fi3300 corporation finance
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FI3300 Corporation Finance. Spring Semester 2010 Dr. Isabel Tkatch Assistant Professor of Finance. Consider the Income Statement. Illustration Company, Income Statement For the Year ending December 31, 2006 (in $ millions). Questions. Was the company profitable? - PowerPoint PPT PresentationTRANSCRIPT
FI3300Corporation Finance
Spring Semester 2010
Dr. Isabel TkatchAssistant Professor of Finance
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Consider the Income Statement
Illustration Company, Income StatementFor the Year ending December 31, 2006 (in $ millions)
Net Sales 400
COGS 280
Gross Profit 120
Operating Expenses 40
Depreciation 20
Operating Income 60
Interest Paid 10
Earnings Before Taxes
50
Taxes 20
Net Income 30
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Questions
☺Was the company profitable?
☺Did the company generate a positive cash flow?
☺How did the company generate its cash flow?
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Learning Objectives
☺Understand the basic difference between net profit and net cash flow
☺Construct the statement of cash flows
☺Use the statement of cash flows to analyze major strengths and weaknesses of a company
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Net Profit vs. Net Cash Flow
☺ Firm’s preferred choice under accrual method of accounting
☺ Easily manipulated
☺ Helps evaluate the firm’s ability to generate cash
☺ Hard to manipulate
Net Profit ≠ Net Cash Flow
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Statement of Cash Flows
☺ Provides information about cash inflows and outflows during an accounting period
☺ Focuses on CASH
☺ Three sections to the statement of cash Flows:
☺ Cash flow from Operating Activities
☺ Cash flow from Investing Activities
☺ Cash flow from Financing Activities
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Useful Tip
For any item on the statement of cash flows
☺ IF the item represents a cash INFLOW you ADD that item
☺ IF an item represents a cash OUTFLOW you SUBTRACT that
item
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What’s Next?
We have to associate the two:
Balance Sheet Accounts:
- Accounts Receivable- Inventories
…
- Retained Earnings
Sections of theStatement of Cash Flows:
1.CF from Operating Activities
2.CF from Investing Activities
3.CF from Financing Activities
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Cash Flow from Operating Activities 1
☺ We use the indirect method: ☺ Start with the net profit (income) and “modify” until
you get the net cash flow
☺ Starting point: Net Income
☺ Step 1: add Depreciation
☺ To find CF from Operating Activities consider only cash flows that are directly related to the production and sales of goods and services
Example: page 69 in the book
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Cash Flow from Operating Activities 2
☺ Step 2: subtract changes in Current Assets (excluding cash):
☺ Accounts receivable
☺ Inventories
☺ Step 3: add changes in Current Liabilities (excluding notes payable and current portion of LTD):
☺ Accounts Payable
☺ Accruals
☺ Result: CF from Operating Activities
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Classification Balance Sheet Item 2005 2006 Difference (Change)
Cash 10 14 14 – 10 = 4
Operating Accounts Receivable 30 25 25 – 30 = -5
Operating Inventories 50 57 57 - 50 = 7
Investing Gross Fixed Assets 160 190 190 – 160 = 30
Less Acc. Depreciation (50) (70) 70 – 50 = 20
Net Fixed Assets 110 120
Total Assets 200 216
Financing Notes Payable 40 29 29 – 40 = -11
Operating Account Payable 20 35 35 – 20 = 15
Operating Accruals 28 32 32 – 28 = 4
Financing Current portion of LTD 0 0 0 – 0 = 0
Financing Long Term Debt (LTD) 52 56 56 – 52 = 4
Financing Common Stock 40 34 34 – 40 = -6
Financing Retained Earnings 20 30 30 – 20 = 10
Total Liabilities and Equity
200 216
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Cash Flow from Investing Activities 1
Investing activities:Buying or selling productive long-lived
assets such as plants and equipment
Gross Fixed Assets are cash investments
(Depreciation is not cash investment)
Buying or selling financial securities (e.g., stocks or bonds of other companies)
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Cash Flow from Investing Activities 2
☺ Starting point: zero
☺ Step 1: ☺ subtract change in Gross Fixed Assets☺ subtract change in Financial Assets
(securities of other companies)
☺ Result: CF from Investing Activities
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Classification Balance Sheet Item 2005 2006 Difference (Change)
Cash 10 14 14 – 10 = 4
Operating Accounts Receivable 30 25 25 – 30 = -5
Operating Inventories 50 57 57 - 50 = 7
Investing Gross Fixed Assets 160 190 190 – 160 = 30
Less Acc. Depreciation (50) (70) 70 – 50 = 20
Net Fixed Assets 110 120
Total Assets 200 216
Financing Notes Payable 40 29 29 – 40 = -11
Operating Account Payable 20 35 35 – 20 = 15
Operating Accruals 28 32 32 – 28 = 4
Financing Current portion of LTD 0 0 0 – 0 = 0
Financing Long Term Debt (LTD) 52 56 56 – 52 = 4
Financing Common Stock 40 34 34 – 40 = -6
Financing Retained Earnings 20 30 30 – 20 = 10
Total Liabilities and Equity
200 216
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Cash Flow from Investing Activities 3
☺ Investing activities refer to changes on the lower left-hand side of balance sheet
☺ Warning: we are looking for changes in Gross Fixed Assets, not Net Fixed Assets!
☺ What if Gross Fixed Assets are not reported in balance sheet?
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Assets Liabilities and Owners Equity
CashMarketable securities Net A/RInventories
Total Current Assets
Gross Fixed Assets(less Accum. Depreciation)
Net Fixed AssetsTotal Assets
Notes PayableAccounts PayableAccrued ExpensesCurrent Portion of LTD
Total Current LiabilitiesLong term (L.T.) Debt
Total LiabilitiesPreferred StockCommon StockRetained Earnings
Total Liabilities and equity
Liquidity
Assets Claims on Assets
Balance Sheet
S.T. Funds
L.T. Capital
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Useful Relations
Change in Gross Fixed Assets = + Change in Net Fixed Assets
+ Depreciation (on the income statement)
Depreciation (on the income statement) = Change in Accumulated
Depreciation (on the balance sheet)
Calculate using book example on page 69.
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Cash Flow from Financing Activities 1
Financing activities:
☺New loans (long-term, short-term debt)
☺Repayment of principal
☺Sale or repurchase of stock (common or
preferred)
☺Payment of dividends
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Cash Flow from Financing Activities 2
Financing activities refer to:☺ Items on lower right-hand side of the
balance sheet☺ Changes in long-term Debt☺ Changes in Equity
☺ Short-term loans☺ Changes in Notes Payable ☺ Changes in the Current Portion of long-term
Debt
☺ Dividends paid to shareholders
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Assets Liabilities and Owners Equity
CashMarketable securities Net A/RInventories
Total Current Assets
Gross Fixed Assets(less Accum. Depreciation)
Net Fixed AssetsTotal Assets
Notes PayableAccounts PayableAccrued ExpensesCurrent Portion of LTD
Total Current LiabilitiesLong term (L.T.) Debt
Total LiabilitiesPreferred StockCommon StockRetained Earnings
Total Liabilities and equity
Liquidity
Assets Claims on Assets
Balance Sheet
S.T. Funds
L.T. Capital
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Cash Flow from Financing Activities 3
☺ Starting point: zero
☺ Step 1: ☺ add change in Notes Payable☺ add change in Current Portion of LT Debt☺ add change in Long Term Debt☺ add change in Common Stock
☺ Step 2: ☺ subtract Dividend Payout
Dividends Paid = Net Income – change in Retained Earnings
☺ Result: Net CF from Financing Activities
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Classification Balance Sheet Item 2005 2006 Difference (Change)
Cash 10 14 14 – 10 = 4
Operating Accounts Receivable 30 25 25 – 30 = -5
Operating Inventories 50 57 57 - 50 = 7
Investing Gross Fixed Assets 160 190 190 – 160 = 30
Less Acc. Depreciation (50) (70) 70 – 50 = 20
Net Fixed Assets 110 120
Total Assets 200 216
Financing Notes Payable 40 29 29 – 40 = -11
Operating Account Payable 20 35 35 – 20 = 15
Operating Accruals 28 32 32 – 28 = 4
Financing Current portion of LTD 0 0 0 – 0 = 0
Financing Long Term Debt (LTD) 52 56 56 – 52 = 4
Financing Common Stock 40 34 34 – 40 = -6
Financing*** Retained Earnings 20 30 30 – 20 = 10
Total Liabilities and Equity
200 216
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Useful Relation:
Net cash flow from Operating Activities+Net cash flow from Investing Activities+Net cash flow from Financing Activities________________________________= CHANGE in the cash account (balance
sheet)
Calculate using book example on page 69.
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Analyzing the Statement of Cash Flows 1
Compare the Net Income and the Net Cash Flow from Operations. If
Net Income>0 but CF from Operations<0
☺ The company could be experiencing rapid growth (book example: golf ball company, Ch. 2)
☺ This could be an indicator of financial miss-management (book example: Bennie’s Auto Parts and Services Center, Ch. 1)
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Analyzing the Statement of Cash Flows 2
Net Cash Flow from Investing activities:
If negative, the company is investing in☺ Plant & equipment (improve efficiency)
☺ Stock of other companies (strategic reasons, e.g., joint venture)
If positive, the company is liquidating assets - Why? Could be an indicator of financial distress!
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Analyzing the Statement of Cash Flows 3
Where did the company get cash to pay dividends? It is a good sign if
CF from operations > Dividend payout
If not, did the company☺Liquidated assets☺Issue new equity or borrow money
To pay dividends?
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Analyzing the Statement of Cash Flows 4
Examine the CF from Financing activities:
☺ Big increases in debt (either short-term or long-term) are not a good sign
☺ Using internal financing rather than debt to finance growth is usually a good sign
☺ Substitution of short-term debt for long-term debt might indicate a worsening of financial conditions
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Summary
☺Net income vs. net cash flows
☺Statement of Cash flows☺Operating activities☺Investing activities☺Financing activities
☺Add CFs that represent inflows
☺Subtract CFs that represent outflows
☺Use the Statement of Cash Flows to analyze the company