Financial Statements, Taxes and Cash Flow
Financial Statements, Taxes, and Cash Flow
Chapter 2
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2.1
Describe the difference between accounting value (or “book” value) and market value
Describe the difference between accounting income and cash flow
Describe the difference between average and marginal tax rates
Determine a firm’s cash flow from its financial statements
Key Concepts and Skills
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The balance sheet is a snapshot of the firm’s assets and liabilities at a given point in time.
Assets are listed in order of decreasing liquidity.
Ease of conversion to cash
Without significant loss of value
Balance Sheet Identity
Assets = Liabilities + Stockholders’ Equity
Balance Sheet
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2.3
The Balance Sheet
Figure 2.1
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2.4
Net Working Capital
= Cu
ent Assets - Cu
ent 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
Ability to convert to cash quickly without a significant loss in value
Liquid firms are less likely to experience financial distress.
But liquid assets typically earn a lower return.
Trade-off to find balance between liquid and illiquid assets
Net Working Capital
and Liquidity
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2.5
U.S. Corporation Balance Sheet Table 2.1
To I/S
Back to Example
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2.6
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?
Market Value vs. Book Value
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2.7
Example 2.2
Klingon Corporation
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2.8
The income statement is more like a video of the firm’s operations for a specified period of time.
You generally report revenues first and then deduct any expenses for the period.
Matching principle – GAAP says to show revenue when it accrues and match the expenses required to generate the revenue
Income Statement
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2.9
U.S. Corporation Income Statement – Table 2.2
To B/S
Back to Example
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2.10
Publicly traded companies must file regular reports with the Securities and Exchange Commission.
These reports are usually filed electronically and can be searched at the SEC public site called EDGAR.
Visit EDGAR to search for company filings.
Work the Web Example
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2.11
Marginal vs. average tax rates
Marginal tax rate – the percentage paid on the next dollar earned
Average tax rate – the tax bill / taxable income
Taxes
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2.12
Cash flow is one of the most important pieces of information that a financial manager can derive from financial statements.
The statement of cash flows does not provide us with the same information
that we are looking at here.
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.
The Concept of Cash Flow
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2.13
Cash Flow From Assets (CFFA) =
Cash Flow to Creditors
XXXXXXXXXXCash Flow to Stockholders
Cash Flow From Assets = Operating Cash Flow - Net Capital Spending - Changes in NWC
Cash Flow From Assets
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2.14
OCF (I/S) = EBIT + depreciation -
taxes = $628
NCS (B/S and I/S) = ending net fixed assets - beginning net fixed assets + depreciation = $130
Changes in NWC (B/S) = ending
NWC - beginning NWC = $391
CFFA = XXXXXXXXXX = $107
Example: U.S. Corporation – Part I
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2.15
CF to Creditors (B/S and I/S) = interest paid - net new bo
owing = $24
CF to Stockholders (B/S and I/S) = dividends paid - net new equity raised = $83
CFFA = XXXXXXXXXX = $107
Example: U.S. Corporation – Part II
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2.16
Cash Flow Summary - Table 2.6
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2.17
Cu
ent Accounts
2018: CA = 3,625; CL = 1,787
2017: CA = 3,596; CL = 2,140
Fixed Assets and Depreciation
2018: NFA = 2,194; 2014: NFA = 2,261
Depreciation Expense = 500
Long-term Debt and Equity
2018: LTD = 538; Common stock & APIC = 462
2017: LTD = 581; Common stock & APIC = 372
Income Statement
EBIT = 1,014; Taxes = 193
Interest Expense = 93; Dividends = 460
Example: Balance Sheet and Income Statement Info
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2.18
OCF = 1, XXXXXXXXXX = 1,321
NCS = 2,194 - 2, XXXXXXXXXX = 433
Changes in NWC = (3,625 - 1, XXXXXXXXXX,596 - 2,140) = 382
CFFA = 1, XXXXXXXXXX = 506
CF to Creditors = XXXXXXXXXX) = 136
CF to Stockholders = XXXXXXXXXX) = 370
CFFA = XXXXXXXXXX = 506
The CF identity holds.
Example: Cash Flows
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2.19
Cu
ent Accounts
2018: CA = 4,400; CL = 1,500
2017: CA = 3,500; CL = 1,200
Fixed Assets and Depreciation
2018: NFA = 3,400; 2014: NFA = 3,100
Depreciation Expense = 400
Long-term Debt and Equity (R.E. not given)
2018: LTD = 4,000; Common stock & APIC = 400
2017: LTD = 3,950; Common stock & APIC = 400
Income Statement
EBIT = 2,000; Taxes = 300
Interest Expense = 350; Dividends = 500
Compute the CFFA
Comprehensive Problem
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2.20
END OF CHAPTER
CHAPTER 2
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2.21
Problem 1 (12 points)
In Excel, create an income statement and balance sheet for 2018 for Klein Manufacturing from the following information.
Cash $500
Accounts Receivable 20% of Sales
Accounts Payable 20% of Cost of Goods Sold
Notes Payable $800
Inventory $2,900
Gross Plant & Equipment $22,000
Long-term Debt $4,000
Common Stock $10,000
Sales $7,500
Cost of Goods Sold 40% of Sales
Depreciation Expense $1,200
Other Operating Expenses $1,000
Interest Expense 8% of Long-term Debt
Income Taxes 25% of Taxable Income
Since I did not give you retained earnings, you will need to calculate it. Retained earnings will be the amount necessary to balance your balance sheet. Accumulated depreciation for 2017 was $6,000.
a. What is the firm’s operating cash flow for 2018?
. If gross plant & equipment for 2017 was $20,000, what is the amount of the net capital spending for 2018?
c. If Klein’s cu
ent assets for 2017 were $4,750 and cu
ent liabilities for 2017 were $1,750 what is the change in the net working capital from 2017 to 2018?
Problem 2 (8 points)
You are planning to purchase a new car at $44,000 and you already saved $4,000 for the down payment and will apply for a car loan to finance the rest of the purchase price. Your bank offers a loan with monthly payments at 4% APR with a term of 36 months. Alternatively, a credit union has a promotional APR of 3% for new customers with a loan term of 48 months.
Build amortization tables of both loan alternatives and calculate total interest paid in each loan.
Calculate Effective Annual Rate (EAR) for each loan.