Business finance
jackson
financialstatements_l2.pptx
Financial Statements, Taxes, and Cash Flow
Ch. 2
Review Questions
Explain the difference between
Capital budgeting and working capital management
Limited and unlimited liability
Corporation and partnership
Dealer markets vs. auction market
Agency problem?
2
Review
The process of planning and managing a firm's long-term investments is called _____________.
The mixture of debt and equity used by the firm to finance its operations is called _____________.
3
Focus on…
Know the difference between book value and market value
Know the difference between average and marginal tax rates
Know how to determine a firm’s cash flow from its financial statements (CFFA)
4
The Balance Sheet (B/S)
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 liquidity
Ease of conversion to cash
Without significant loss of value
Balance Sheet Identity
Assets = Liabilities + Stockholders’ Equity
5
5
B/S
6
6
Market vs. Book Value
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?
7
7
ABC Corporation
| ABC CORPORATION | |||||
| Balance Sheets | |||||
| Market Value versus Book Value | |||||
| Book | Market | Book | Market | ||
| Assets | Liabilities and Shareholders’ Equity | ||||
| NWC | $ 400 | $ 600 | LTD | $ 500 | $ 500 |
| NFA | 700 | 1,000 | SE | 600 | 1,100 |
| 1,100 | 1,600 | 1,100 | 1,600 |
8
8
Income Statement
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 say to show revenue when it accrues and match the expenses required to generate the revenue
9
9
Income Statement - example
10
| XYZ Corporation Income Statement |
| Sales (or Revenue) |
| - Cost of goods sold |
| - Expenses |
| - Depreciation |
| EBIT |
| - Interest |
| Taxable Income |
| - Taxes |
| Net Income |
| Dividends & Retaining Earning |
Taxes
The one thing we can rely on with taxes is that they are always changing
Marginal vs. average tax rates
Marginal – the percentage paid on the next dollar earned
Average – the tax bill / taxable income
11
11
Example: Marginal vs. Average Rates
Suppose your firm earns $4 million in taxable income and pays $1,360,000 taxes.
What is the average tax rate?
Answer: 1.36m/4m = 34%
What is the marginal tax rate?
Answer: 34% (since $4,000,001 is within the 34% tax rate – see next slide)
If you are considering a project that will increase the firm’s taxable income by $1 million, what tax rate should you use in your analysis?
Answer: Marginal tax rate
12
12
Corporate Tax Rates
| Taxable Income | Tax Rate |
| $0 ~ $50,000 | 15% |
| 50,001 ~ 75,000 | 25% |
| 75,001 ~ 100,000 | 34% |
| 100,001 ~ 335,000 | 39% |
| 335,001 ~ 10,000,000 | 34% |
| 10,000,001 ~ 15,000,000 | 35% |
| 15,000,001 ~ 18,333,333 | 38% |
| 18,333,334 + | 35% |
13
The Concept of Cash Flow
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
14
Cash Flow From Assets (CFFA)
Generating
Cash Flow From Assets = Operating Cash Flow – Net Capital Spending – Changes in NWC
Spending
Cash Flow From Assets (CFFA) = Cash Flow to Creditors + Cash Flow to Stockholders
15
15
US Corporation: B/S & I/S
Current Accounts
2017: CA = 1560; CL = 540
2018: CA = 1850; CL = 620
Fixed Assets and Depreciation
2017: Net Fixed Assets (NFA) = 1855
2018: NFA = 1950
Depreciation expense = 80
LT (Long-Term) Liabilities and Equity (*LTD = long-term debt)
2017: LTD = 450; Common Equity = 1600; RE = 825
2018: LTD = 490; Common Equity = 1685; RE = 1005
Income Statement Information
EBIT = 730; Interest Expense = 45; Taxes = 280; Dividends = 225
Example: US Corporation’s CFFA
OCF (I/S) = EBIT + depreciation – taxes =
730 + 80 – 280 = 530
NCS ( B/S and I/S) = ending (this year) net fixed assets – beginning (last year) net fixed assets + depreciation =
1950 – 1855 + 80 = 175
Changes in NWC (B/S) = ending NWC – beginning NWC = (1850 – 620) – (1560 – 540) = 210
CFFA (generating) = 530 – 175 – 210 = 145
*NWC = Net Working Capital = (Current Assets – Current Liabilities, see slide #6)
17
17
Example: US Corporation
CF to Creditors (B/S and I/S) = interest paid – net new borrowing = 45 – (490 – 450) = 5
CF to Stockholders (B/S and I/S) = dividends paid – net new equity raised = 225 – (1685 – 1600) = 140
CF to Creditors & Stockholders = CFFA (spending) = 5 + 140 = 145
CF Identity holds! CFFA (generating) = 145 = CFFA (spending) = 145
*Net new borrowing = this year LTD – last year LTD
*Net new equity raised = this year Common Equity – last year Common Equity
18
18
Table 2.5
19
19
Example: ABC Corporation
Current Accounts
2017: CA = 1500; CL = 1300
2018: CA = 2000; CL = 1700
Fixed Assets and Depreciation
2017: NFA = 3000
2018: NFA = 4000
Depreciation expense = 300
LT Liabilities and Equity
2017: LTD = 2200; Common Equity = 500; RE = 500
2018: LTD = 2800; Common Equity = 750; RE = 750
Income Statement Information
EBIT = 2700; Interest Expense = 200; Taxes = 1000; Dividends = 1250
20
20
Example: ABC Corporation’s CFFA
OCF =
NCS =
Changes in NWC =
CFFA (generating) =
CF to Creditors =
CF to Stockholders =
CF to Creditors & Stockholders (spending) =
Check: the CF identity holds?
21
21
Daily Assignment #2
What is the difference between book value and market value? Which should we use for decision making purposes?
What is the difference between average and marginal tax rates? Which should we use when making financial decisions?
Answer slide #3.
Answer slide #21. Show your calculations & check CF identify.
Find the tax payments for a company with taxable income of $400,000. Show your work.
22
