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Financial Management 2
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Chapter 2 - Chapter 2 - Understanding Financial Understanding Financial
Statements, Taxes, and Cash Statements, Taxes, and Cash FlowsFlows
2005, Pearson Prentice Hall
SALESSALES
- - EXPENSESEXPENSES
= PROFIT= PROFIT
Income StatementIncome Statement
SALESSALES
- - EXPENSESEXPENSES
= PROFIT= PROFIT
Income StatementIncome Statement
Revenue
Income StatementIncome Statement
SALESSALES
- - EXPENSESEXPENSES
= PROFIT= PROFIT
•Cost of Goods Sold
Income StatementIncome Statement
SALESSALES
- - EXPENSESEXPENSES
= PROFIT= PROFIT
•Cost of Goods Sold•Operating Expenses
Income StatementIncome Statement
SALESSALES
- - EXPENSESEXPENSES
= PROFIT= PROFIT
•Cost of Goods Sold•Operating Expenses (marketing, administrative)
Income StatementIncome Statement
SALESSALES
- - EXPENSESEXPENSES
= PROFIT= PROFIT
•Cost of Goods Sold•Operating Expenses (marketing, administrative)•Financing Costs
Income StatementIncome Statement
SALESSALES
- - EXPENSESEXPENSES
= PROFIT= PROFIT
•Cost of Goods Sold•Operating Expenses (marketing, administrative)•Financing Costs•Taxes
SALESSALES
- - Cost of Goods SoldCost of Goods Sold
GROSS PROFITGROSS PROFIT
- - Operating ExpensesOperating Expenses
OPERATING INCOME (EBIT)OPERATING INCOME (EBIT)
- - Interest ExpenseInterest Expense
EARNINGS BEFORE TAXES (EBT)EARNINGS BEFORE TAXES (EBT)
- - Income TaxesIncome Taxes
EARNINGS AFTER TAXES (EAT)EARNINGS AFTER TAXES (EAT)
- - Preferred Stock DividendsPreferred Stock Dividends
- - NET INCOME AVAILABLENET INCOME AVAILABLE
TO COMMON STOCKHOLDERSTO COMMON STOCKHOLDERS
Income StatementIncome Statement
SALESSALES
- - Cost of Goods SoldCost of Goods Sold
GROSS PROFITGROSS PROFIT
- - Operating ExpensesOperating Expenses
OPERATING INCOMEOPERATING INCOME (EBIT)(EBIT)
- - Interest ExpenseInterest Expense
EARNINGS BEFORE TAXES (EBT)EARNINGS BEFORE TAXES (EBT)
- - Income TaxesIncome Taxes
EARNINGS AFTER TAXES (EAT)EARNINGS AFTER TAXES (EAT)
- - Preferred Stock DividendsPreferred Stock Dividends
- - NET INCOME AVAILABLENET INCOME AVAILABLE
TO COMMON STOCKHOLDERSTO COMMON STOCKHOLDERS
Income StatementIncome Statement
SALESSALES
- - Cost of Goods SoldCost of Goods Sold
GROSS PROFITGROSS PROFIT
- - Operating ExpensesOperating Expenses
OPERATING INCOME (EBIT)OPERATING INCOME (EBIT)
- - Interest ExpenseInterest Expense
EARNINGS BEFORE TAXES (EBT)EARNINGS BEFORE TAXES (EBT)
- - Income TaxesIncome Taxes
EARNINGS AFTER TAXES (EAT)EARNINGS AFTER TAXES (EAT)
- - Preferred Stock DividendsPreferred Stock Dividends
- NET INCOME AVAILABLE- NET INCOME AVAILABLE
TO COMMON STOCKHOLDERSTO COMMON STOCKHOLDERS
Income StatementIncome Statement
Balance SheetBalance Sheet
Total Assets =Total Assets =
OutstandingDebt
+Shareholders’
Equity
Balance SheetBalance Sheet
Balance SheetBalance SheetAssets
Balance SheetBalance SheetAssets Liabilities (Debt) & Equity
Balance SheetBalance SheetAssets Liabilities (Debt) & Equity
Current AssetsCurrent Assets CashCash
Marketable SecuritiesMarketable Securities
Accounts ReceivableAccounts Receivable
InventoriesInventories
Prepaid ExpensesPrepaid Expenses
Fixed AssetsFixed Assets Machinery & EquipmentMachinery & Equipment
Buildings and LandBuildings and Land
Other AssetsOther AssetsInvestments & patentsInvestments & patents
Current LiabilitiesCurrent Liabilities Accounts PayableAccounts Payable Accrued ExpensesAccrued Expenses Short-term notesShort-term notesLong-Term LiabilitiesLong-Term Liabilities Long-term notes Long-term notes MortgagesMortgagesEquityEquity Preferred Stock Preferred Stock Common Stock (Par Common Stock (Par value)value) Paid in CapitalPaid in Capital Retained EarningsRetained Earnings
AssetsAssets Current AssetsCurrent Assets::
AssetsAssets Current AssetsCurrent Assets: assets that are : assets that are
relatively liquid, and are expected to be relatively liquid, and are expected to be converted to cash within a year.converted to cash within a year.
AssetsAssets Current AssetsCurrent Assets: assets that are : assets that are
relatively liquid, and are expected to be relatively liquid, and are expected to be converted to cash within a year.converted to cash within a year. Cash, marketable securities, accounts Cash, marketable securities, accounts
receivable, inventories, prepaid expenses.receivable, inventories, prepaid expenses.
AssetsAssets Current AssetsCurrent Assets: assets that are : assets that are
relatively liquid, and are expected to be relatively liquid, and are expected to be converted to cash within a year.converted to cash within a year. Cash, marketable securities, accounts Cash, marketable securities, accounts
receivable, inventories, prepaid expenses.receivable, inventories, prepaid expenses.
Fixed AssetsFixed Assets::
AssetsAssets Current AssetsCurrent Assets: assets that are : assets that are
relatively liquid, and are expected to be relatively liquid, and are expected to be converted to cash within a year.converted to cash within a year. Cash, marketable securities, accounts Cash, marketable securities, accounts
receivable, inventories, prepaid expenses.receivable, inventories, prepaid expenses.
Fixed AssetsFixed Assets: machinery: machinery
and equipment, buildings,and equipment, buildings,
and land. and land.
AssetsAssets Current AssetsCurrent Assets: assets that are : assets that are
relatively liquid, and are expected to be relatively liquid, and are expected to be converted to cash within a year.converted to cash within a year. Cash, marketable securities, accounts Cash, marketable securities, accounts
receivable, inventories, prepaid expenses.receivable, inventories, prepaid expenses.
Fixed AssetsFixed Assets: machinery and : machinery and equipment, buildings, and land.equipment, buildings, and land.
Other AssetsOther Assets::
AssetsAssets Current AssetsCurrent Assets: assets that are : assets that are
relatively liquid, and are expected to be relatively liquid, and are expected to be converted to cash within a year.converted to cash within a year. Cash, marketable securities, accounts Cash, marketable securities, accounts
receivable, inventories, prepaid expenses.receivable, inventories, prepaid expenses.
Fixed AssetsFixed Assets: machinery and : machinery and equipment, buildings, and land.equipment, buildings, and land.
Other AssetsOther Assets: any asset that is not a : any asset that is not a current asset or fixed asset.current asset or fixed asset.
AssetsAssets Current AssetsCurrent Assets: assets that are : assets that are
relatively liquid, and are expected to be relatively liquid, and are expected to be converted to cash within a year.converted to cash within a year. Cash, marketable securities, accounts Cash, marketable securities, accounts
receivable, inventories, prepaid expenses.receivable, inventories, prepaid expenses.
Fixed AssetsFixed Assets: machinery and : machinery and equipment, buildings, and land.equipment, buildings, and land.
Other AssetsOther Assets: any asset that is not a : any asset that is not a current asset or fixed asset.current asset or fixed asset. Intangible assets, such as patents and Intangible assets, such as patents and
copyrights.copyrights.
FinancingFinancing Debt CapitalDebt Capital::
FinancingFinancing Debt CapitalDebt Capital: financing provided by a : financing provided by a
creditor. creditor.
FinancingFinancing Debt CapitalDebt Capital: financing provided by a : financing provided by a
creditor. creditor. Short-term debtShort-term debt::
FinancingFinancing Debt CapitalDebt Capital: financing provided by a : financing provided by a
creditor. creditor. Short-term debtShort-term debt: borrowed money that : borrowed money that
must be repaid within the next 12 must be repaid within the next 12 months. months.
FinancingFinancing Debt CapitalDebt Capital: financing provided by a : financing provided by a
creditor. creditor. Short-term debtShort-term debt: borrowed money that : borrowed money that
must be repaid within the next 12 must be repaid within the next 12 months. months. Accounts payable, other payables such as Accounts payable, other payables such as
interest or taxes payable, accrued interest or taxes payable, accrued expenses, short-term notes.expenses, short-term notes.
FinancingFinancing Debt CapitalDebt Capital: financing provided by a : financing provided by a
creditor. creditor. Short-term debtShort-term debt: borrowed money that : borrowed money that
must be repaid within the next 12 must be repaid within the next 12 months. months. Accounts payable, other payables such as Accounts payable, other payables such as
interest or taxes payable, accrued interest or taxes payable, accrued expenses, short-term notes.expenses, short-term notes.
Long-term debtLong-term debt::
FinancingFinancing Debt CapitalDebt Capital: financing provided by a : financing provided by a
creditor. creditor. Short-term debtShort-term debt: borrowed money that : borrowed money that
must be repaid within the next 12 must be repaid within the next 12 months. months. Accounts payable, other payables such as Accounts payable, other payables such as
interest or taxes payable, accrued interest or taxes payable, accrued expenses, short-term notes.expenses, short-term notes.
Long-term debtLong-term debt: loans from banks or : loans from banks or other sources that lend money for other sources that lend money for longer than 12 months.longer than 12 months.
FinancingFinancing Equity CapitalEquity Capital::
FinancingFinancing Equity CapitalEquity Capital: shareholders’ : shareholders’
investment in the firm. investment in the firm.
FinancingFinancing Equity CapitalEquity Capital: shareholders’ : shareholders’
investment in the firm. investment in the firm. Preferred StockholdersPreferred Stockholders::
FinancingFinancing Equity CapitalEquity Capital: shareholders’ : shareholders’
investment in the firm. investment in the firm. Preferred StockholdersPreferred Stockholders: receive fixed : receive fixed
dividends, and have higher priority than dividends, and have higher priority than common stockholders in event of common stockholders in event of liquidation of the firm.liquidation of the firm.
FinancingFinancing Equity CapitalEquity Capital: shareholders’ : shareholders’
investment in the firm. investment in the firm. Preferred StockholdersPreferred Stockholders: receive fixed : receive fixed
dividends, and have higher priority than dividends, and have higher priority than common stockholders in event of common stockholders in event of liquidation of the firm.liquidation of the firm.
Common StockholdersCommon Stockholders::
FinancingFinancing Equity CapitalEquity Capital: shareholders’ : shareholders’
investment in the firm. investment in the firm. Preferred StockholdersPreferred Stockholders: receive fixed : receive fixed
dividends, and have higher priority than dividends, and have higher priority than common stockholders in event of common stockholders in event of liquidation of the firm.liquidation of the firm.
Common StockholdersCommon Stockholders: residual : residual owners of a business. They receive owners of a business. They receive whatever is left after creditors and whatever is left after creditors and preferred stockholders are paid. preferred stockholders are paid.
Corporate Income Tax RatesCorporate Income Tax RatesSince 1993Since 1993
Taxable Income Corporate Tax RateTaxable Income Corporate Tax Rate
$1 - $50,000 15%$1 - $50,000 15%$50,001 - $75,000 25%$50,001 - $75,000 25%$75,001 - $100,000 $75,001 - $100,000 34% 34%$100,001 - $335,000 39%$100,001 - $335,000 39%$335,001 - $10,000,000 34%$335,001 - $10,000,000 34%$10,000,001 - $15,000,000$10,000,001 - $15,000,000 35% 35%$15,000,001 - $18,333,333$15,000,001 - $18,333,333 38% 38%over $18,333,333over $18,333,333 35% 35%
Free Cash FlowsFree Cash Flows
Free cash flow:Free cash flow: cash flow that is free and cash flow that is free and available to be distributed to the firm’s available to be distributed to the firm’s investors (both debt and equity investors).investors (both debt and equity investors).
Free Cash FlowsFree Cash Flows
Cash Flows from Cash Flows from AssetsAssets = Cash Flows from
Financing
Cash flows generated through the firm’s
assets=
Cash flows paid to - or received from - the
firm’s investors (creditors & stockholders)
Calculating Free Cash Flows:Calculating Free Cash Flows:An Asset PerspectiveAn Asset Perspective
After-tax cash flow After-tax cash flow from operationsfrom operations
lessless
investment in net investment in net operating operating working capitalworking capital
lessless
investments in fixed investments in fixed and other assetsand other assets
Calculating Free Cash Flows:Calculating Free Cash Flows:An Asset PerspectiveAn Asset Perspective
After-tax cash flow After-tax cash flow from operationsfrom operations
lessless
investment in net investment in net operating operating working capitalworking capital
lessless
investments in fixed investments in fixed and other assetsand other assets
Operating income + depreciation - cash tax payments
Calculating Free Cash Flows:Calculating Free Cash Flows:An Asset PerspectiveAn Asset Perspective
After-tax cash flow After-tax cash flow from operationsfrom operations
lessless
investment in net investment in net operating operating working capitalworking capital
lessless
investments in fixed investments in fixed and other assetsand other assets
[Change in current assets]-
[change in non-interest bearing current liabilities]
Calculating Free Cash Flows:Calculating Free Cash Flows:An Asset PerspectiveAn Asset Perspective
After-tax cash flow After-tax cash flow from operationsfrom operations
lessless
investment in net investment in net operating operating working capitalworking capital
lessless
investments in fixed investments in fixed and other assetsand other assets
Change in gross fixed assets, and any other assets that are on the balance sheet.
Calculating Free Cash Flows:Calculating Free Cash Flows:A Financing PerspectiveA Financing Perspective
Interest payments to creditorsInterest payments to creditors
- change in debt principal- change in debt principal
- dividends paid to stockholders- dividends paid to stockholders
- change in stock- change in stock
= Financing Free Cash Flows= Financing Free Cash Flows
Tax Example:Tax Example:
Space Cow Computer has sales of Space Cow Computer has sales of $32 $32 millionmillion, cost of goods sold at , cost of goods sold at 60%60% of of sales, cash operating expenses of sales, cash operating expenses of $2.4 $2.4 millionmillion, and , and $1.4 million$1.4 million in in depreciation expense. The firm has depreciation expense. The firm has $12 $12 millionmillion in in 9.5%9.5% bonds outstanding. bonds outstanding. The firm will pay The firm will pay $500,000$500,000 in dividends in dividends to its common stock holders.to its common stock holders.
Calculate the firm’s tax liability.Calculate the firm’s tax liability.
SalesSales $32,000,000$32,000,000
Cost of Goods SoldCost of Goods Sold (19,200,000)(19,200,000)
Operating ExpensesOperating Expenses (2,400,000)(2,400,000)
Depreciation ExpenseDepreciation Expense (1,400,000) (1,400,000)
EBIT or NOIEBIT or NOI 9,000,0009,000,000
Interest ExpenseInterest Expense (1,140,000)(1,140,000)
Taxable IncomeTaxable Income 7,860,000 7,860,000
Income Income tax rate tax rate tax paymenttax payment
$50,000 x .15 = $50,000 x .15 = $ 7,500$ 7,500
$25,000 x .25 = $25,000 x .25 = 6,2506,250
$25,000 x .34 = $25,000 x .34 = 8,5008,500
$235,000 x .39 = $235,000 x .39 = 91,650 91,650
$7,525,000 x .34 = $7,525,000 x .34 = 2,558,5002,558,500
Total Tax payment Total Tax payment $2,672,400$2,672,400
short cut:short cut: $7,860,000 x .34 = $7,860,000 x .34 = $2,672,400$2,672,400