Business Question

chapter 2 assignment. •Based on the information for Mara Corporation (Book, page 38)or (Slide #34), Prepare the balance sheet for 2008 and 2009. Next, Calculate the CFFA using two methods; externally and internally for 2009.

Chapter 2
Financial Statements,
Taxes, and Cash Flow
Copyright © 2012 McGraw-Hill Education. All rights reserved.
Key Concepts and Skills
• Know the difference between book value
and market value
• Know the difference between accounting
income and cash flow
• Know the difference between average
and marginal tax rates
• Know how to determine a firm’s cash flow
from its financial statements
• Understand the different point of view
between accounting and finance
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Chapter Outline
• The Balance Sheet
• The Income Statement
• Taxes
• Cash Flow
• Accounting versus Finance
2-3
Balance Sheet
• The balance sheet is a snapshot of the firm.
It is summarizing what a firm owns(its
assets), what the firm owes(its liabilities),
and the difference between the two(the
firm’s equity) at a given point in time.
• Assets are listed in order of decreasing
liquidity; cash, cash receivable and
inventory.
– Ease of conversion to cash
– Without significant loss of value
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• Balance Sheet Identity
– Assets = Liabilities + Stockholders’ Equity
The Balance Sheet – Figure
2.1
2-6
BALANCE SHEET
Assets
• Current Assets: have a
life less than one year;
the asset will convert to
cash within 12 months.
For example, cash.
• Fixed Assets: have a long
life. It can be either
tangible. For example,
truck or computer. Or,
intangible. For instance,
trademark or patent.
liabilities
• Current Liabilities: have a
life less than one year
(they must be paid within
a year). For example,
accounts payable.
• Long-term debt: a loan
that the firm will pay off in
five years.
• Shareholders’ equity=the
T.V of assets – the T.V of
liabilities
Net Working Capital and
Liquidity
• Net Working Capital
– = Current Assets – Current Liabilities
– Positive when the cash that will be received over the next 12
months exceeds the cash that will be paid out
– Usually positive in a healthy firm
• Liquidity
– Ability to convert to cash quickly without a significant loss in
value
– Liquid firms are less likely to experience financial distress
– But liquid assets typically earn a lower return
– Trade-off to find balance between liquid and illiquid assets
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Debt versus Equity
• The use of debt in a firm’s capital
structure is called Financial Leverage.
• The
debt a firm has, the
is its
degree of financial leverage.
• So, Financial leverage increases the
potential reward to shareholders, but it
also increases the potential for financial
distress and business failure.
Market Value 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?
Market values are generally more important for the
decision making process because they are more
reflective of the cash flows that would occur today.
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Example 2.2 Klingon
Corporation
KLINGON CORPORATION
Balance Sheets
Market Value versus Book Value
Book
Market
Assets
Book
Market
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
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Income Statement
• The income statement is more like a
video of the firm’s operations for a
specified period of time. Usually quarter
or a year.
• You generally report revenues first and
then deduct any expenses for the period.
• Matching principle –Generally Accepted
Accounting Principles (GAAP) says to
show revenue when it accrues and match
the expenses required to generate the
revenue
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Earning per share/ Dividend
per share
• Earnings per share (EPS) is the portion of a
company’s profit that is allocated to each
outstanding share of common stock, serving as
an indicator of the company’s profitability.
• Dividend per share (DPS) is the
total dividends paid out over an entire year
(including interim dividends but not including
special dividends) divided by the number of
outstanding ordinary shares issued.
CALCULATING EARNINGS AND
DIVEDINTS PER SHARE
• Earning per share=Net income/total
shares outstanding
• Dividends per share=total
dividends/total shares outstanding
Noncash Items
• A primary reason that accounting income
differs from cash flow is that an income
statement contains noncash Items
• the most important of these is
Depreciation.
• Depreciation isn’t cash, it’s an accounting
number.
Work the Web Example
• Publicly traded companies must file
regular reports with the Securities and
Exchange Commission
• These reports are usually filed
electronically and can be searched at the
securities and exchange commission
(SEC) public site called Electronic Data
Gathering, Analysis, and Retrieval
(EDGAR).
• Click on the web surfer, pick a company,
and see what you can find!
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Taxes
• The one thing we can rely on with taxes is
that they are always changing
• Marginal vs. average tax rates
– Marginal tax rate – the percentage paid on
the next dollar earned
– Average tax rate – the tax bill / taxable
income
• Other taxes
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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
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Cash Flow From Assets
• Cash Flow From Assets (CFFA) =
Cash Flow to Creditors + Cash Flow
to Stockholders
• Cash Flow From Assets = Operating
Cash Flow – Net Capital Spending –
Changes in NWC
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Cash Flow From Assets
• Involves three components:
1. Operating Cash Flow: refers to the cash flow
that results from the firm’s day-to-day activities
of producing and selling.
➢ It tells us whether a firm’s cash inflow from its
business operations are sufficient to cover its
everyday cash outflows
1. Capital spending: refers to the net spending on
fixed assets.
2. Change in net working capital: measured as the
net change in current assets relative to current
liabilities.
US Corporation Balance Sheet
– Table 2.1
Place Table 2.1 (US Corp Balance Sheet)
here
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US Corporation Income
Statement – Table 2.2
Insert new Table 2.2 here (US Corp Income
Statement)
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Example: US Corporation –
Part I
Operating Cash Flow
• OCF (I/S) = EBIT + depreciation – taxes =
$547
U.S CORPORATION
2009 OPERATING Cash Flow
Earning before interest and taxes
$ 694
+ Depreciation
65
– Taxes
212
Operating Cash Flow
$ 547
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Net Capital Spending
• NCS ( B/S and I/S) = ending net
fixed assets – beginning net fixed
assets + depreciation = $130
Ending Net Fixed Assets
$1,709
– Beginning net fixed assets
1,644
+ Depreciation
65
Net Capital Spending
$ 130
Changes in NWC
• Changes in NWC (B/S) = ending
NWC – beginning NWC = $330
•
•
NWC 2009= 1,403-389= $1,014
NWC 2008= 1,112- 428= $ 684
Ending NWC
$ 1,014
– Beginning NWC
684
Change in NWC
$ 330
Cash Flow From Assets
• CFFA = 547 – 130 – 330 = $87
U.S Corporation
2009 Cash Flow from Assets
Operating Cash Flow
$547
– Net Capital Spending
130
– Change in NWC
330
Cash Flow From Assets
$ 87
Example: US Corporation –
Part II
• CF to Creditors (B/S and I/S) = interest
paid – net new borrowing = $24
• 2009-2008
• Long-term debt rose by:454-408=$ 46
Cash Flow to Creditors
Interest Paid
$70
– Net new borrowing
46
Cash Flow To Creditors
$ 24
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• CF to Stockholders (B/S and I/S) =
dividends paid – net new equity
raised = $63
• 640-600= $ 40
Cash Flow To Stockholders
Dividends Paid
$ 103
– Net New Equity Raised
40
Cash Flow To Stockholders
$ 63
• CFFA = 24 + 63 = $87
Cash Flow Summary Table 2.6
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Example: Balance Sheet and
Income Statement Information
• Current Accounts
– 2009: CA = 3625; CL = 1787
– 2008: CA = 3596; CL = 2140
• Fixed Assets and Depreciation
– 2009: NFA = 2194; 2008: NFA = 2261
– Depreciation Expense = 500
• Long-term Debt and Equity
– 2009: LTD = 538; Common stock & APIC = 462
– 2008: LTD = 581; Common stock & APIC = 372
• Income Statement
– EBIT = 1014; Taxes = 368
– Interest Expense = 93; Dividends = 285
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Example: Cash Flows
• OCF = 1,014 + 500 – 368 = 1,146
• NCS = 2,194 – 2,261 + 500 = 433
• Changes in NWC = (3,625 – 1,787) – (3,596 –
2,140) = 382
• CFFA = 1,146 – 433 – 382 = 331
• CF to Creditors = 93 – (538 – 581) = 136
• CF to Stockholders = 285 – (462 – 372) = 195
• CFFA = 136 + 195 = 331
• The CF identity holds.
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Quick Quiz
• What is the difference between book value
and market value? Which should we use for
decision-making purposes?
• What is the difference between accounting
income and cash flow? Which do we need to
use when making decisions?
• What is the difference between average and
marginal tax rates? Which should we use
when making financial decisions?
• How do we determine a firm’s cash flows?
What are the equations, and where do we
find the information?
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H.W#2 Comprehensive
Problem
• Current Accounts
– 2009: CA = 4,400; CL = 1,500
– 2008: CA = 3,500; CL = 1,200
• Fixed Assets and Depreciation
– 2009: NFA = 3,400; 2008: NFA = 3,100
– Depreciation Expense = 400
• Long-term Debt and Equity (R.E. not given)
– 2009: LTD = 4,000; Common stock & APIC = 400
– 2008: LTD = 3,950; Common stock & APIC = 400
• Income Statement
– EBIT = 2,000; Taxes = 300
– Interest Expense = 350; Dividends = 500
• Compute the CFFA
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Q# 2.1
2008
2009
Sales
Cost of goods sold
Depreciation
Interest
Dividends
Current assets
Net fixed assets
Current liabilities
$ 4,203
2,422
785
180
225
2,205
7,344
1,003
$4,507
2,633
952
196
250
2,429
7,650
1,255
Long-term debt
Tax 35%
3,106
2,085
Question 2.1 (Book, page
38)
• Based on the previous information
for Mara Corporation, Prepare an
income statement for 2009 and
balance sheet for 2008 and 2009.
Next, Calculate the CFFA using two
methods; externally and internally for
2009.
End of Chapter
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