Financial Statements(Ch 2 & 3)

The Balance Sheet

The Income Statement

Taxes

Free Cash Flow/Cash Flow From Assets

Ratio Analysis

Financial Statement (Ch2&3) – Fin301 1

Financial Statement (Ch 2&3) –Fin301 2

1. The Balance Sheet

Financial Statement (Ch 2&3) –Fin301 3

Balance Sheet

Assets and Liabilities

Net Working Capital

liquidity

Debt versus Equity

Market Value versus Book Value

Financial Statement (Ch 2&3) –Fin301 4

GAAP

General Accepted Accounting Principles: The Common Set of Standards and Procedures by which Audited Financial Statements are Prepared.

show assets at historical costs

Financial Statement (Ch 2&3) –Fin301 5

2. Income Statement

Income Statement

actual cash flow versus realized revenues and expenses

accrual and matching depreciation

Financial Statement (Ch 2&3) –Fin301 6

Marginal versus Average Corporate Tax Rates What are marginal corporate tax rates? What are average corporate tax rates at the top of each bracket?

Marginal and average tax rates under the 1993 Omnibus Budget Reconciliation Act

Taxable Income Marginal Tax Cumulative Average Tax Rates Tax Liability Rates

$0 - 50,000 15%

50,001 - 75,000 25%

75,001 - 100,000 34%

100,001 - 335,000 39%

335,001 - 10 mil 34%

10 mil - 15 mil 35%

15 mil - 18.33 mil 38%

18.33 mil + 35%

Financial Statement (Ch 2&3) –Fin301 7

4. Cash Flow

Cash flow from assetsCash flow from assets = Operating cash flow

– Net capital spending – Additions to net working capital (NWC)

where Operating cash flow = Earnings before interest and taxes (EBIT)

+ Depreciation – Taxes Net capital spending = Ending net fixed assets – Beginning net fixed assets

+ Depreciation Change in NWC = Ending NWC – Beginning NWC (NWC: net working capital)

Financial Statement (Ch 2&3) –Fin301 8

Balance Sheet

Beg End Beg End

Cash $100 $150 A/P $100 $150

A/R 200 250 N/P 200 200

Inv 300 300 C/L 300 350

C/A $600 $700 LTD $400 $420

NFA 400 500 C/S 50 60

R/E 250 370

$300 $430

Total $1000 $1200 Total $1000 $1200

Financial Statement (Ch 2&3) –Fin301 9

Income Statement

Sales $2000

Costs 1400

Depreciation100

EBIT 500

Interest 100

Taxable Income 400

Taxes 200

Net Income$200

Dividends$_____

Addition to R/E _____

Financial Statement (Ch 2&3) –Fin301 10

Cash Flow from Assets (free Cash Flow Calculation)

1. Operating cash flow = EBIT + _____________ – Taxes= $500 +

100 – 200= $_____

2. Change in NWC = ___________ – ___________= $350 –

$_____= $_____

3. Net capital spending = $_____ + Dep – _____= $500 +

100 – 400= $_____

4. Cash flow from assets = OCF – chg. NWC – Cap. sp.= $400 – 50

– 200= $150

Financial Statement (Ch 2&3) –Fin301 11

5. Financial Ratios

Short-Term Solvency, or Liquidity Ability to pay bills in the short-run

Long-Term Solvency, or Financial Leverage Ability to meet long-term obligations

Asset Management, or Turnover Intensity and efficiency of asset use

Profitability The ability to control expenses

Market Value Going beyond financial statements

Financial Statement (Ch 2&3) –Fin301 12

A. Short-term Solvency, Liquidity Ratios

Current assets

Current ratio = Current liabilities

Quick ratio = (Current assets - inventory) / Current liabilities

Cash ratio = Cash / Current liabilities

Current assets

Interval measure = Average daily operating costs

Financial Statement (Ch 2&3) –Fin301 13

Du Pont Identity

Return on Equity (ROE)

Return on Assets (ROA)

Financial Statement (Ch 2&3) –Fin301 14

B. Long-term Solvency, or Financial Leverage Ratios

Total assets - Total equity

Total debt ratio = Total assets

Debt/equity ratio = Total debt/Total equity

Equity multiplier = Total assets/Total equity

Long-term debt

Long-term debt ratio = Long-term debt + Total equity

EBIT

Times interest earned ratio = Interest

EBIT + depreciation

Cash coverage ratio = Interest

Financial Statement (Ch 2&3) –Fin301 15

C. Asset Utilization, or Turnover Ratios

Cost of goods sold

Inventory turnover = Inventory

365 days

Days’ sales in inventory = Inventory turnover

Sales

Receivables turnover = Accounts receivable

365 days

Days’ sales in receivables = Receivables turnover

Sales

NWC turnover = NWC

Sales

Fixed asset turnover = Net fixed assets

Sales

Total asset turnover = Total assets

Financial Statement (Ch 2&3) –Fin301 16

D. Profitability Ratios

Net income

Profit margin = Sales

Net income

Return on assets (ROA) = Total assets

Net income

Return on equity (ROE) = Total equity

Financial Statement (Ch 2&3) –Fin301 17

E. Market Value Ratios

Price per share

Price-earnings ratio = Earnings per share

Market value per share

Market-to-book ratio = Book value per share