Chapter 2 Financial Statements, Taxes and Cash FlowsMay 071Financial Statements, Taxes&Cash Flows2Basic Financial StatementsAnnual report includes:Balance sheetIncome statementStatement of Retained EarningsCash Flows3Basic Financial StatementsBalance SheetAssets = Liabilities + Owner’s EquityCurrent AssetsCash + MSA/RInventoryFixed AssetsLandPlantEquipmentLess:DepreciationCurrent LiabilitiesA/PNotes PayableAccrualsL-T LiabilitiesBondsPreferred StockCommon StockPar ValuePaid in CapitalRetained Earnings4Basic Financial StatementsBalance SheetSimsboro Computer CompanyAssets Liabilities Cash $175Accounts Receivable 430Inventories 625Current Assets $1,230Plant & Equipment $2,500Less:Acc. Depr. (1,200)Net Fixed Assets $1,300Total Assets $2,530Accounts Payable $115Accruals 115Current Liabilities $230Bonds $600Owner’s EquityCommon Stock $300Paid-in Capital 600Retained Earnings 800Total Owners’ Equity$1,700Total Liabilities andOwners Equity $2,5301,230– 2301,000Net Working Capital = Current Assets– Current LiabilitiesChapter 2 Financial Statements, Taxes and Cash FlowsMay 075Basic Financial StatementsIncome StatementRevenues - Expenses = Net IncomeSalesInvestment IncomeGainsInterest ReceivedDividend ReceivedCOGSSalariesDepreciationTaxesOther ExpensesInterest PaidDividendsRetainedEarnings7Basic Financial StatementsThe income statement for the Simsboro Computer Company:Income StatementSimsboro Computer CompanyRevenueExpensesProfitDistribution of ProfitSubtotalSales $1,450Cost of Goods Sold 875Gross Profit $575Operating Expenses 45Depreciation 200EBIT $330Interest Expense 60Net Income Before Taxes $270Taxes (40%) 108Net Income $162Dividends Paid 100Addition to Retained Earnings $628Basic Financial StatementsBalance SheetSimsboro Computer CompanyCash $175 Accounts Payable $115Accounts Receivable 430 Accruals 115Inventories 625 Current Liabilities $230Current Assets $1,230 Bonds $600Plant & Equipment $2,500 Owner’s EquityLess:Acc. Depr. (1,200) Common Stock $300Net Fixed Assets $1,300Paid-in Capital 600Total Assets $2,530 Retained Earnings 800Total Owners’ Equity $1,700Total Liabilities andOwners Equity $2,530Assets Liabilities Income StatementSimsboro Computer CompanySales $1,450Cost of Goods Sold 875Gross Profit $575Operating Expenses 45Depreciation 200Net Operating Income $330Interest Expense 60Net Income Before Taxes $270Taxes (40%) 108Net Income $162Dividends Paid 100Addition to Retained Earnings $62Statement of Retained EarningsSimsboro Computer CompanyRetained Earnings (Dec 31, 2001) $738Add: Net Income 2002 162Less: Dividends to Common Stockholders 100Balance of Retained Earnings Dec 31, 2002 $800Statement of Retained Earnings10Federal Income TaxationMarginal / Average Tax RatesMarginal = Tax Rate on the next dollar of income.Average = Taxes paid, divided by taxable income.Progressive Tax SystemAverage tax rate increases with the level of taxable income.Marginal tax rate is greater than or equal to the average tax rate.Chapter 2 Financial Statements, Taxes and Cash FlowsMay 0711Federal Income TaxationTax ComputationTaxable Income Tax Rate$0 - $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%Corporate Tax Rates16Federal Income TaxationCorporate Tax RatesTaxable Income Tax Rate$0 - $50,000 15%$50,001 - $75,000 25%$75,001 - $100,000 34%$100,001-$335,000 39%1st Bracket $50,000 x15% =$ 7,5002nd Bracket $25,000 x25% =$ 6,2503rd Bracket $25,000 x34% =$ 8,5004th Bracket $60,000 x39% =$23,400$45,650 Tax LiabilityTax Computation ExampleCompute Tax for Corporation with Taxable Income of $160,00018Federal Income TaxationCorporate Tax RatesMarginal tax rate = 39%Average = Tax Liability= $45,650 = 28.53%Tax Rate Taxable Income $160,000Tax Computation ExampleCompute Tax for Corporation with Taxable Income of $160,000Taxable Income Tax Rate$0 - $50,000 15%$50,001 - $75,000 25%$75,001 - $100,000 34%$100,001-$335,000 39%190.00%10.00%20.00%30.00%40.00%50.00%5000075000 100,000 335,000AverageMarginal10,000,000 15,000,000 18,333,333Comparison of Marginal & Average Rates$160,00039%28.53%Chapter 2 Financial Statements, Taxes and Cash FlowsMay 0720AverageMarginalComparison of Marginal & Average RatesMarginal Rate = Average RateTaxes on $4,500,000 = .34(4,500,000) = $1,530,0000.00%10.00%20.00%30.00%40.00%50.00%5000075000 100,000 335,00010,000,000 15,000,000 18,333,333$4,500,00034%34%21AverageMarginalComparison of Marginal & Average RatesTaxes on $12,500,000 = .34(10,000,000) = $3,400,0000.00%10.00%20.00%30.00%40.00%50.00%5000075000 100,000 335,00010,000,000 15,000,000 18,333,333$12,500,00035%34%>AVG>35%+ .35(2,500,000) = $875,000$4,275,000 AVG RATE?22The Concept of Cash FlowsIncome Statement Measures Accounting ProfitsDoes not take into account the actual Cash FlowsAdditional investments in assetsPayments to investorsCapital raised from investorsCash Flows measure how cash is generated from utilizing assets and how it is paid to those that finance the purchase of the assetsFocus of many of the recent accounting scandals (AOL, WorldCom)Inflating earnings using GAAP, but cannot inflate the Cash Flow of the firm.23Firm’s Cash Flows from assets=Cash Flow to InvestorsCash flows generated through the firm’s1. operations 2. investments in assets=Cash flows 1. paid to the firm’s investors 2. or received by the firm’s investorsFirm’s Cash FlowsChapter 2 Financial Statements, Taxes and Cash FlowsMay 0724Cash Flows From AssetsOverview of CalculationOperating Cash FlowsCash flows generated from the OPERATIONS of the FirmChange in net working capitalChange in Net Working CapitallessCapital SpendingChange in grossfixed assetsless25Cash Flows From AssetsOverview of CalculationEnding NWC– Beginning NWCEnding Net Fixed Assets– Beginning Net Fixed Assets+ DepreciationOperating income (EBIT)+ depreciation - cash tax paymentsChange in net working capitalCapital SpendingOperating Cash Flowslessless26Operating Cash FlowsOverview of CalculationOperating income (EBIT)+ depreciation - cash tax paymentsIncome StatementSimsboro Computer CompanySales $1,450Cost of Goods Sold 875Gross Profit $575Operating Expenses 45Depreciation 200Net Operating Income $330Interest Expense 60Net Income Before Taxes $270Taxes (40%) 108Net Income $162Dividends Paid