mba 7200 chapter 2

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Financial Statements, Taxes, and CashFlow

Chapter 2

Copyri ght 2013 by The McGraw-H il l Companies, I nc. All ri ghts reserved.McGraw-Hill/Irwin

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Chapter Outline

The Balance Sheet The Income Statement Taxes Cash Flow

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Balance SheetThe most important relationshipyou can bring to this class (from your accounting), is the formula of theBalance Sheet Identity : Total Assets = Total Liabilities +

Stockholders Equity

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The Balance SheetFigure 2.1

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Net Working Capital

NWC = Current Assets Current LiabilitiesPositive when the cash that will be receivedover the next 12 months exceeds the cash thatwill be paid out

Usually positive in a financially healthy firm

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LiquidityAbility to convert to cash quicklywithout a significant loss in valueLiquid firms are less likely toexperience financial distressBut liquid assets typically earn alower returnTrade-off to find balance betweenliquid and illiquid assets

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US Corporation Balance Sheet Table 2.1

Place Table 2.1 (US Corp Balance Sheet) here

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Book

Value

Market

Value

Versus

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Market Value vs. BookValue

The balance sheet provides thebook value of the assets,

liabilities, and equity.

Market value is the price at which

the assets, liabilities, or equity canactually be bought or sold.

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ar e a ue vs. oo a ueClassroom Discussion

Questions

1. Market value and book value areoften very different. Why?

2. Which is more important to thedecision-making process?

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US Corporation IncomeStatement Table 2.2

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Work the Web Example

Publicly traded companies must file regular reports with the Securities and Exchange

CommissionThese reports are usually filed electronicallyand can be searched at the SEC public site

called EDGARClick on the web surfer, pick a company, andsee what you can find!
http://www.sec.gov/edgar/searchedgar/webusers.htmhttp://www.sec.gov/edgar/searchedgar/webusers.htm

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TaxesThe one thing we can rely on with taxes isthat they are always changing!Marginal vs. average tax rates

Marginal tax rate

the percentage paid on thenext dollar earned Average tax rate the tax bill / taxable income

Other taxes

StateLocal (City or Town)
http://www.irs.gov/

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Corporate ProgressiveTaxes

Just like personal tax rates in theUnited States, corporations paytaxes on their taxable earnings

A significant difference is thatcorporate tax rates fit into just 8

categories

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A significant difference betweenindividual tax rates andcorporate tax rates is that there

are only 8 categories:

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Marginal Tax Rate : The tax rateyou would pay if you had onemore taxable dollar

Average Tax Rate : The tax rateyou are paying on all of your

taxable income which averagesacross all of your corporate taxcategories

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Corporate Tax Rates

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Example: Marginal Vs.Average Rates

Suppose your firm earns $4 million intaxable income.

What is the firms tax liability?

What is the average tax rate?What is the marginal tax rate?

If you are considering a project that

will increase the firms taxable incomeby $1 million, what tax rate should youuse in your analysis?

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Corporate Tax RatesEach major industry has different tax incentivesprovided by the US Government and as such, mayactually pay a different average tax rate:

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The Concept of Cash FlowCash flow is one of the most importantpieces of information that a financialmanager can derive from financialstatements

The Statement of Cash Flows does

not provide us with the sameinformation that we are looking at here

We will look at how cash is generatedfrom utilizing assets and how it is paidto those that finance the purchase of

the assets .

C h Fl S T bl

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Cash Flow Summary Table2.6

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Cash Flow From Assets

Cash Flow From Assets (CFFA) = Cash Flowto Creditors + Cash Flow to Stockholders

CFFA = CF to creditors + CF toStockholders

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Example of CCFA: Part I

CF to Creditors ( B/S and I/S) = interestpaid net new borrowing = $24

CF to Stockholders ( B/S and I/S) =dividends paid net new equity raised =$63


CFFA = 24 + 63 = $87

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Cash Flow From Assets

Cash Flow From Assets = Operating CashFlow Net Capital Spending Changes inNWC

CFFA = OCF NCS - NWC

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Example of CCFA: Part IIOCF ( I/S) = EBIT + depreciation taxes= $547

NCS ( B/S and I/S) = ending net fixedassets beginning net fixed assets +depreciation = $130

Changes in NWC ( B/S ) = ending NWC

beginning NWC = $330CFFA = OCF NCS - NWC

CFFA = 547 130 330 = $87

g Balance

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e g c ure ro em: BalanceSheet and Income Statement

Information

Current Accounts2009: CA = 3625; CL = 17872008: CA = 3596; CL = 2140

Fixed Assets and Depreciation2009: NFA = 2194; 2008: NFA = 2261Depreciation Expense = 500

Long-term Debt and Equity2009: LTD = 538; Common stock & APIC =

4622008: LTD = 581; Common stock & APIC =372

Income StatementEBIT = 1014; Taxes = 368Interest Expense = 93; Dividends = 285

C h Fl P bl

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Cash Flow ProblemAnswers:

OCF = 1,014 + 500 368 = 1,146NCS = 2,194 2,261 + 500 = 433Changes in NWC = (3,625 1,787) (3,596 2,140) = 382CFFA = 1,146 433 382 = 331CF to Creditors = 93 (538 581) = 136

CF to Stockholders = 285 (462 372) = 195CFFA = 136 + 195 = 331The CF identity holds!

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Comprehensive ProblemCurrent Accounts

2009: CA = 4,400; CL = 1,5002008: CA = 3,500; CL = 1,200

Fixed Assets and Depreciation2009: NFA = 3,400; 2008: NFA = 3,100

Depreciation Expense = 400Long-term Debt and Equity (R.E. not given)

2009: LTD = 4,000; Common stock & APIC = 4002008: LTD = 3,950; Common stock & APIC = 400

Income StatementEBIT = 2,000; Taxes = 300Interest Expense = 350; Dividends = 500

Task: Compute the CFFA

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Ethics Issues

Why is manipulation of financialstatements not only unethical and

illegal, but also bad for stockholders?

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Formulas

Total Assets = Total Liabilities +Stockholders Equity


CFFA = OCF NCS - NWC

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Key Concepts and Skills Identify the difference between book value

and market value

Identify the difference between accountingincome and cash flow

Differentiate between average and marginaltax rates

Calculate a firms cash flow from itsfinancial statements

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1. Know the difference between book value and the market value of a

company

2. Be able to compute the average andthe marginal tax rates of a company

3. Be able to compute the firms cashflow from its financial statements

What are the mostimportant topics of this

chapter?

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mba 7200 chapter 2

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