Ch,2 - Understanding Financial
Statements,Taxes,and Cash Flows
? 2002,Prentice Hall,Inc,
SALES
- EXPENSES
= PROFIT
Income Statement
SALES
- EXPENSES
= PROFIT
Income Statement
Revenue
Income Statement
SALES
- EXPENSES
= PROFIT
Income Statement
SALES
- EXPENSES
= PROFIT
?Cost of Goods Sold
Income Statement
SALES
- EXPENSES
= PROFIT
?Cost of Goods Sold
?Operating Expenses
Income Statement
SALES
- EXPENSES
= PROFIT
?Cost of Goods Sold
?Operating Expenses
(marketing,administrative)
Income Statement
SALES
- EXPENSES
= PROFIT
?Cost of Goods Sold
?Operating Expenses
(marketing,administrative)
?Financing Costs
Income Statement
SALES
- EXPENSES
= PROFIT
?Cost of Goods Sold
?Operating Expenses
(marketing,administrative)
?Financing Costs
?Taxes
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
Income Statement
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
Income Statement
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
Income Statement
Balance Sheet
Total Assets =
Outstanding
Debt
+
Shareholders’
Equity
Balance Sheet
Balance Sheet
Assets
Balance Sheet
Assets Liabilities (Debt) & Equity
Balance Sheet
Assets Liabilities (Debt) & 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 notes
Long-Term Liabilities
Long-term notes
Mortgages
Equity
Preferred Stock
Common Stock (Par value)
Paid in Capital
Retained Earnings
Assets
? Current Assets,
Assets
? Current Assets,assets that are relatively
liquid,and are expected to be converted to
cash within a year,
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,
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,
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,
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,
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,
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,
Financing
? Debt Capital,
Financing
? Debt Capital,financing provided by a
creditor,
Financing
? Debt Capital,financing provided by a
creditor,
? Short-term debt,
Financing
? Debt Capital,financing provided by a
creditor,
? Short-term debt,borrowed money that
must be repaid within the next 12 months,
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,
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,
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,
Financing
? Equity Capital,
Financing
? Equity Capital,shareholders’ investment in
the firm,
Financing
? Equity Capital,shareholders’ investment in
the firm,
? Preferred Stockholders,
Financing
? 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,
Financing
? Equity Capital,shareholders’ investment in
the firm,
? Preferred Stockholders,received fixed
dividends,and have higher priority than
common stockholders in event of liquidation
of the firm,
? Common Stockholders,
Financing
? Equity Capital,shareholders’ investment in
the firm,
? Preferred Stockholders,received 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,
Corporate Income Tax Rates
Since 1993
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%
Free Cash Flows
Free cash flow,cash flow that is free and
available to be distributed to the firm’s
investors (both debt and equity investors)
Free Cash Flows
Firm’s Operating
Free cash flows =
Firm’s Financing
Free cash flows
Cash flows generated
through the firm’s
operations and
investments in assets
= Cash flows paid to - or received by - the firm’s investors
(creditors &
stockholders)
Calculating Free Cash Flows,
An Operating Perspective
After-tax cash flow
from operations
less
investment in net
operating
working capital
less
investments in fixed
and other assets
Calculating Free Cash Flows,
An Operating Perspective
After-tax cash flow
from operations
less
investment in net
operating
working capital
less
investments in fixed
and other assets
Operating income
+ depreciation
- cash tax payments
Calculating Free Cash Flows,
An Operating Perspective
After-tax cash flow
from operations
less
investment in net
operating
working capital
less
investments in fixed
and other assets
[Change in current
assets] -
[change in non-interest
bearing current liabilities]
Calculating Free Cash Flows,
An Operating Perspective
After-tax cash flow
from operations
less
investment in net
operating
working capital
less
investments in fixed
and other assets
Change in gross fixed
assets,and any other
assets that are on the
balance sheet,
Calculating Free Cash Flows,
A Financing Perspective
Interest payments to creditors
- change in debt principal
- dividends paid to stockholders
- change in stock
= Financing Free Cash Flows
Tax Example,
? Space Cow Computer has sales of $32
million,cost of goods sold at 60% of
sales,cash operating expenses of $2.4
million,and $1.4 million in
depreciation expense,The firm has $12
million in 9.5% bonds outstanding,
The firm will pay $500,000 in dividends
to its common stock holders,
? Calculate the firm’s tax liability,
Sales $32,000,000
Cost of Goods Sold (19,200,000)
Operating Expenses (2,400,000)
Depreciation Expense (1,400,000)
EBIT or NOI 9,000,000
Interest Expense (1,140,000)
Taxable Income 7,860,000
Income tax rate tax payment
$50,000 x,15 = $ 7,500
$25,000 x,25 = 6,250
$25,000 x,34 = 8,500
$235,000 x,39 = 91,650
$7,525,000 x,34 = 2,558,500
Total Tax payment $2,672,400
short cut,$7,860,000 x,34 = $2,672,400
Statements,Taxes,and Cash Flows
? 2002,Prentice Hall,Inc,
SALES
- EXPENSES
= PROFIT
Income Statement
SALES
- EXPENSES
= PROFIT
Income Statement
Revenue
Income Statement
SALES
- EXPENSES
= PROFIT
Income Statement
SALES
- EXPENSES
= PROFIT
?Cost of Goods Sold
Income Statement
SALES
- EXPENSES
= PROFIT
?Cost of Goods Sold
?Operating Expenses
Income Statement
SALES
- EXPENSES
= PROFIT
?Cost of Goods Sold
?Operating Expenses
(marketing,administrative)
Income Statement
SALES
- EXPENSES
= PROFIT
?Cost of Goods Sold
?Operating Expenses
(marketing,administrative)
?Financing Costs
Income Statement
SALES
- EXPENSES
= PROFIT
?Cost of Goods Sold
?Operating Expenses
(marketing,administrative)
?Financing Costs
?Taxes
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
Income Statement
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
Income Statement
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
Income Statement
Balance Sheet
Total Assets =
Outstanding
Debt
+
Shareholders’
Equity
Balance Sheet
Balance Sheet
Assets
Balance Sheet
Assets Liabilities (Debt) & Equity
Balance Sheet
Assets Liabilities (Debt) & 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 notes
Long-Term Liabilities
Long-term notes
Mortgages
Equity
Preferred Stock
Common Stock (Par value)
Paid in Capital
Retained Earnings
Assets
? Current Assets,
Assets
? Current Assets,assets that are relatively
liquid,and are expected to be converted to
cash within a year,
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,
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,
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,
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,
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,
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,
Financing
? Debt Capital,
Financing
? Debt Capital,financing provided by a
creditor,
Financing
? Debt Capital,financing provided by a
creditor,
? Short-term debt,
Financing
? Debt Capital,financing provided by a
creditor,
? Short-term debt,borrowed money that
must be repaid within the next 12 months,
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,
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,
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,
Financing
? Equity Capital,
Financing
? Equity Capital,shareholders’ investment in
the firm,
Financing
? Equity Capital,shareholders’ investment in
the firm,
? Preferred Stockholders,
Financing
? 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,
Financing
? Equity Capital,shareholders’ investment in
the firm,
? Preferred Stockholders,received fixed
dividends,and have higher priority than
common stockholders in event of liquidation
of the firm,
? Common Stockholders,
Financing
? Equity Capital,shareholders’ investment in
the firm,
? Preferred Stockholders,received 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,
Corporate Income Tax Rates
Since 1993
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%
Free Cash Flows
Free cash flow,cash flow that is free and
available to be distributed to the firm’s
investors (both debt and equity investors)
Free Cash Flows
Firm’s Operating
Free cash flows =
Firm’s Financing
Free cash flows
Cash flows generated
through the firm’s
operations and
investments in assets
= Cash flows paid to - or received by - the firm’s investors
(creditors &
stockholders)
Calculating Free Cash Flows,
An Operating Perspective
After-tax cash flow
from operations
less
investment in net
operating
working capital
less
investments in fixed
and other assets
Calculating Free Cash Flows,
An Operating Perspective
After-tax cash flow
from operations
less
investment in net
operating
working capital
less
investments in fixed
and other assets
Operating income
+ depreciation
- cash tax payments
Calculating Free Cash Flows,
An Operating Perspective
After-tax cash flow
from operations
less
investment in net
operating
working capital
less
investments in fixed
and other assets
[Change in current
assets] -
[change in non-interest
bearing current liabilities]
Calculating Free Cash Flows,
An Operating Perspective
After-tax cash flow
from operations
less
investment in net
operating
working capital
less
investments in fixed
and other assets
Change in gross fixed
assets,and any other
assets that are on the
balance sheet,
Calculating Free Cash Flows,
A Financing Perspective
Interest payments to creditors
- change in debt principal
- dividends paid to stockholders
- change in stock
= Financing Free Cash Flows
Tax Example,
? Space Cow Computer has sales of $32
million,cost of goods sold at 60% of
sales,cash operating expenses of $2.4
million,and $1.4 million in
depreciation expense,The firm has $12
million in 9.5% bonds outstanding,
The firm will pay $500,000 in dividends
to its common stock holders,
? Calculate the firm’s tax liability,
Sales $32,000,000
Cost of Goods Sold (19,200,000)
Operating Expenses (2,400,000)
Depreciation Expense (1,400,000)
EBIT or NOI 9,000,000
Interest Expense (1,140,000)
Taxable Income 7,860,000
Income tax rate tax payment
$50,000 x,15 = $ 7,500
$25,000 x,25 = 6,250
$25,000 x,34 = 8,500
$235,000 x,39 = 91,650
$7,525,000 x,34 = 2,558,500
Total Tax payment $2,672,400
short cut,$7,860,000 x,34 = $2,672,400
