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CHAPTER 3 Financial Statements, Cash Flow, and Taxes. Key Financial Statements Balance sheet Income statements Statement of retained earnings Statement of cash flows Accounting income vs. cash flow Federal tax system. The annual report. - PowerPoint PPT Presentation
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CHAPTER 3Financial Statements, Cash Flow, and Taxes
Key Financial Statements Balance sheet Income statements Statement of retained earnings Statement of cash flows
Accounting income vs. cash flow
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
20057,282
632,1601,287,3601,926,8021,202,950 263,160 939,7902,866,592
200457,600
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
2005524,160
636,808 489,6001,650,568
723,432460,000
32,592 492,5922,866,592
2004145,600200,000
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
20056,034,000
5,528,000 519,988
(13,988) 116,960(130,948) 136,012(266,960) (106,784) (160,176)
20043,432,0002,864,000 358,672
209,328 18,900
190,428 43,828
146,600 58,640
87,960
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Other data
No. of sharesEPSDPSStock priceLease pmts
2005100,000-$1.602
$0.11$2.25
$40,000
2004100,000
$0.88$0.22$8.50
$40,000
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Statement of Retained Earnings (2005)
Balance of retainedearnings, 12/31/04
Add: Net income, 2005
Less: Dividends paid
Balance of retained earnings, 12/31/05
$203,768
(160,176)
(11,00
0)
$32,592
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Statement of Cash Flows (2005)
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 (2005)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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What can you conclude about D’Leon’s financial condition from its statement of CFs?
Net cash from operations = -$164,176, mainly because of negative NI.
The firm borrowed $825,808 to meet its cash requirements.
Even after borrowing, the cash account fell by $50,318.
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Did the expansion create additional net operating after taxes (NOPAT)?
NOPAT = EBIT (1 – Tax rate)
NOPAT05 = -$130,948(1 – 0.4)
= -$130,948(0.6)= -$78,569
NOPAT04 = $114,257
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NOWC = Operating - Non-interest
current assets bearing CL
NOWC05 = ($7,282 + $632,160 + $1,287,360) – ($524,160 + $489,600)
= $913,042
NOWC04 = $842,400
What effect did the expansion have on net operating working capital?
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What effect did the expansion have on operating capital?
Operating capital = NOWC + Net Fixed Assets
Operating Capital05 = $913,042 + $939,790
= $1,852,832
Operating Capital04 = $1,187,200
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What is your assessment of the expansion’s effect on operations?
SalesNOPATNOWCOperating
capitalNet Income
2005 $6,034,000
-$78,569$913,042
$1,852,832-$160,176
2004 $3,432,00
0$114,257$842,400$1,187,20
0$87,960
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What effect did the expansion have on net cash flow and operating cash flow?
NCF05 = NI + Dep = ($160,176) + $116,960
= -$43,216NCF04 = $87,960 + $18,900 = $106,860
OCF05 = NOPAT + Depreciation and amortization
= ($78,569) + $116,960 = $38,391
OCF04 = $114,257 + $18,900
= $133,157
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What was the free cash flow (FCF) for 2005?
NOWC
esexpenditurCapital -
onamortizatiandDepr T)-(1 EBIT FCF
FCF05 = [-$130,948(1 – 0.4) + $116,960] – [($1,202,950 – $491,000) + $70,642]= -$744,201
Is negative free cash flow always a bad sign?
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Economic value added (EVA)
EVA = NOPAT – Annual dollar cost of capital
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 2004 and 13% in 2005.
EVA05 = NOPAT – (A-T cost of capital) (Capital)
= -$78,569 – (0.13)($1,852,832)= -$78,569 – $240,868= -$319,437
EVA04 = $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
During the last year, the stock price has decreased 73%. As a consequence, the market value of equity has declined, and therefore MVA has declined, as well.
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Does D’Leon pay its suppliers on time? Probably not. A/P increased 260%, over the
past year, while sales increased by only 76%.
If this continues, suppliers may cut off D’Leon’s trade credit.
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Does it appear that D’Leon’s sales price exceeds its cost per unit sold?
NO, the negative NOPAT and decline in cash position shows that D’Leon is spending more on its operations than it is taking in.
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What if D’Leon’s sales manager decided to offer 60-day credit terms to customers, rather than 30-day credit terms?
If competitors match terms, and sales remain constant … A/R would Cash would
If competitors don’t match, and sales double … Short-run: Inventory and fixed assets to
meet increased sales. A/R , Cash . Company may have to seek additional financing.
Long-run: Collections increase and the company’s cash position would improve.
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How did D’Leon finance its expansion? D’Leon financed its expansion with
external capital. D’Leon issued long-term debt
which reduced its financial strength and flexibility.
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Would D’Leon have required external capital if they had broken even in 2005 (Net Income = 0)?
YES, the company would still have to finance its increase in assets. Looking to the Statement of Cash Flows, we see that the firm made an investment of $711,950 in net fixed assets. Therefore, they would have needed to raise additional funds.
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What happens if D’Leon depreciates fixed assets over 7 years (as opposed to the current 10 years)?
No effect on physical assets.
Fixed assets on the balance sheet would decline.
Net income would decline.
Tax payments would decline.
Cash position would improve.
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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, although corporations with income between $15 million and $18.33 million pay a marginal tax rate of 38%.
Also subject to state tax (around 5%). Individuals
Rates begin at 10% and rise to 35% for individuals with income over $319,100.
May be subject to state tax.
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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), 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 – Most investors pay 15%
taxes. Investors in the 10% tax bracket pay 5% on dividends. Dividends are paid out of net income which has already
been taxed at the corporate level, this is a form of “double taxation”.
A portion of dividends received by corporations is tax excludable, in order to avoid “triple taxation”.
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More tax issues Tax Loss Carry-Back and Carry-Forward – since
corporate incomes can fluctuate widely, the Tax Code allows firms to carry losses back to offset profits in previous years or forward to offset profits in the future.
Capital gains – defined as the profits from the sale of assets not normally transacted in the normal course of business, capital gains for individuals are generally taxed as ordinary income if held for less than a year, and at the capital gains rate if held for more than a year. Corporations face somewhat different rules.