Slide 1

Understanding Financial Statements, Taxes, and Cash Flows

Income Statement Balance Sheet Taxes Free Cash Flow (FCF)

Slide 2

Income Statement

SALES

– EXPENSES

= PROFIT

•Cost of Goods Sold•Operating Expenses (marketing, administrative)•Financing Costs•Taxes

Slide 3

Income Statement (Continued)SALES

– Cost of Goods Sold= GROSS PROFIT

– Operating Expenses = OPERATING INCOME (EBIT)

– Interest Expense= EARNINGS BEFORE TAXES (EBT)

– Income Taxes= EARNINGS AFTER TAXES (EAT)

– Preferred Stock Dividends= NET INCOME AVAILABLE TO COMMON STOCKHOLDERS

Operating Activities

Financing Activities

Slide 4

Balance SheetTotal Assets = Outstanding Debt + Shareholders’ Equity

Assets Liabilities and Shareholders’ Equity

Current Assets

Cash

Marketable Securities

Accounts Receivable

Inventories

Prepaid Expenses

Fixed Assets

Machinery & Equipment

Buildings and Land

Other Assets

Investments & patents

Current Liabilities

Accounts Payable Accrued Expenses Short-term notesLong-Term Liabilities Long-term notes MortgagesEquity Preferred Stock Common Stock (Par value) Paid in Capital Retained Earnings

Slide 5

Assets Current Assets: assets that are relatively liquid,

and are expected to be converted to cash within a year Cash, marketable securities, accounts receivable,

inventories, prepaid expenses. Fixed Assets: machinery and equipment,

buildings, and land Other Assets: any asset that is not a current asset

or fixed asset Intangible assets such as patents and copyrights

Slide 6

Financing Debt Capital: financing provided by a creditor Short-Term Debt: borrowed money that must be

repaid within the next 12 months Accounts payable, other payables such as interest or

taxes payable, accrued expenses, short-term notes Long-Term Debt: loans from banks or other

sources that lend money for longer than 12 months

Slide 7

Financing (Continued) Equity Capital: shareholders’ investment in the

firm Preferred Stockholders: receive fixed dividends,

and have higher priority than common stockholders in event of liquidation of the firm

Common Stockholders: residual owners of a business. They receive whatever is left after creditors and preferred stockholders are paid

Slide 8

Corporate Tax Rates

Taxable Income Corporate Tax Rate$1 - $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%over $18,333,333 35%

Slide 9

Free Cash Flow (FCF) Free Cash Flow: cash flow that is free and available to be

distributed to the firm’s investors (both debt and equity investors)

Firm’s Operating Free Cash Flow should be equal to Firm’s Financing Free Cash Flow

Operating Free Cash Flow: Cash flows generated through the firm’s operations and investments in assets

Financing Free Cash Flow: Cash flows paid to – or received by – the firm’s investors (creditors & stockholders)

Slide 10

Operating Free Cash Flow Operating Cash Flow (OCF) = EBIT + Depreciation – Taxes Change in NWC (ΔNWC) = Ending NWC – Beginning NWC

NWC = Net Working Capital = Current Assets – Current Liabilities Note that the Current Liabilities exclude interest bearing Current Liabilities

Net Capital Spending (NCS) = Ending NFA – Beginning NFA + Depreciation

NFA = Net Fixed Assets Note that if you are given gross value of Fixed Assets (FA) then the Net

Capital Spending is the difference between Ending FA and Beginning FA

Operating Free Cash Flow (OFCF) = OCF – ΔNWC – NCS

Slide 11

Financing Free Cash Flow Cash Flow to Creditors (CFC) = Interest Paid – Net New

Borrowing Net New Borrowing = (Ending LTD + Ending Interest Bearing Current

Liabilities) – (Beginning LTD + Beginning Interest Bearing Current Liabilities)

LTD = Long-Term Debt

Cash Flow to Shareholders (CFS) = Dividend Paid – Net New Equity

Net New Equity = Ending Common Stock – Beginning Common Stock Common Stock excludes Retained Earnings Addition to Retained Earnings = Net Income – Dividends Paid

Financing Free Cash Flow (FFCF) = Cash Flow to Creditors + Cash Flow to Shareholders