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McGraw-Hill/Irwin Copyright © 2015 by The McGraw-Hill Companies, Inc. All rights reserved.
“My problem lies in
reconciling my gross
habits with my net
income”
Errol Flynn
Professor James J. Barkocy
Principles of Corporate Finance
2
The Balance Sheet
Definition
Financial statements that show the
value of the firm’s assets and
liabilities at a particular point in time
(from an accounting perspective).
3
Home Depot Balance Sheet
4
Main Balance Sheet Items
Current Assets
• Cash & Securities
• Receivables
• Inventories
Fixed Assets
• Tangible Assets
• Intangible Assets
+
___________________
Total Assets
Current Liabilities
• Payables
• Short-term Debt
+
Long-term Liabilities
+
Shareholders’ Equity
____________________
Total Liabilities &
Shareholders’ Equity
5
Net Working Capital
How much short-term cash flow does a company need to pay its bills?
Net
Working
Capital
Current
Assets
Fixed Assets
1 Tangible
2 Intangible
Shareholders’
Equity
Current
Liabilities
Long-Term
Debt
6
Market Value vs. Book Value
Book Values are determined by GAAP
Market Values are determined by current values
Equity and Asset “Market Values” are usually higher than their “Book Values”
7
Market Value vs. Book Value
Book Value Balance Sheet
Assets = $10 bil Debt = $4 bil
Equity = $6 bil
Market Value Balance SheetAssets = $11.5 bil Debt = $4 bil
Equity = $7.5 bil
8
The Income Statement
Definition
Financial statement that shows the
revenues, expenses, and net income of a
firm over a period of time (from an
accounting perspective).
The Income Statement
9
Earnings Before Interest & Taxes (EBIT)
EBIT = - total Revenues
- costs
- deprecation
10
The Income Statement
11
Profits vs. Cash Flows
Differences
“Profits” subtract depreciation (a non-cash expense)
“Profits” ignore cash expenditures on new capital
(the expense is capitalized)
“Profits” record income and expenses at the time of
sales, not when the cash exchanges actually occur
“Profits” do not consider changes in working
capital
12
The Statement of Cash Flows
Definition
Financial statement that shows the firm’s cash
receipts and cash payments over a period of
time.
13
14
The Statement of Cash Flows
Cash flow from operations
+Cash flow from investments
+Cash flow from financing____________________________
Change in cash balance
15
Cash Flows
Free Cash Flow (FCF)
➔Cash available for distribution to investors after
firm pays for new investments or additions to
working capital
FCF = EBIT – taxes + depreciation - change
in net working capital - capital expenditures
16
Accounting Practice
Subjective aspects exist in reporting earnings and book value
Stock options
Allowance for bad debts and Revenue Recognition
International practices
Some liabilities may be excluded from balance sheets
17
Taxes
Taxes have a major impact on financial decisions
Average Tax Rate is the total tax bill divided by total income.
Marginal Tax Rate is the tax that the company pays on each extra dollar of income.
18
Corporate Taxes
In the United States, corporations pay tax on their income.
US Corporate Tax Rates, 2018
The U.S. Tax Cuts and Jobs Act, passed in
December 2017, reduced the corporate tax
rate from 35% to 21%. Thus for every
$100 that the company earns, it pays $21
in federal tax.
19
Taxes - 2018
FOOD FOR THOUGHT - If you were both the debt and equity holders of the firm, which would generate more cash flow to you? (assume Net Income = Cash Flow)
Firm A Firm B
EBIT 100 100
Interest 40 0
Pretax Income 60 100
Taxes (21%) 12.6 21
Net Income 47.4 79
?
20
Taxes - 2018
FOOD FOR THOUGHT - If you were both the debt and
equity holders of the firm, which would generate more cash
flow to you? (assume Net Income = Cash Flow)
Firm A Firm B
Net Income 47.4 79
+ Interest 40 0
Net Cash Flow 87.4 79
?
