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Cash Flows _ Financial Statements

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									AD 311 Business Finance Attila Odabasi Lec 2: Financial Statements, Taxes, and Cash Flows

03.11.2009

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Main Points

 Know the difference between book value
and market value  Know the difference between accounting income and cash flow  Know the difference between average and marginal tax rates  Know how to determine a firm’s cash flow from its financial statements
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Chapter Outline

 The Balance Sheet  The Income Statement  Taxes  Cash Flow

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Financial Statements and Cash Flows
 Much of the information about businesses comes in the   
form of standard financial statements published in annual and quarterly reports. They are prepared according to rules established by the accounting profession, and it is therefore important to understand what those rules are. Financial analysts sometimes disagree with how accountants measure certain key financial variables. Most fundamental disagreement is about how to measure the values of assets and liabilities.
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Functions of Financial Statements

 They provide

 info to the owners and creditors (O&Cs) of the
firm about the company’s current status and past financial performance.  A convenient way for O&Cs to set performance targets and to impose restrictions on the managers of the firm.  Convenient templates for financial planning.

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Balance Sheet
 A firm’s balance sheet shows its assets (what it
owns) and its liabilities (what it owes) at a point in time  Assets are listed in order of liquidity



 Liquidity means:  Ease of conversion to cash  Without significant loss of value

The values of assets and liabilities are measured at historical acquisiton costs in accordance with GAAP.
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The Balance Sheet - Figure 2.1

2-7

Net Working Capital and Liquidity
 Net Working Capital  Current Assets – 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

 Liquidity

 Positive NWC firms are assumed to be liquid.  Liquid firms are less likely to experience financial distress  But, liquid assets earn a lower return  Try to find balance between liquid and illiquid assets
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B/S (in mio’s)
2006 Cash & S-T Inv AR Inventories Total CA 100 50 150 300 2007 120 60 180 360 Diff 20 AP 10 S-T Debt 30 Total CL 60 L-T Debt (@12%) 2006 60,0 90,0 150,0 150,0 2007 72,0 184,6 256,6 150,0 Diff 12,0 94,6 106,6 0,0

PP&E
Accum. Depr Net PP&E Total Assets
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400
100 300 600

490
130 360 720

90 Stockholder Eq.
30 Paid-in Capital 60 Retained Earn. 120 Total Liabilities Price per share

300,0
200,0 100,0 600,0

313,4
200,0 113,4 720,0 2,72

13,4
0,0 13,4

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Market Vs. Book Value

 The balance sheet provides the book
value of the assets, liabilities and equity.  Market value is the price at which the assets, liabilities or equity can actually be bought or sold.  Market value and book value are often very different. Why?  Which is more important to the decisionmaking process?
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Example: MV vs BV
Balance Sheets 2007 Market Value versus Book Value Book Market Book Market Assets Liabilities and Shareholders’ Equity
NWC
NFA
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$ 103,4 $ 103,4 LTD
360 463,4 590,6 SE 694,0

$150
313,4 463,4

$ 150
544 694,0
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Market Value vs Book Value
 Shareholders are the ones that benefit from increases in
the market value of a firm’s assets. They are also the ones that bear the losses of a decrease in market value. Consequently, managers need to consider the impact of their decisions on the market value of assets, not on their book value.

 Suppose that the MV of assets declined to $500 (a
change of -90,6$) and the market value of liabilities remained unchanged. What would happen to the market value of equity? It would decrease to 544 – 90,6 = 453,4.
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Market Value vs Book Value
 MV/BV = 544 / 313,4 = 1,73 (before)  MV/BV = 453,4 / 313,4 = 1,45 (after)

 The market-to-book ratio, which compares the
market value of equity to the book value of equity, is often used by analysts as a measure of valuation for a stock. It is generally a bad sign if a company’s market-to-book ratio approaches 1.00 (meaning market value = book value).
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Income Statement
 Summarizes the profitability of the firm over a
period of time (a year?).  Income, profit, and earnings all mean the same thing – the difference between revenues and expenses.  You generally report revenues first and then deduct any expenses for the period.  Matching principle – GAAP say to show revenue when it accrues and match the expenses required to generate the revenue
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The Income Statement
 
Shows the financial performance of a firm over a year Structure:  Net Sales  - Operating Costs  = EBITDA  - Depreciation  = EBIT (Operating Income)  - Interest payments  = EBT  - Taxes  -Dividend to preferred stocks (if any)  =NI (Net income, profit, earnings) EPS = NI / Number of shares outstanding
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

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Basitleştirilmiş Gelir Tablosu
                
Satışlar (brüt) -Satış iade ve indirimleri =Net Satışlar - Satılan Malın Maliyeti (amortisman hariç) = Brüt satış karı/zararı - Satış giderleri - Yönetim giderleri - Ar-Ge giderleri = EBITDA - Amortisman gideri = Faiz Vergi Öncesi Kar (FVÖK) : EBIT, Faaliyet Geliri - Faiz + Diğer Gelirler - Diğer Giderler = Vergi öncesi kar (VÖK) : EBT, Bilanço Kar/Zararı - Ödenecek Vergi ve Fonlar = Dönem Net KArı/Zararı

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Income Statement for 2007 (in mio’s)
Sales Revenue
Cost of Goods sold Gen., selling & admin Depreciation

200,0
(80,0) (30,0) (30,0)

Operating Income - EBIT
Interest Expense (12%) Taxable Income - EBT Income tax

60,0
(18,0) On L.T. Debt 42,0 (14,7)

Net Income
Earning per share Allocation of NI Dividends

27,3
27,3/200= 0,136 13,9

Change in RE
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13,4
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How to Calculate the Income Tax in USA?
Corp. Taxable Income At Least But < $ 0 $ 50,000 50,000 75,000 75,000 100,000 100,000 335,000 335,000 10,000,000 10,000,000 15,000,000 15,000,000 18,333,333 18,333,333
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Tax Rate 15% 25% 34% 39% 34% 35% 38% 35%

Tax Calculation .15x(Inc > 0) $ 7,500 + .25x(Inc > 50,000) 13,750 + .34x(Inc > 75,000) 22,250 + .39x(Inc > 100,000) 113,900 + .34x(Inc > 335,000) 3,400,000 + .35x(Inc > 10,000,000) 5,150,000 + .38x(Inc > 15,000,000) 6,416,667 + .35x(Inc > 18,333,333)
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The income tax in the example:
 What is the firm’s tax liability?  What is the average tax rate?  What is the marginal tax rate?

 Taxable inc.= 42m, tax?  For the first 18,33m:5,15+0,38(3,33) = 6,42m  For the rest: (42 – 18,33)x 0,35 = 8,28m  Tax liability = 14,70m tax  Average tax rate = 14,7 / 42 = 0,35  Marginal tax rate = 0,35
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Free Cash Flow Concept
 Cash flow: we simply mean the difference
between the number of dollars that came in and the number that went out.  Firms generate cash flows by operating their assets and the cash generated is spent on: Expenses (current period) Assets that will be expensed in the future

 Surplus funds or free cash flows belong to firm’s
owners or creditors. Companies do not have money themselves!
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Cash Flow From Assets

 Cash Flow From Assets =

 Cash Flow From Assets (CFFA) =  This is called cash flow identity.
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Operating Cash Flow – Net Capital Spending – Changes in NWC

Cash Flow to Creditors + Cash Flow to Stockholders

FCF – S.T. Debt Part of Operations
After Tax Cash Flow from Operations Operating Income, EBIT + Depreciaiton 60,0 +30,0 -14,7 $75,3

- Tax -Investments in net operating working capital
Ending Net Working Capital -Beginning NWC -Investments in fixed and other assets Ending Net Fixed Assets

+$46.6
+103.4 -150.0 -$90,0 +360,0

- Beginning Netixed Assets
+ Depreciation =Free Cash Flow to Firm
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-300,0
+30,0 +31.9
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Free Cash Flow - Financing
Cash Flow to/from Creditors Interest payments to creditors - Net new borrowing Cash Flow to Shareholders Dividends paid to stockholders - Net new equity raised = Financing Free Cash Flows +13,9 0,0 $+31.9
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+$18.0
+18 0.0 +$13,9

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 Following slides are optional for this
lecture.

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Statement of Cash Flows

 Statement that shows all of the cash that
flowed into and out of the firm during a period of time. Differs from the income statement, which shows the firm’s revenues and expenses.  It focuses attention on what is happening to the firm’s cash position over time.  It is not influenced by accrual accounting decisions.
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Sources and Uses
 Activities that bring in cash are called sources of
 Sources:  Cash inflow – occurs when we “sell” something  Decrease in asset account  Increase in liability or equity account
cash.

 Activities that involve spending cash are called
 Uses:  Cash outflow – occurs when we “buy” something  Increase in asset account  Decrease in liability or equity account
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uses (or applications) of cash.

Organization of the Statement of Cash Flow

 Organizes cash flows into three sections:  Operating Activity – includes net income and
changes in most current accounts
+Net Income +Depreciation +Decrease in C/A accounts (except cash) +Increase in C/L accounts (except Notes payable) - Increase in C/A accounts (except Cash) - Decrease in C/L accounts (except Notes payable)
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Contn’d
 Investment Activity – includes changes in fixed assets
+Ending net fixed assets -Beginning net fixed assets +Depreciation

 Financing Activity – includes changes in notes payable,
+/- Change in Notes payable +/- Change in Long term debt +/- Change in Common stock - Dividends
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long-term debt and equity accounts as well as dividends

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Cash Flow Statement for 2003
Cash Flow from Operating Activities $29,3

Net Income + Depreciaiton
- Increase in AR - Increase in inventories + Increase in AP Cash Flow from Investing Activities - Investment in plant and equipment Cash Flow from Financing Activities + Increase in S-T Debt - Dividends paid Net cash flow
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+27,3
+30,0 -10,0 -30,0 +12,0 -$90 -90,0 +80,7 +94,6 -13,9

$20
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