I have a timed test in 7 hrs

Balance Sheet Income Statement

Cash Flow Excercies

FIN355-Corporate Finance Chapter 2

Financial Statements, Taxes, and Cash Flow

Siqi Wei, Ph.D.†

† Department of Finance, Financial Planning, and Insurance David Nazarian College of Business and Economics

California State University, Northridge

[B [email protected]] Siqi Wei, Ph.D (CSUN) Corporate Finance 1 / 31

Balance Sheet Income Statement

Cash Flow Excercies

Chapter Overview

1 Balance Sheet Net Working Capital (NWC) Liquidity Balance Sheet Structure Market Value vs Book Value

2 Income Statement Income statement structure Taxes & Tax Brackets Tax Example

3 Cash Flow Cash Flow Identity Cash flow Example

4 Excercies

Siqi Wei, Ph.D (CSUN) Corporate Finance 2 / 31

Balance Sheet Income Statement

Cash Flow Excercies

Focus

Review of Some Important Accounting Concepts The Balance Sheet The Income Statement Taxes Cash Flow

Our emphasis here is not preparing financial statements. Instead, we recognize that financial statements are frequently a key source of information for financial decisions, so our goal is to briefly examine such statements and point out some of their relevent features.

Siqi Wei, Ph.D (CSUN) Corporate Finance 3 / 31

Balance Sheet Income Statement

Cash Flow Excercies

The Framework of Financial Analysis

Accounting The language of finance Basic concepts should be familiar to you by now STOCK variables (not equities) vs. FLOW variables

Balance Sheet and Income Statement Perspectives Balance sheet: snapshot of financial status quo (stock) Income statement: rate of change of the status quo (flow) Financial status⇔ balance sheet Financial decisions⇔ income statement

Siqi Wei, Ph.D (CSUN) Corporate Finance 4 / 31

Balance Sheet Income Statement

Cash Flow Excercies

NWC Liquidity BS Structure MV vs BV

The Balance Sheet

Balance Sheet Identity Total Assets = Total Liabilities + Stockholders’ Equity

* Balance sheet is a financial statement showing a firm’s accounting value on a particular date.

Asset: The Left Hand Side Current asset (Asset that has a life less than one year) Fixed asset (Asset that has a relatively longer life)

tangible intangible

Liabilities and Owners’ Equity: The Right Hand Side Current liabilities (eg: Account payable) Long-term debt (eg: Long-term bond) Shareholders’ equity (eg: Stock)

Siqi Wei, Ph.D (CSUN) Corporate Finance 5 / 31

Balance Sheet Income Statement

Cash Flow Excercies

NWC Liquidity BS Structure MV vs BV

The Balance Sheet

Net Working Capital (NWC) Net Working Capital = Current Asset - Current Liabilities

* NWC: the cash that will become available over the next 12 months exceeds the cash that must be paid over the same period.

Siqi Wei, Ph.D (CSUN) Corporate Finance 6 / 31

Balance Sheet Income Statement

Cash Flow Excercies

NWC Liquidity BS Structure MV vs BV

The Balance Sheet

Liquidity Liquidity refers to the speed and ease with which an Asset can be converted to Cash

A high liquid asset can be quikly sold without significant loss of value Liquidity is valuable, but there is a trade-off

forgone potential profits Assets are listed on the balance sheet in order of decreasing liquidity, most liquid asset listed first

Siqi Wei, Ph.D (CSUN) Corporate Finance 7 / 31

Balance Sheet Income Statement

Cash Flow Excercies

NWC Liquidity BS Structure MV vs BV

The Balance Sheet

Siqi Wei, Ph.D (CSUN) Corporate Finance 8 / 31

Balance Sheet Income Statement

Cash Flow Excercies

NWC Liquidity BS Structure MV vs BV

Sources of Accounting Statements

Siqi Wei, Ph.D (CSUN) Corporate Finance 9 / 31

Balance Sheet Income Statement

Cash Flow Excercies

NWC Liquidity BS Structure MV vs BV

Real Example

U.S. Securities and Exchange Commission - Edgar https://www.sec.gov/edgar/searchedgar/companysearch.html

Siqi Wei, Ph.D (CSUN) Corporate Finance 10 / 31

Balance Sheet Income Statement

Cash Flow Excercies

NWC Liquidity BS Structure MV vs BV

Market Value vs Book Value

Historical Cost Under Gernally Accepted Accounting Principles (GAAP), audited financial statements in US mostly show assets at historical cost. Assets are carried on the books at what the firm paid for them, no matter how long ago they were purchased or how much they are worth today

current asset: Market value and book value might be similar Fixed asset: Different

Siqi Wei, Ph.D (CSUN) Corporate Finance 11 / 31

Balance Sheet Income Statement

Cash Flow Excercies

IS structure Taxes & Tax Brackets Tax Example

The Income Statement

Income Statement Equation Revenues - Expenses = Income

* Income statement summarizes a company’s performance over some period of time, usually a quarter or a year. (contrast Income statement to Balance sheet?) * Inflow vs Outflow

"flow" concept Expense vs Cost

Non-cash Items Depreciation (Page 27)

Siqi Wei, Ph.D (CSUN) Corporate Finance 12 / 31

Balance Sheet Income Statement

Cash Flow Excercies

IS structure Taxes & Tax Brackets Tax Example

The Income Statement

Siqi Wei, Ph.D (CSUN) Corporate Finance 13 / 31

Balance Sheet Income Statement

Cash Flow Excercies

IS structure Taxes & Tax Brackets Tax Example

The Income Statement: An Example Problem

Papa Roach Exterminators, Inc., has sales of $624,000, costs of $335,000, depreciation expense of $43,000, interest expense of $20,000, and a tax rate of 40 percent. What is the net income for firm?

Structure Sales → EBIT → EBT → NI

Siqi Wei, Ph.D (CSUN) Corporate Finance 14 / 31

Balance Sheet Income Statement

Cash Flow Excercies

IS structure Taxes & Tax Brackets Tax Example

The Income Statement: An Example Problem

Papa Roach Exterminators, Inc., has sales of $624,000, costs of $335,000, depreciation expense of $43,000, interest expense of $20,000, and a tax rate of 40 percent. What is the net income for firm?

Structure Sales → EBIT → EBT → NI

Siqi Wei, Ph.D (CSUN) Corporate Finance 14 / 31

Balance Sheet Income Statement

Cash Flow Excercies

IS structure Taxes & Tax Brackets Tax Example

The Income Statement: An Excercise

Billy’s Exterminators, Inc., has sales of $655,000, costs of $304,000, depreciation expense of $56,000, interest expense of $38,000, a tax rate of 35 percent, and paid out $88,000 in cash dividends. The firm has 100,000 shares of common stock outstanding.

What are the earnings per share? What are the dividends per share?

Siqi Wei, Ph.D (CSUN) Corporate Finance 15 / 31

Balance Sheet Income Statement

Cash Flow Excercies

IS structure Taxes & Tax Brackets Tax Example

The Income Statement: An Excercise

Billy’s Exterminators, Inc., has sales of $655,000, costs of $304,000, depreciation expense of $56,000, interest expense of $38,000, a tax rate of 35 percent, and paid out $88,000 in cash dividends. The firm has 100,000 shares of common stock outstanding.

What are the earnings per share? What are the dividends per share?

Siqi Wei, Ph.D (CSUN) Corporate Finance 15 / 31

Balance Sheet Income Statement

Cash Flow Excercies

IS structure Taxes & Tax Brackets Tax Example

The Income Statement: An Excercise, Cont’d

Billy’s Exterminators, Inc., has sales of $655,000, costs of $304,000, depreciation expense of $56,000, interest expense of $38,000, a tax rate of 35 percent, and paid out $88,000 in cash dividends. The firm has 100,000 shares of common stock outstanding.

What are the earnings per share? What are the dividends per share?

EPS =NI/Shares = 167050/100000 = $1.67per share

DPS =Dividend/Shares = 88000/100000 = $0.88per share

Siqi Wei, Ph.D (CSUN) Corporate Finance 16 / 31

Balance Sheet Income Statement

Cash Flow Excercies

IS structure Taxes & Tax Brackets Tax Example

Taxes

Taxes can be on of the largest cash outflow a firm experiences One thing we can rely on with taxes is that they are always changing! Corporate Tax Rates - Tax Bracket

Siqi Wei, Ph.D (CSUN) Corporate Finance 17 / 31

Balance Sheet Income Statement

Cash Flow Excercies

IS structure Taxes & Tax Brackets Tax Example

Taxes

Tax Brackets

Two concepts need to be distinguished: Average tax rate: Tax bill

Taxable income Marginal tax rate: Rate of the extra tax you would pay if you earned one more dollar

Siqi Wei, Ph.D (CSUN) Corporate Finance 18 / 31

Balance Sheet Income Statement

Cash Flow Excercies

IS structure Taxes & Tax Brackets Tax Example

Taxes: An Example

An Example: Calculate the corporate tax bill, ATR, and MTR Algernon, Inc., has a taxable income of $85,000. What is its tax bill? Average tax rate? Marginal tax rate?

Siqi Wei, Ph.D (CSUN) Corporate Finance 19 / 31

Balance Sheet Income Statement

Cash Flow Excercies

IS structure Taxes & Tax Brackets Tax Example

Taxes: An Example, Cont’d

the tax rate applied to the first $50,000 is 15%; the rate applied to the next $25,000 is 25%; and the rate applied after that up to $100,000 is 34%

0.15∗$50,000 = $7,500 (1) 0.25∗($75,000−50,000) = $6,250 (2) 0.34∗($85,000−75,000) = $3,400 (3) $7,500+6,250+3,400 = $17,150 (4)

Siqi Wei, Ph.D (CSUN) Corporate Finance 20 / 31

Balance Sheet Income Statement

Cash Flow Excercies

IS structure Taxes & Tax Brackets Tax Example

Taxes: An Example, Cont’d

Average tax rate =Tax bill/Taxable income = $17,150/85,000=20.18% The Marginal tax rate is 34% because the company’s tax would rise by 34 cents if it had another dollar in taxable income.

Siqi Wei, Ph.D (CSUN) Corporate Finance 21 / 31

Balance Sheet Income Statement

Cash Flow Excercies

Cash Flow Identity

Cash Flow

Cash Flow Identity Cash flow from assets = Cash flow to creditors + Cash flow to stockholders

By cash flow, we mean the difference between the number of dollars that came in and the number that went out how cash is generated from utilizing assets and how it is paid to those that finance the purchase of the assets

Siqi Wei, Ph.D (CSUN) Corporate Finance 22 / 31

Balance Sheet Income Statement

Cash Flow Excercies

Cash Flow Identity

Cash Flow

Cash flow from Asset (Free Cash Flow, FCF) Operating Cash Flow (OCF): It tells us whether a firm’s cash inflows from its business operations are sufficient to cover its everyday cash outflows. (Headsup, be careful with non-cash item, depreciation) Capital Spending: Money spent on fixed assets less than money recieved from the sale of fixed assets Change in Net Working Capital: Net change in CA and CL

Siqi Wei, Ph.D (CSUN) Corporate Finance 23 / 31

Balance Sheet Income Statement

Cash Flow Excercies

Cash Flow Identity

Cash Flow

Cash Flow to Creditors and Stockholders Net payments to creditors and owners during the year

CF to Creditors = Interest Paid - Net New Borrowing CF to Stockholders = Dividend Paid - Net New Equity Raised

Siqi Wei, Ph.D (CSUN) Corporate Finance 24 / 31

Balance Sheet Income Statement

Cash Flow Excercies

Cash Flow Identity

Cash Flow

Cash Flow Summary *

Siqi Wei, Ph.D (CSUN) Corporate Finance 25 / 31

Balance Sheet Income Statement

Cash Flow Excercies

Selected Example problems

Example: Practice problem on Connect During 2014, Raines Umbrella Corp. had sales of $700,000. Cost of goods sold, administrative and selling expenses, and depreciation expenses were $500,000, $90,000, and $95,000, respectively. In addition, the company had an interest expense of $94,000 and a tax rate of 35 percent. (Ignore any tax loss carryback or carryforward provisions.) Suppose Raines Umbrella Corp. paid out $58,000 in cash dividends. Is this possible? If spending on net fixed assets and net working capital was zero, and if no new stock was issued during the year, what is the net new long-term debt?

Siqi Wei, Ph.D (CSUN) Corporate Finance 26 / 31

Balance Sheet Income Statement

Cash Flow Excercies

Selected Example problem, Cont’d

Siqi Wei, Ph.D (CSUN) Corporate Finance 27 / 31

Balance Sheet Income Statement

Cash Flow Excercies

Selected Example problem, Cont’d

Siqi Wei, Ph.D (CSUN) Corporate Finance 28 / 31

Balance Sheet Income Statement

Cash Flow Excercies

Summary

This Chapter reviewed spme fundamental accounting concepts Balance sheet is a financial statement showing a firm’s accounting value on a particular date Income statement summarizes a company’s performance over some period of time Tax bracket. Marginal tax rate and Average tax rate Cash flow identity

Siqi Wei, Ph.D (CSUN) Corporate Finance 29 / 31

Balance Sheet Income Statement

Cash Flow Excercies

End-chapter questions for you to think about

What is liquidity? What is balance sheet identity what is market value and book value? From a view of financial manager, which one is more important What is marginal tax rate and avg tax rate? whish one is relevant for financial decision making?

Siqi Wei, Ph.D (CSUN) Corporate Finance 30 / 31

Balance Sheet Income Statement

Cash Flow Excercies

Q & A

Any Questions?

Siqi Wei, Ph.D (CSUN) Corporate Finance 31 / 31