chapter 3 & web appendix 3a financial statements, cash flows, and taxes
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Chapter 3 & Web Appendix 3AChapter 3 & Web Appendix 3A
Financial Statements, Cash Flows, and Taxes
Topic Overview
Key Financial Statements (See Best Buy Spreadsheet for Example) Balance sheet Income statements Statement of retained earnings Statement of cash flows
Accounting Income vs. Cash Flow Statement of Cash Flows Individual and Corporate Income Taxes
The annual report
Balance sheet – provides a snapshot of a firm’s financial position at one point in time. (Please review section 3.3)
Income statement – summarizes a firm’s revenues and expenses over a given period of time. (Please review section 3.4)
Statement of retained earnings – shows how much of the firm’s earnings were retained, rather than paid out as dividends. (Please review section 3.7)
Statement of cash flows – reports the impact of a firm’s activities on cash flows over a given period of time.
Homer & Son Balance Sheet: Assets
2006 2005 2006-2005
Assets
Current Assets
900 800 100
Net Fixed Assets
1500 1300 200
Total Assets
2400 2100
Homer & Son Balance Sheet: Liabilities
Liabilities 2006 2005 2006-2005
Acct Pay 450 350 100
Accruals 200 150 50
Notes Payable
150 150
Total CL 800 650
Long-term Debt
600 600
Total Liab 1400 1250
Homer & Son Balance Sheet: Equity and Total Liabilities and Equity
2006 2005
Total Liab 1400 1250
Common Stock
700 700
Retained Earnings
300 150
Total Equity 1000 850
Total Liab & Equity
2400 2100
2006 Homer & Son Income Statement
Sales 3000
Cost of good sold 1800
Gross Profit 1200
SGA Expense 720
Depreciation 100
Operating Inc. 380
Interest Exp 80
EBT 300
Taxes (40%) 120
Net Income 180
Some Balance Sheet Comments
Net Working Capital = Current Assets – Current Liabilities
Assets (particularly Long-term) and Equity on Balance Sheet are Book (or historical-based) Values.
Market Value of Assets and Equity (# of shares x market price/share) can be vastly different for a given firm. For Best Buy: 2/25/2006 Book Value of Equity
= $5.247 billion, 2/25/2006 Market Value= $26.6 billion
Accounting Income vs. Cash Flow
An Income Statement
Sales Cost of Goods Sold Selling & Gen. Adm.
Exp Depreciation Interest Exp Taxable Income Taxes Net Income
Do all items reflect all cash collected and paid?
NO!!! Income statement is on an accrued basis.
What is and who is depreciation?
Net Cash Flow or Simple Income Net Cash Flow or Simple Income Statement Cash FlowStatement Cash Flow
If all other revenues and expenses are in cash or non-cash revenues and expenses net to zero, then
Net Cash Flow(NCF) = Net Income + Depreciation(& Amortization)
2006 Homer & Son, Depreciation = 100; Net Income = 180
NCF = 180 + 100 = 280 Otherwise, Net Cash Flow = Cash
Revenues - Cash Expenses
Statement of Cash Flows
Shows how the firm used and raised cash during the year.
Reconciles the Income Statement by the changes in the Balance Sheet from the beginning of the year to the end of the year
Statement of Cash Flows: General Concepts
Overall: Inflows(or sources) of cash are net
income, depreciation, decreases in assets, and increases in liabilities
Outflows(or uses) of cash are increases in assets, decreases in liabilities, and dividends
Parts of Statement of Cash Flows
Operating Cash Flow = net cash income from income statement: net income, Depreciation,change in A/R, Inv, Other CA, A/P, Accruals (Wages & Taxes), Other CL
Investing Cash Flow = Purchases and Sales of long-term real assets and investments (Marketable Securities)
Financing Cash Flow = issuances and payments of debt and stock: L-T Debt, Common and Preferred Stock, Notes Payable & Dividends Paid
Best Buy Statement of Cash Flow Information (millions$)
-1,500
-1,000
-500
0
500
1,000
1,500
2,000
2006 2005 2004
OperatingInvestingFinancingChange in Cash
Using Accounting Data to Measure Other Cash Flows for Investors
Operating Cash Flow = total cash available for new asset investment, and for debt & equity investors.
Free Cash Flow = cash available for debt & equity investors. This measure is often use to value a firm.
Operating Cash Flow (OCF)
OCF = Net Operating Profit After Taxes (NOPAT) + Depreciation & Amortization NOPAT = Earnings Before Interest &
Taxes (EBIT) x (1 – Tax Rate) OCF = EBIT(1 – tax rate) +
Depreciation & Amortization
What is Homer & Son’s 2006 Operating Cash Flow?
Free Cash Flow (FCF)
FCF = Operating Cash Flow (OCF) – Investment in Operating Capital Investment in Operating Capital =
Increase in Gross Fixed Assets (Capital Expenditures) + Increase in Net Operating Working Capital
Increase in Gross Fixed Assets = Increase in Net Fixed Assets + Depreciation
Increase in Net Operating Working Capital = Increase in Current Assets – Increase in non-interest bearing current liabilities
Alternate FCF Definition
This definition is not developed or presented in the chapter itself but is used in some of the problem solutions.
The term Investment in Net Operating Capital is created which is Increase in Net Fixed Assets + Increase in Net Operation Working Capital.
Since depreciation is deducted in the Net Operating Capital term it must be deducted from the OCF term.
FCF = NOPAT – Investment in Net Operating Capital
What is Homer & Son’s 2006 Free Cash Flow?
INCOME TAXES
2006 Single Individual Tax RatesNote: Appendix 3A provides 2004 brackets.
Taxable Income Tax on Base Rate*
0 – 7,550 0 10%7,550 - 30,650 755.00 15%30,650 - 74,200 4,220.00 25%74,200 - 154,800 15,107.50 28%154,800 - 336,550Over 336,550
37,675.5097.653.00
33%35%
*Plus this percentage on the amount over the bracket base.
O
Personal Income Taxes
Marginal tax rate = the tax rate on the next dollar of income.
Wages, tips, and interest income are considered ordinary taxable income.
Deductions: charitable donations, mortgage interest, a portion of student loan interest, personal exemptions, and medical expenses to an extent(> 7.5% of gross income).
Personal Investment Taxes
Interest Income taxed at individual’s marginal tax rate.
Dividend Income tax rate: 15% or less Financial and Real assets held for less than
12 MONTHS and then sold for a gain are considered short-term capital gains and taxed at the taxpayer’s marginal tax rate.
Long-term (held more than 12 months) capital gains are taxed at a max rate of 15%.
Corporate Income Taxes
Corporate deductions from income: operating expenses, depreciation, interest expense.
Dividends paid are NOT deductible. Interest and capital gain income is fully
taxable. 30% (in general) of Dividend income is
taxable. Losses can be carried back 2 years and
carried forward up to 20 years
Corporate Tax Rates
Taxable Income Tax on Base Rate*
0 - 50,000 0 15%50,000 - 75,000 7,500 25%75,000 - 100,000 13,750 34%100,000 - 335,000 22,250 39%
Over 18.3M 6.4M 35%
*Plus this percentage on the amount over the bracket base.
... ... ...
Assume a corporation has Assume a corporation has $100,000 of taxable income $100,000 of taxable income from operations, $5,000 of from operations, $5,000 of
interest income, and $10,000 of interest income, and $10,000 of dividend income.dividend income.
What’s its tax liability?
State and local government bonds (munis) are generally exempt from federal taxes.
Taxable vs.Taxable vs.Tax Exempt BondsTax Exempt Bonds
After-tax Investment Returns
After-tax Return=Before-tax Return(1-T) After-tax Corporate Dividend Return =
Before-tax Dividend Yield (1 - .3T) Municipal Bond Interest is tax exempt on the
federal level Equivalent pretax return
= Muni Return/(1-T)
Which of the following would you prefer if your marginal tax rate is 28%?
Exxon bonds at 10% or California municipal bonds at 7%.
At what marginal tax rate would you be indifferent be these two bonds?
After-Tax Return Example