View
216
Download
3
Category
Preview:
Citation preview
1
FINC3131Business Finance
Chapter 3:
Income Statements Balance Sheets
Cash Flow Statement
2
Importance of Financial Statements
Form the basis for understanding the financial position of a business
Provide information regarding the financial policies and strategies and insight into future performance
10-K and 10-Q
3
Income Statement Overview 1 Also called
• earnings statement• profit & loss statement
Matches revenues & expenses over a period of time, e.g., past fiscal quarter or year
‘Flow’ measure statement• Each value on an income statement represents cumulative
amount of that item through the accounting period
Profit vs. Cash flow• Seldom the same
4
Income Statement Overview 2Income StatementCompany Name
For the time period ending date
Net Sales- Cost of Goods Sold- Operating Expenses- Depreciation= Operating Profit- Interest Expense= Profit Before Taxes- Taxes= Net Income
•Operating income
•Earnings before interest & taxes (EBIT)
•Earnings before taxes (EBT)
•Earnings
•Net profit
5
Income Statement Items 1• Net sales
= Gross sales – (returns & allowances)
• Cost of Goods Sold (COGS)
include raw material and labor costs
6
Income Statement Items 2 Operating expenses
• Include management salaries, advertising expenditures, repairs & maintenance, R&D, general & administrative expenses, lease payments.
Interest expense• Cost of borrowing money
Taxes• Federal, state and/or local levels
Net income• ‘bottom line’ of income statement• Base profit earned during accounting period
7
Income Statement Items 3 Earnings per common share (EPS)
Net income available to common shareholders
# common shares outstanding
indicator of firm’s current performance
Income Statement Items 3 Companies with complex capital
structures, which means existence of convertible securities (such as bonds convertible into common stock) and stock options, must calculate two amounts for earnings per share: basic and diluted.
8
Where does Net Income go?
NI = Retained Earnings + Dividend Payout
Common Dividends per share (DPS)common stock dividends paid
# common shares outstanding
9
IBM’s Income Statement Where to find?
10
11
ExamplePrepare a multi-step income statement for the ABC company for the year ending Dec 31, 2006, given the information below:
Advertising expenditures 68,000Cost of goods sold 2,433,000Depreciation 78,000Gross sales 3,210,000Interest expenses 64,000Lease payment 52,000Management salary 240,000Material purchase 2,425,000R&D expenditures 35,000Repair and maintenance costs 22,000Returns and allowances 48,000Taxes 51,000
12
SolutionGross Sales 3,210,000
Return and Allowance 48,000
Net Sales 3,162,000
Cost of Goods Sold 2,433,000
Gross Profit 729,000
Operating Expenses 417,000
Depreciation 78,000
EBIT 234,000
Interest Expense 64,000
EBT 170,000
Tax 51,000
Net Income 119,000
13
Overview of Balance Sheet Show what a company owns vs. owes at
a specific point in time. Categorizes company’s resources as:
• Assets• Liabilities• Owner’s equity
Balance sheet identity:
Total Assets = Total Liabilities + Shareholders’ Equity
14
Assets Liabilities and Owners Equity
CashMarketable securities Accounts ReceivableInventories
Total Current Assets
Gross Fixed Assets(less Accum. Depreciation)
Net Fixed AssetsOther long-term investments such as stock and bonds
Total 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 Overview
S.T. Funds
L.T. Capital
15
Balance Sheet Items: Current Assets 1
Current asset : Easily converted into cash within a year Cash
• Most liquid asset; frequently represented by demand deposits
Marketable Securities: e.g. short-term T-bills Accounts Receivable (A/R) Occurs because
company sells products/services on credit
16
Inventory• Raw materials, work in process (WIP), finished goods• Different valuation methods: FIFO, LIFO, average cost
Total current assets
= Cash + Marketable Securities + A/R + Inventory
Balance Sheet Items: Current Assets 2
17
Balance Sheet Items: Long-term assets 1
Fixed assets• Equipment, buildings, vehicles, computers etc• Permanent nature; needed for business operations• Reported at book value
= original historical cost – allowable depreciation Gross fixed assets (GFA): original cost of assets Accumulated depreciation (AD)
• Straight-line • Accelerated cost recovery
Net fixed assets (NFA) = gross fixed assets – accumulated depreciation
Example: GFA, AD, NFA.
18
Balance Sheet Items: Long-term assets 2
Total assets = Current assets + long-term assets
Assets (LHS of balance sheet) must be financed by a combination of liabilities and owner’s equity (RHS of balance sheet)
firms should try to finance assets with the lowest cost funds available. Not only is it important for a firm’s financial managers to focus on assets, they must focus on the structure and composition of liabilities and net worth as well.
19
Balance Sheet Items:Liabilities & Equity 1
Current liabilities1. Notes payable
2. Accounts payable
3. Accrued expenses (accruals)
4. Current portion of long-term debt 1+2+3+4 = total current liabilities
Long-term debt1. Liabilities with maturities in excess of 1 year
20
Balance Sheet Items:Liabilities & Equity 2
Total liabilities• = current liabilities + L.T. debt
Preferred stock• Like debt: Pays fixed periodic dollar amount• Like equity: If payment is not made,
company is not in default• Preferred dividends are usually cumulative;
no voting rights
21
Balance Sheet Items:Liabilities & Equity 3
Common stock• Common stock at par
No. of shares outstanding =common stock book value
Par value per share
• Additional paid-in capital (capital surplus) Additional money generated when company sold stock
Retained earnings• Cumulative total of all net income reinvested into
the company• Annual addition to retained earnings
= net income – dividends paid Example: RE, NI, dividend, annual RE
22
Balance Sheet Items:Liabilities & Equity 4
Common Shareholders’ equity
= common stock at par +
additional paid-in capital +
retained earnings
Common equity also known as:• Net worth, owners’ equity or book value of
firm’s equity
• What is the market value of the firms’ equity?
23
Market Value Added (MVA)
Market Value of Equity 2010:• (100,000)($6.00) = $600,000.
Book Value of Equity 2010:• $557,632.
MVA = $600,000 - $557,632 = $42,368.
24
Balance Sheet Items:Liabilities & Equity 5
Total liabilities and equity = total liabilities +
preferred stock (if any) +
shareholders’ equity
• Must equal total assets
IBM’s Balance Sheet Where to find?
25
26
exampleFrom the following accounts, prepare a balance sheet for the BCD company for the year ending Dec 31, 2006:
Gross fixed assets 284,950Inventory 136,500Accrued expenses 11,850Accumulated depreciation 82,310Notes payable 32,570Preferred stock 8,000Retained earnings 89,280Current portion of L-T debt 4,080Long-term debt 134,300Accounts receivable 105,770Additional paid-in capital 71,600Accounts payable 50830Common stock ($0.20 par) 60,000Cash ?
Solution
27
cash x notes payable 32570
A/R 105770 Accounts payable 50830
Incentory 136500 current portion of LT debt 4080
Current Asset 242270+x Accrued expenses 11850
Current liability 99330
long-term debt 134300
total liability 233630
Gross fixed asset 284950 common stock 60000
accumulated dep. 82310 additional paid-in 71600
Net fixed asset 202640 prefered stock 8000
retained earnings 89280
Equity 228880
total asset 444,910+x Liability and Equity 462510
example What does the balance sheet summarize
for a business enterprise?
(a) Operating results for period
(b) Financial position at a point in time
(c) Financing and investment activities for a period
(d) Profit or loss at a point in time
28
Effect of Debt vs. Equity Financing on Return
29
assets $12 miloperating income $5 mil
case 1 12 mil equity 0 debtcase 2 1 mil equity 11 mil debtr=10%
case 1 case 2operating income 5 5less: interest 0 1.1Taxable income 5 3.9less: tax (30%) 1.5 1.17Net Income 3.5 2.73
Return on Equity 3.5/12=29% 2.73/1=273%Income availabe toasset funders(operating income - tax) 3.5 3.83return on asset funder's investment 3.5/12=29% 3.83/12=31.92%
30
Manipulating financial dataExamples:
• Adjusting credit terms to affect net sales • Switching inventory valuation methods• Choice of depreciation method: straight-line
method smoothes earnings • Discretionary expense items such as R&D
Example (million)
31
Net Sales 400
COGS 260
Gross Profit 140
Operating Expenses 70
Operating Income 70
Interest Paid 20
Earnings before taxes 50
Taxes 30
Net Income 20
Questions
1. Was the company profitable?
2. Did the company indeed receive 20 million cash as profit in its bank account?
32
33
Learning Objectives of Statement of Cash Flows
Understand difference between net profit and net cash flow.
Construct statement of cash flows using indirect method.
Use the statement of cash flows to analyze a company.
34
Net profit vs. net cash flow
Net profit firm performance
under accrual method of accounting
Easily manipulated
Net cash flow firm performance in
terms of ability to generate cash
Harder to manipulate
Net profit does not equal net cash flow
35
Statement of Cash Flows Provides information about cash inflows
and outflows during an accounting period Focuses on CASH. Has THREE sections:
• Cash flow from Operating Activities (OCF)• Cash flow from Investing Activities (ICF)• Cash flow from Financing Activities (FCF )
36
Useful TipCash flow from Operating Activities
+
Cash flow from Investing Activities
+
Cash flow from Financing Activities
= CHANGE in cash account for the period!
37
Another Useful TipNo matter which section you are doing (operating,
investing or financing), IF the change is a cash INFLOW, you add that
change. + IF the change is a cash OUTFLOW, you
subtract that change. -inflow: decreases in assets or increases in liabilities or
equity.outflow: increases in assets or decreases in liabilities or
equity.
38
Cash flows from operating activities
Net income
+ Depreciation
+ Decrease in any asset account related to IS
- Increase in any asset account related to IS
- Decrease in any liability account related to IS
+ Increase in any liability account related to IS
= Net cash flow from operating activities
IS means Income
Statement
39
Cash flows from operating activities 3
Asset accounts related: Accounts receivable Inventories
Liability accounts related: Accounts payable Accruals
Warning: Notes payable NOT included! Belongs to financing activities.
40
Cash flows from operating activities 4
Asset Liability
Decreases Add
(cash inflow)
Subtract
(cash outflow)
Increases Subtract
(cash outflow)
Add
(cash inflow)
41
Cash flows from investing activities 1
Investing activities:
• Buying or selling productive assets
(plant & equipment)
• Buying or selling financial securities that
expire after 1 year
(e.g., stock of other companies, bonds)
42
Cash flows from investing activities 2
Inflows: Means:Decrease in gross fixed assets Firm sells long-lived assets such as
gross property, plant and equipment
Decrease in long-term investments
Firm sells debt or equity securities of other firms
Outflows:Increase in gross fixed assets Firm buys long-lived assets such as
gross property, plant and equipment
Increase in long-term investments
Firm buys debt or equity securities of other firms
43
Cash flows from investing activities 3
Investing activities refer to changes on the lower left-hand side of balance sheet
Warning: we want changes in GROSS fixed assets. We don’t want the changes in net fixed assets!
BUT, if gross fixed assets not reported in balance sheet, ….?
44
Useful relationships1) Change in gross fixed assets
= change in net fixed assets
+ depreciation
2) Depreciation (on IS)
= change in accumulated depreciation (on BS)
45
Assets Liabilities and Owners Equity
CashMarketable securities Net A/RInventories
Total Current Assets
Gross Fixed Assets(less Accum. Depreciation)
Net Fixed AssetsOther long-term assets such asstocks and bonds
Total 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 Overview
S.T. Funds
L.T. Capital
46
Cash flows from financing activities 1
Financing activities:
• Loans from creditors (long-term, short-term)
• Repayment of principal
• Sale or repurchase of stock (common or
preferred) from firm’s equity holders
• Payment of dividends
47
Cash flows from financing activities 2
Inflows: Means:
•increase in notes payable •increase in long-term debt
Firm borrows money
•increase in common stock Firm sells equity securities
Outflows:
•decrease in notes payable•decrease in long-term debt
Firm repays debt
•decrease in common stock Firm buys back shares
•Payment of dividends Firm pays cash to shareholders
48
Cash flows from financing activities 3
Financing activities refer to:• Items on lower right-hand side of balance
sheet (long-term debt, equity)
• Changes in notes payable (short-term bank loans).
Useful relationship:
Dividends paid
= net income – change in retained earnings
IBM’s Statement of Cash Flow Where to find?
49
50
Solve Assignment 3.1
51
Analyzing Statement of Cash Flows 1
Statement of CF can help you analyze a company:
1) Relationship between net income and net cash flow from operations (OCF)
If net income positive, but OCF is negative, could mean:
Company is growing rapidly Financial mis-management
52
Analyzing Statement of Cash Flows 2
2) Net cash flow from investing activities (ICF)
If negative, company is making investments Buying plant & equipment (improve
efficiencies) Buying another company’s stock (strategic
reasons, e.g., joint venture)
If positive, company is liquidating assets. Why? Financial distress?
53
Analyzing Statement of Cash Flows 3
3) Does company have sufficient cash to pay dividends?
OCF should exceed dividends.
If dividends exceed OCF, why? Company liquidated assets to pay dividends? Company issued equity or borrow to pay
dividends? Neither situation is good.
54
Analyzing Statement of Cash Flows 4
4) Changes in debt Look at cash flow from financing
activities Big increases in debt (either short-term
or long-term) are not good. Substituting short-term debt for long-term
debt may indicate worsening financial health.
Summary Income Statement Balance Sheet Statement of Cash Flow Assignment:
1. Textbook problems (page 86):3-2, 3-3, 3-4, 3-8, 3-9
2. additional cash flow assignment on course web
55
Recommended