Financial Statement, Cash Flows, And Taxes
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7/30/2019 Financial Statement, Cash Flows, And Taxes
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FINANCIAL STATEMENTS, CASH
FLOW, AND TAXES
Financial Management
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Financial Statements, Cash Flow and
Taxes
Income statement
Balance sheet
Statement of cash flows Free cash flow
MVA and EVA
Corporate taxes
Personal taxes
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The Annual Report
Balance sheetprovides a snapshot of a firmsfinancial position at one point in time.
Income statementsummarizes a firmsrevenues and expenses over a given period oftime.
Statement of retained earnings shows howmuch of the firms earnings were retained,rather than paid out as dividends.
Statement of cash flows reports the impact ofa firms activities on cash flows over a givenperiod of time.
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How can Financial Statements be used to
increase value or make money in Business
Use to evaluate investment opportunities
1. Internal - From within company
i.e.: investments in fixed assets to increase FCFs &
value
2. External:
To make informed investment decisions into specific
companies
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Value = + + +FCF1 FCF2 FCF
(1 + WACC)1 (1 + WACC)(1 + WACC)2
Free cash flow(FCF)
Market interest rates
Firms business riskMarket risk aversion
Firms debt/equity mixCost of debt
Cost of equity
Weighted average
cost of capital(WACC)
Sales revenues
Operating costs and taxes
Required investments in operating capital
=
Determinants of Intrinsic Value: Calculating FCF
...
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Income Statement
Revenue (Sales)
-Costs (COGS)
-Operating exp
- Deprec. exp=EBIT Earnings b/4 interest & Taxes Op Income b/4 taxes
-Int. expense
=EBT Earnings b/4 taxes Taxable Income
-Taxes Tax Expense= Net Income Profit
NI / #shs c. stk =EPS Earning per share
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Statement of Retained Earnings
Beginning RE
+ NI
-Divids
Ending RE
Divids / #shs c. stk =DPS
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Balance Sheet
ASSETS= LIABILITIES + OWNERS EQUITY
Current Assets Current Liabilities
Cash
Accounts Receivable Accounts Payable Common Stock
Inventory Accruals (other s/t payables) Addtl Paid-in-Cap
Prepaids S/T Notes Payable Prfd. Stock
Marketable Securities Retained Earnings
Non-Current Assets Non-Current Liabilities
Property N/P
Plant Mortgage Payable
Equipment Bonds Payable
-Accum Deprec
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The Balance Sheet
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Statement of Cash Flows
Is used to help answer questions such as:
Is the firm generating enough cash to purchasethe additional assets required for growth?
Is the firm generating any extra cash that can beused to repay debt or to invest in newproducts?
Such information is useful both for
managers and investors
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Sources of cash Uses of cash
Net income + depreciation
Increase in long-term debt
Increase in equity
Increases in current liabilities
Decreases in fixed assets
Decreases in current assets
other than cash
Dividend payments
Increases in current assets
other than cash
Decrease in long-term debt
Decrease in equity
Increases in fixed assets
Cash and
cash
equivalents
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Statement of Cash Flows
Summarizes the changes in a companys
cash position
The statement separates activities into
three categories, plus a summary section:
Operating activities
Investment activities
Financing activities
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Operating activities
Includes:
net income,
depreciation,
changes in current assets and liabilities other than
cash,
short-term investments and
short term debt
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Investing activities
Includes:
investments in fixed assets
or sales of fixed assets
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Financing activities
Includes:
Raising cash by selling short-term investments or
by issuing short-term debt
Long term debt, or stock
Also because both dividends paid and cash used to
buy back outstanding stock or bonds reduce the
companys cash, such transactions are includedhere
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Modifying Accounting Data for
Managerial Decisions We have to divide total assets in twocategories
Operating assets which consist of the assets
necessary to operate the business
Non-operating assets which would include cash
and short term investments above the level
required for normal operations, land held forfuture use
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Operating assets are further divided
into
Operating current assets
Are the current assets that are used to support
operations, such as cash, accounts receivable,
inventory
They do not include short-term investments
Long-term operating assets
Such as plant and equipment They do not include any long-term investments that
pay interest or dividends
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Operating Current Liabilities
Are the current liabilities that occur as a
natural consequence of operations
Such as accounts payable and accruals
They do not include notes payable or any other
short-term debts that charge interest
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Net operating working capital
Is the difference between operating current
assets and operating current liabilities
NOWC= (Cash+Accounts receivable+Inventories)
(Accounts payable+Accruals)
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What effect did the expansion have on net
operating working capital?
NOWC = Current - Non-interestassets bearing CL
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What effect did the expansion have on
operating capital?
Operating capital = NOWC + Net Fixed Assets
Operating capital = total net operating capital = net
operating assets
It is the total amount of capital needed to run the
business
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Net Operating Profit After Tax(NOPAT)
NOPAT = EBIT (1 Tax rate)
It is the after-tax profit a company wouldhave if it had no debt and no investmentsin nonoperating assets
Because it excludes the effects of financingdecisions, it is a better measure ofoperating performance than is net income
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Free Cash Flow (to Firm)
Free cash flow (FCF) is the amount of cash
flow remaining after a company makes the
asset investments necessary to support
operations
FCF is the amount of cash flow available for
distribution to investors
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Free cash flows (to Firms)
FCF= cash available for distribution to
investors. Greater the FCF, more attractive
that company is to investors. Therefore, value
of the firm is primarily dependent on itsexpected future free cash flows!
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What are the five uses of FCF?
1. Pay interest on debt.
2. Pay back principal on debt.
3. Pay dividends.4. Buy back stock.
5. Buy nonoperating assets (e.g., marketable
securities, investments in other companies,etc.)
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Earning before interest and taxes
(1 Tax rate)
Net operating profit after taxes
X
Operating current assets
Operating current liabilities
Net operating working capital
Total net operating capital
Operating long-term assets+
Net operating working capital
Free cash flow
Net investment in operating capital
Net operating profit after taxes
Total net operating capital this year
Total net operating capital last year
Net investment in operating capital
Calculating Free Cash Flow in 5 Easy StepsStep 1 Step 2
Step 3
Step 4
Step 5
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Free Cash Flow (to Firm)
FCF = OCF Gross capital investment
FCF = (NOPAT + Dep) - Gross capital investmentGross investment in operating capital = Net investment+ Depreciation
- OR
FCF = NOPAT Net investment in operating capital
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Economic Value Added (EVA)
Is an estimate of the value created by
management during the year
It differs substantially from accounting profit
because no charge for the use of equity capital
is reflected in accounting profit
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Economic Value Added (EVA)
EVA = After-tax __ After-tax
Operating Income Capital costs
= Funds Available __ Cost of
to Investors Capital Used
= NOPAT After-tax Cost of Capital
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EVA
EVA = Net operating profit after taxes (NOPAT)
- After-tax dollar cost of capital used to
support operations
EVA = EBIT (1
Tax rate) (Total Net Operating Capital)(WACC)
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EVA Concepts
In order to generate positive EVA, a firm
has to more than just cover operating
costs.
It must also provide a return to those who
have provided the firm with capital.
EVA takes into account the total cost of
capital, which includes the cost of equity.
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Market Value Added (MVA)
MVA = Market value __ Equity capital
of equity supplied
by shareholders
= (Shares outstanding)(Stock price) Total
common
equity
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What happens if a company depreciates fixed
assets over 7 years (as opposed to the current 10
years)? No effect on physical assets.
Fixed assets on the balance sheet would decline.
Net income would decline.
Tax payments would decline.
Cash position would improve.
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Corporate and Personal Taxes
Both have a progressive structure (the higher the income, the
higher the marginal tax rate).
Corporations
30% + 3% cess
Individuals
Rates begin at 10% and rise to 30% + 3% cess
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Tax treatment of various uses and
sources of funds
Interest paid tax deductible for corporations (paid outof pre-tax income), but usually not for individuals(interest on home loans being the exception).
Interest earned usually fully taxable (an exception being
interest from a tax free bond) Dividends paid paid out of after-tax income.
Dividends received dividend distribution tax 15% +5% + 3%
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More tax issues
Tax Loss Carry-Back and Carry-Forward sincecorporate incomes can fluctuate widely, the tax codeallows firms to carry losses back to offset profits inprevious years or forward to offset profits in the
future. Capital gains defined as the profits from the sale of
assets not normally transacted in the normal courseof business, capital gains for individuals are generally
taxed as ordinary income if held for less than a year,and at the capital gains rate if held for more than ayear. Corporations face somewhat different rules.
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