to operate the business

Non-operating assets which would include cash

and short term investments above the level

required for normal operations, land held forfuture use


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Operating assets are further divided

into

Operating current assets

Are the current assets that are used to support

operations, such as cash, accounts receivable,

inventory

They do not include short-term investments

Long-term operating assets

Such as plant and equipment They do not include any long-term investments that

pay interest or dividends


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Operating Current Liabilities

Are the current liabilities that occur as a

natural consequence of operations

Such as accounts payable and accruals

They do not include notes payable or any other

short-term debts that charge interest


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Net operating working capital

Is the difference between operating current

assets and operating current liabilities

NOWC= (Cash+Accounts receivable+Inventories)

(Accounts payable+Accruals)


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What effect did the expansion have on net

operating working capital?

NOWC = Current - Non-interestassets bearing CL


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What effect did the expansion have on

operating capital?

Operating capital = NOWC + Net Fixed Assets

Operating capital = total net operating capital = net

operating assets

It is the total amount of capital needed to run the

business


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Net Operating Profit After Tax(NOPAT)

NOPAT = EBIT (1 Tax rate)

It is the after-tax profit a company wouldhave if it had no debt and no investmentsin nonoperating assets

Because it excludes the effects of financingdecisions, it is a better measure ofoperating performance than is net income


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Free Cash Flow (to Firm)

Free cash flow (FCF) is the amount of cash

flow remaining after a company makes the

asset investments necessary to support

operations

FCF is the amount of cash flow available for

distribution to investors


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Free cash flows (to Firms)

FCF= cash available for distribution to

investors. Greater the FCF, more attractive

that company is to investors. Therefore, value

of the firm is primarily dependent on itsexpected future free cash flows!


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What are the five uses of FCF?

1. Pay interest on debt.

2. Pay back principal on debt.

3. Pay dividends.4. Buy back stock.

5. Buy nonoperating assets (e.g., marketable

securities, investments in other companies,etc.)


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Earning before interest and taxes

(1 Tax rate)

Net operating profit after taxes

X

Operating current assets

Operating current liabilities


Total net operating capital

Operating long-term assets+


Free cash flow

Net investment in operating capital

Net operating profit after taxes

Total net operating capital this year

Total net operating capital last year

Net investment in operating capital

Calculating Free Cash Flow in 5 Easy StepsStep 1 Step 2

Step 3

Step 4

Step 5


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Free Cash Flow (to Firm)

FCF = OCF Gross capital investment

FCF = (NOPAT + Dep) - Gross capital investmentGross investment in operating capital = Net investment+ Depreciation

- OR

FCF = NOPAT Net investment in operating capital


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Economic Value Added (EVA)

Is an estimate of the value created by

management during the year

It differs substantially from accounting profit

because no charge for the use of equity capital

is reflected in accounting profit


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Economic Value Added (EVA)

EVA = After-tax __ After-tax

Operating Income Capital costs

= Funds Available __ Cost of

to Investors Capital Used

= NOPAT After-tax Cost of Capital


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EVA

EVA = Net operating profit after taxes (NOPAT)

- After-tax dollar cost of capital used to

support operations

EVA = EBIT (1

Tax rate) (Total Net Operating Capital)(WACC)


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EVA Concepts

In order to generate positive EVA, a firm

has to more than just cover operating

costs.

It must also provide a return to those who

have provided the firm with capital.

EVA takes into account the total cost of

capital, which includes the cost of equity.


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Market Value Added (MVA)

MVA = Market value __ Equity capital

of equity supplied

by shareholders

= (Shares outstanding)(Stock price) Total

common

equity


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What happens if a company depreciates fixed

assets over 7 years (as opposed to the current 10

years)? No effect on physical assets.

Fixed assets on the balance sheet would decline.

Net income would decline.

Tax payments would decline.

Cash position would improve.


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Corporate and Personal Taxes

Both have a progressive structure (the higher the income, the

higher the marginal tax rate).

Corporations

30% + 3% cess

Individuals

Rates begin at 10% and rise to 30% + 3% cess


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Tax treatment of various uses and

sources of funds

Interest paid tax deductible for corporations (paid outof pre-tax income), but usually not for individuals(interest on home loans being the exception).

Interest earned usually fully taxable (an exception being

interest from a tax free bond) Dividends paid paid out of after-tax income.

Dividends received dividend distribution tax 15% +5% + 3%


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More tax issues

Tax Loss Carry-Back and Carry-Forward sincecorporate incomes can fluctuate widely, the tax codeallows firms to carry losses back to offset profits inprevious years or forward to offset profits in the

future. Capital gains defined as the profits from the sale of

assets not normally transacted in the normal courseof business, capital gains for individuals are generally

taxed as ordinary income if held for less than a year,and at the capital gains rate if held for more than ayear. Corporations face somewhat different rules.

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Financial Statement, Cash Flows, And Taxes

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