"Cash Flows Financial Statements"
Financial Statements, Taxes, and Cash Flows 07.04.2009 1 Key Concepts and Skills 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 07.04.2009 2 Chapter Outline The Balance Sheet The Income Statement Taxes Cash Flow 07.04.2009 3 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. 07.04.2009 4 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. 07.04.2009 5 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. 07.04.2009 6 The Balance Sheet - Figure 2.1 2-7 B/S – Assets (in mio’s) 2002 2003 Change Cash & S-T Inv 100 120 20 AR 50 60 10 Inventories 150 180 30 Total CA 300 360 60 PP&E 400 490 90 Accum. Depr 100 130 30 Net PP&E 300 360 60 Total Assets 600 720 120 07.04.2009 8 B/S – Liabilities (in mio’s) 2002 2003 Change AP 60,0 72,0 12,0 S-T Debt 90,0 184,6 94,6 Total CL 150,0 256,6 106,6 L-T Debt (@12%) 150,0 150,0 0,0 Stockholder Eq. 300,0 313,4 13,4 Paid-in Capital 200,0 200,0 0,0 Retained Earn. 100,0 113,4 13,4 Total Liabilities 600,0 720,0 Price per share 2,72 07.04.2009 9 Net Working Capital and Liquidity Net Working Capital Current Assets – Current Liabilities For 2003: CA – CL = 360 – 256,6 = 103,4 mio 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 07.04.2009 10 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 decision- making process? 07.04.2009 11 Example: MV vs BV Balance Sheets 2003 Market Value versus Book Value Book Market Book Market Assets Liabilities and Shareholders’ Equity NWC $ 103,4 $ 103,4 LTD $150 $ 150 NFA 360 590,6 SE 313,4 544 463,4 694,0 463,4 694,0 07.04.2009 12 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. 07.04.2009 13 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). 07.04.2009 14 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 07.04.2009 15 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 07.04.2009 16 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 07.04.2009 17 Income Statement for 2003 (in mio’s) Sales Revenue 200,0 Cost of Goods sold (80,0) Gen., selling & admin (30,0) Depreciation (30,0) Operating Income - EBIT 60,0 Interest Expense (12%) (18,0) On L.T. Debt Taxable Income - EBT 42,0 Income tax (14,7) Net Income 27,3 Earning per share 27,3/200= 0,136 Allocation of NI Dividends 13,9 07.04.2009 18 Change in RE 13,4 How to Calculate the Income Tax in USA? Corp. Taxable Income Tax At Least But < Rate Tax Calculation $ 0 $ 50,000 15% .15x(Inc > 0) 50,000 75,000 25% $ 7,500 + .25x(Inc > 50,000) 75,000 100,000 34% 13,750 + .34x(Inc > 75,000) 100,000 335,000 39% 22,250 + .39x(Inc > 100,000) 335,000 10,000,000 34% 113,900 + .34x(Inc > 335,000) 10,000,000 15,000,000 35% 3,400,000 + .35x(Inc > 10,000,000) 15,000,000 18,333,333 38% 5,150,000 + .38x(Inc > 15,000,000) 18,333,333 35% 6,416,667 + .35x(Inc > 18,333,333) 07.04.2009 19 The income tax in the example: Taxable inc.= 42 mio, tax? For the first 18,33 mio = 6,42 mio For the rest: (42 – 18,33)x 0,35 = 8,28 mio TOTAL = 14,70 mio tax 07.04.2009 20 The Concept of Cash Flow Cash flow: we simply mean the difference between the number of dollars that came in and the number that went out. How to determine this amount? We will look at how cash is generated from utilizing assets and how it is paid to those that finance the purchase of the assets: Cash flow from assets = Cash flow to creditors + Cash flow to stockholders This is called cash flow identity. 07.04.2009 21 Free Cash Flow Concept 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! 07.04.2009 22 Cash Flow From Assets Cash Flow From Assets (CFFA) = Cash Flow to Creditors + Cash Flow to Stockholders Cash Flow From Assets = Operating Cash Flow – Net Capital Spending – Changes in NWC 07.04.2009 23 FCF – S.T. Debt Part of Operations After Tax Cash Flow from Operations $75,3 Operating Income, EBIT 60,0 + Depreciaiton +30,0 - Tax -14,7 -Investments in net operating working capital +$46.6 Ending Net Working Capital +103.4 -Beginning NWC -150.0 -Investments in fixed and other assets -$90,0 Ending Net Fixed Assets +360,0 - Beginning Netixed Assets -300,0 + Depreciation +30,0 =Free Cash Flow to Firm 07.04.2009 +31.9 24 Free Cash Flow - Financing Cash Flow to/from Creditors +$18.0 Interest payments to creditors +18 - Net new borrowing 0.0 Cash Flow to Shareholders +$13,9 Dividends paid to stockholders +13,9 - Net new equity raised 0,0 = Financing Free Cash Flows $+31.9 07.04.2009 25 Following slides are optional for this lecture. 07.04.2009 26 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. 07.04.2009 27 Sources and Uses Activities that bring in cash are called sources of cash. Sources: Cash inflow – occurs when we “sell” something Decrease in asset account Increase in liability or equity account Activities that involve spending cash are called uses (or applications) of cash. Uses: Cash outflow – occurs when we “buy” something Increase in asset account Decrease in liability or equity account 07.04.2009 28 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) 07.04.2009 29 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, long-term debt and equity accounts as well as dividends +/- Change in Notes payable +/- Change in Long term debt +/- Change in Common stock - Dividends 07.04.2009 30 Cash Flow Statement for 2003 Cash Flow from Operating Activities $29,3 Net Income +27,3 + Depreciaiton +30,0 - Increase in AR -10,0 - Increase in inventories -30,0 + Increase in AP +12,0 Cash Flow from Investing Activities -$90 - Investment in plant and equipment -90,0 Cash Flow from Financing Activities +80,7 + Increase in S-T Debt +94,6 - Dividends paid -13,9 Net cash flow $20 07.04.2009 31