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2-1
TOPIC 3Financial Statements and
Cash Flows
Balance sheet Income statement Statement of retained earnings Statement of cash flows 5 Questions about cash Federal tax system
(continued)
2-2
Ratio Analysis
Du Pont system
Effects of improving ratios
Limitations of ratio analysis
Qualitative factors
2-3
ANNUAL REPORT
Primary Purpose—To communicate with stockholders and potential investors.
Contains: 1. Balance Sheet
2. Income Statement
3. Statement of Retained Earnings
4. Statement of Cash Flows
Usually covers several years.
Explains what has happened and why.
2-4
Balance Sheet: Assets
CashA/RInventories
Total CAGross FALess: Dep.
Net FATotal Assets
20047,282
632,1601,287,3601,926,8021,202,950 263,160 939,7902,866,592
200357,600
351,200 715,2001,124,000
491,000 146,200 344,8001,468,800
2-5
OBSERVATIONS ABOUT THE BALANCE SHEET
1. Assets listed in order of “currency.”
2. Current versus fixed assets
3. Is depreciation a true expense?
2-6
Balance sheet: Liabilities and Equity
Accts payableNotes payableAccruals
Total CLLong-term debtCommon stockRetained earnings
Total EquityTotal L & E
2002524,160
636,808 489,6001,650,568
723,432460,000
32,592 492,5922,866,592
2001145,600200,000
136,000481,600323,432460,000
203,768 663,7681,468,800
2-7
1. What is the difference between Equity, Stockholder’s Equity, and New Worth?
2. What is “Retained Earnings?”
2-8
Income statement
SalesCOGSOther expenses
EBITDADepr. & Amort.
EBITInterest Exp.EBTTaxesNet income
20046,034,000
5,528,000 519,988
(13,988) 116,960(130,948) 136,012(266,960) (106,784) (160,176)
20033,432,0002,864,000 358,672
209,328 18,900
190,428 43,828
146,600 58,640
87,960
2-9
BOTTOM OF INCOME STATEMENT
NET INCOME BEFORE PREFERREDDIVIDENDS $117.5
- PREFERRED DIVIDENDS 4.0
NET INCOME $113.5
- COMMON DIVIDENDS 57.5
ADDITION TO R.E. 56.0
Dividends on CS are paid after taxes and after PS dividends
2-10
ANOTHER WAY TO MEASURE PERFORMANCE
(t = 40%) CO. A CO. BSALES 10 10 - COSTS 7 7= EBIT 3 3 - INTEREST 2 1= EBT 1 2 - TAXES .4 .8= NET INCOME .61.2
2-11
NOPAT(NET OPERATING PROFIT AFTER TAXES)
(t = 40%)
NOPAT = EBIT (1 – t)
FOR CO. A: 3 (1 - .4) = 1.8
FOR CO. B: 3 (1 - .4) = 1.8
2-12
Statement of Retained Earnings (2004)
Balance of retainedearnings, 12/31/03
Add: Net income, 2004
Less: Dividends paid
Balance of retained earnings, 12/31/02
$300,000
100,000 40,000
$360,000
2-13
1. WHAT WAS THE “DIVIDEND PAYOUT RATIO?”
2. WHAT WAS THE “RETENTION” OR “PLOWBACK” RATIO?
2-14
NET CASH FLOW(Assume sales and expenses
are all cash)
SALES $10-COSTS 8-DEPRECIATION 1= NET INCOME 1
HOW MUCH CASH WAS GENERATED?
DOES NOT NECESSARILY SHOW THE AMOUNT OF CASH ON THE BALANCESHEET BECAUSE THE CASH FLOW CAN BE USED IN A VARIETY OF WAYS.
2-15
FREE CASH FLOW
THE CASH FLOW ACTUALLY AVAILABLEFOR DISTRIBUTION TO ALL INVESTORSIN THE COMPANY (STOCKHOLDERS ANDBONDHOLDERS)
FREE CASH FLOW =
NOPAT – ALL NECESSARY INVESTMENTS IN INVESTMENTS IN WORKING CAPITAL AND FIXED ASSETS
2-16
BALANCE SHEET
Left Hand Side shows “investments” (or where you put your money)
Right Hand Side shows “financing” (or where you get your money)
2-17
ANY INCREASE IN AN ITEM ON THE RIGHT HAND SIDE and ANY DECREASEIN AN ITEM ON THE LEFT HAND SIDEINCREASES “FINANCING” OR PROVIDES FUNDS and ANY DECREASE IN AN ITEM ON THE LEFT HAND SIDE
e.g., if Accounts Payable increase—or Accounts Receivable decrease—additional funds will be provided
ANY INCREASE IN AN ITEM ON THE LEFT HAND SIDE INCREASES “INVESTMENTS” OR USES FUNDS.
2-18
A STATEMENT OF CASH FLOWS SHOWS: 1. OPERATING ACTIVITIES
(Includes net income, depreciation, and changes in current assets and current liabilities (other than cash and short-term debt)
2. INVESTING ACTIVITIES (Includes investments in or sales of fixed assets)
3. FINANCING ACTIVITIES (Includes cash raised by short-term debt, bonds, and stock. Also includes cash for dividends and buy-backs of stocks and bonds.
2-19
Statement of Cash Flows (2004)
OPERATING ACTIVITIESNet income
Add (Sources of cash):DepreciationIncrease in A/PIncrease in accruals
Subtract (Uses of cash):Increase in A/RIncrease in inventories
Net cash provided by ops.
(160,176)
116,960378,560353,600
(280,960)(572,160)(164,176)
2-20
Statement of Cash Flows (2004)L-T INVESTING ACTIVITIES
Investment in fixed assets
FINANCING ACTIVITIESIncrease in notes payableIncrease in long-term debtPayment of cash dividendNet cash from financing
NET CHANGE IN CASH
Plus: Cash at beginning of year
Cash at end of year
(711,950)
436,808400,000
(11,000)825,808
(50,318)
57,6007,282
2-21
REVIEWWHICH STATEMENT (OR CONCEPT)SHOWS:
1. HOW MUCH CASH DO WE HAVE?
2. HOW MUCH CASH DID WE GENERATE DURING THE PERIOD?
3. WHAT DID WE DO WITH THE CASH WE GENERATED?
4. HOW MUCH CASH COULD WE DISTRIBUTE TO OUR INVESTORS?
5. HOW MUCH CASH DID WE ACTUALLY PAY TO OUR STOCKHOLDERS?
2-22
Federal Income Tax System
2-23
Corporate and Personal Taxes
Both have a progressive structure (the higher the income, the higher the marginal tax rate).
Corporations Rates begin at 15% and rise to 35% for
corporations with income over $10 million. Also subject to state tax (around 5%).
Individuals Rates begin at 10% and rise to 38.6% for
individuals with income over $307,050. May be subject to state tax.
2-24
Tax treatment of various uses and sources of funds Interest paid – tax deductible for corporations
(paid out of 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 (muni”).
Dividends paid – paid out of after-tax income. Dividends received – taxed as ordinary income
for individuals (“double taxation”). A portion of dividends received by corporations is tax excludable, in order to avoid “triple taxation”.
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