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CHAPTER 2Financial Statements, Cash Flow, and Taxes

Balance sheet Income statement Statement of cash flows Accounting income vs. cash

flow MVA and EVA Federal tax system

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The Annual Report Balance sheet – provides a snapshot of a

firm’s financial position at one point in time. Income statement – summarizes a firm’s

revenues and expenses over a given period of time.

Statement of retained earnings – shows how much of the firm’s earnings were retained, rather than paid out as dividends.

Statement of cash flows – reports the impact of a firm’s activities on cash flows over a given period of time.

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Balance Sheet: Assets

CashA/RInventories

Total CAGross FALess: Dep.

Net FATotal Assets

20027,282

632,1601,287,3601,926,8021,202,950 263,160 939,7902,866,592

200157,600

351,200 715,2001,124,000

491,000 146,200 344,8001,468,800

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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

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Income statement

SalesCOGSOther expenses

EBITDADepr. & Amort.

EBITInterest Exp.EBTTaxesNet income

20026,034,000

5,528,000 519,988

(13,988) 116,960(130,948) 136,012(266,960) (106,784) (160,176)

20013,432,0002,864,000 358,672

209,328 18,900

190,428 43,828

146,600 58,640

87,960

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Statement of Retained Earnings (2002)

Balance of retainedearnings, 12/31/01

Add: Net income, 2002

Less: Dividends paid

Balance of retained earnings, 12/31/02

$203,768

(160,176)

(11,00

0)

$32,592

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Statement of Cash Flows (2002)

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)

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Statement of Cash Flows (2002)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

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Net operating profit after taxes (NOPAT)?

NOPAT = EBIT (1 – Tax rate)

NOPAT02 = -$130,948(1 – 0.4)= -$130,948(0.6)= -$78,569

NOPAT01 = $190,428(1 – 0.4)= $190,428(0.6)

= $114,257

- This is the after-tax profit a company would have if it had no debt and no non-operating assets and is thus a better measure of operating performance than is net income

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Net operating working capital?

NOWC = Current - Non-interest

assets bearing CL

NOWC02 = ($7,282 + $632,160 + $1,287,360) – ( $524,160 + $489,600)

= $913,042

NOWC01 = $842,400

- The working capital acquired with investor-supplied funds

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Operating capital?

Operating capital = NOWC + Net Fixed Assets

Operating Capital02 = $913,042 + $939,790

= $1,852,832

Operating Capital01 = $1,187,200

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Net cash flow and operating cash flow?

NCF02 = NI + Dep

= ($160,176) + $116,960 = -$43,216NCF01 = $87,960 + $18,900 = $106,860

OCF02 = NOPAT + Dep

= ($78,569) + $116,960 = $38,391

OCF01 = $114,257 + $18,900

= $133,157

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What is the free cash flow (FCF)?

The cash flow actually available for distribution to all investors (stockholders and debt holders) after the company has made all the investments in fixed assets, new products, and working capital necessary to sustain ongoing operations.

FCF = NOPAT – Net (investment in) operating capital

FCF = OCF - Gross (investment in) operating capital* * Gross (investment in) operating capital = Net (investment in) operating capital+ Dep

or

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What was the free cash flow (FCF) for 2002?

FCF02 = NOPAT – Net (investment in) operating capital

= -$78,569 – ($1,852,832 -$1,187,200)

= -$744,201

- OR -FCF02 = OCF-(Gross (investment in) operating capital)

= OCF -(Net (investment in) operating capital+ Dep.)= $38,391 – ($1,852,832 -$1,187,200 + 116,960)= -$744,201

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Economic Value Added (EVA)

An estimate of the value created by management during the year, and it differs substantially from accounting profit because no charge for the use of equity capital is reflected in accounting profit.

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Economic Value Added (EVA)EVA = After-tax __ After-tax

Operating Income Capital costs

= Funds Available __ Cost of to Investors Capital Used

= NOPAT – After-tax Cost of Capital

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EVA Concepts In order to generate positive EVA,

a firm has to more than just cover operating costs. It must also provide a return to those who have provided the firm with capital.

EVA takes into account the total cost of capital, which includes the cost of equity.

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What is the firm’s EVA? Assume the firm’s after-tax percentage cost of capital was 10% in 2001 and 13% in 2002

EVA02 = NOPAT – (A-T cost of capital) (Capital)

= -$78,569 – (0.13)($1,852,832)= -$78,569 - $240,868= -$319,437

EVA01 = $114,257 – (0.10)($1,187,200)

= $114,257 - $118,720= -$4,463

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Did the expansion increase or decrease MVA?

MVA = Market value __ Equity capital

of equity supplied =(Shares o/s x Stock price) - Common Equity

MVA – reflects shareholders wealth relative to what they supplied the company with.

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How can one finance its expansion? With external capital which will

dilute ownership By issuing long-term debt which

will reduce financial strength and flexibility.

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Jamaican Tax System

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Corporate and Personal Taxes

Corporations Rates at 33 1/3%

Individuals Rates at 25% for individuals whose

income over $120,432 p.a.

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Tax treatment of various uses and sources of funds Interest paid – tax deductible for

corporations (paid out of pre-tax income Interest earned – usually fully taxable at

source (withholding tax) Dividends paid – paid out of after-tax

income. Dividends received – no longer taxed

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More tax issues Tax Loss Carry-Forward – since corporate

incomes can fluctuate widely, companies can carry losses forward to offset profits in the future.