1FI3300Corporation Finance 010Spring Semester 2010Dr. Isabel TkatchAssistant Professor of Finance1Agenda☺Accounting Review: ☺ Income Statement Bln Sh t2☺Balance Sheet☺Background for the next 3 chapters: how to interpret and work with financial statementsLearning objectives☺ Income statement & Balance sheet☺ Identify & define items ☺ Construct basic financial statements☺Describe the difference between 3☺Describe the difference between accounting data and cash☺ Explain the importance of accounting to a business☺ Identify some ways in which a firm may (legally) manipulate its financial dataIncome Statement☺ The Income Statement is also called☺ Earnings Statement☺ Profit and Loss (P&L) Statement☺ Summary of the company’s 4yf p yRevenues (+) and Expenses (-)over a period of time (e.g., one quarter or one year)☺ A flow measureEach value on the income statement represents the cumulative amount of an item for the accounting periodIncome StatementNet Sales- Cost of Goods Sold (COGS)= Gross Profit- Operating Expenses = Operating Profit (EBIT)5 Operating Profit (EBIT)- Interest Expense= Profit Before Taxes (EBT)-Taxes= Net IncomeIncome Statement: Net SalesNet Sales = Gross Sales – (Returns and Allowances)Gross Sales: sale revenue is recorded when the ownership is transferred from the seller to the buyer (Accrual rather than Cash Accounting)Returns and Allowances: 6Returns and Allowances: not all sales will result in full payment (money-back guarantee, trial period, default etc.)Example: In 2006, Tanner, Inc. had Gross Sales of $1,253,400 andreported a Returns and Allowances estimate of $ 53,400What did Tanner, Inc. report as Net Sales in 2006? $ ________2Income Statement: COGSCost of Goods Sold = + Beginning Inventory+ Materials Purchases– Ending inventory7COST OF GOODS SOLD (COGS):direct costs of manufacturing/selling a productRetailer: COGS are the cost of materials purchased for resaleManufacturing company: materials, labor costs, manufacturing overheadService company: usually no COGS on their income statementIncome Statement: COGSExample: In 2006, Tanner, Inc. sold 25 shirts. The company purchased 45 shirts from the manufacturer in 3 batches:The first batch of 20 shirts @ $ 8 a shirtThe second batch of 15 shirts @ $10 a shirtThe third batch of 10 shirts @ $14 a shirt8The cost of 45 shirts: + 20 x $ 8 = $160+ 15 x $10 = $150+ 10 x $14 = $140= $450What is the cost of the 25 shirts that Tanner, Inc. sold in 2006?Inventory ValuationExample: In 2006, Tanner, Inc. sold 25 shirts. The company purchased 45 shirts from the manufacturer:The first batch of 20 shirts @ $ 8 a shirtThe second batch of 15 shirts @ $10 a shirtThe third batch of 10 shirts @ $14 a shirtFIFO (First In First Out): (20x$8 + 5x$10) / 25 = $ a shirt9FIFO (First In First Out): (20x$8 5x$10) / 25 $____ a shirt20 shirts @ $ 8 a shirt5 shirts @ $10 a shirtLIFO (Last In First Out): (20x$8 + 5x$10) / 25 = $____ a shirt20 shirts @ $ 8 a shirt5 shirts @ $10 a shirtAverage Cost (AC): (20x$8 + 15x$10 + 10x$14) / 45 = $____ a shirtIncome Statement: COGS, ACExample Continued: Assume that Tanner, Inc. had no inventory in the beginning of 2006 Assume that Tanner, Inc. assigns the Average Cost to each shirtCalculate the Cost Of Goods Sold (COGS)Beginning Inventory= $______10gg y$______Materials Purchases = $______Ending inventory = $______Cost of Goods Sold = $______ Income Statement: COGS, FIFOExample Continued: Assume that Tanner, Inc. had no inventory in the beginning of 2006 Assume that Tanner, Inc. use the FIFO methodCalculate the Cost Of Goods Sold (COGS)Beginning Inventory= $______11gg y$______Materials Purchases = $______Ending inventory = $______Cost of Goods Sold = $______ Income Statement: COGS, LIFOExample Continued: Assume that Tanner, Inc. had no inventory in the beginning of 2006 Assume that Tanner, Inc. use the LIFO methodCalculate the Cost Of Goods Sold (COGS)Beginning Inventory= $______12gg y$______Materials Purchases = $______Ending inventory = $______Cost of Goods Sold = $______3Income Statement:Operating ExpensesOperating Expenses:business-related expenses other than Cost Of Goods Sold (COGS) that the company incurs in the normal course of businessOperating Expenses include:13Management salariesAdvertising expendituresLease paymentsRepairs & maintenanceResearch and Development (R&D)General & administrative expenses (salaries to paper clips)Depreciation included in operating expenses for retail companiesIncome Statement:Interest and TaxesInterest Expense:The cost of borrowing money. Depends on the overall level of firm debt and the firm’s interest rateExample: In 2006, the company’s debt outstanding was $500,000 its annual interest rate was 8%. Tanner’s interest expense was:0 08 x$500 000 = $140.08 x$500,000 = $________.Income Taxes:Taxes are paid on the earned income (on earnings before taxes) at the federal, state and local levels Taxes are paid on an estimated basis throughout the yearTaxes owed are calculated at the end of the year based on the firm’s actual profit before taxesIncome Statement: Net Income, EPSNet Income (Net Profit, Earnings):The “bottom line” of the income statement. Reports the base profit earned by a firm in a given accounting period.Note that Net Profit (Earnings) ≠ Cash-FlowE i P Sh (EPS) 15Earnings Per Share (EPS) = Net Income / Number of Shares OutstandingExample: In 2006 Tanner, Inc. had 100,000 shares outstanding and its Earnings (income) Before Taxes (ETS) was $20,000. If the tax rate is 40%, calculate the Net Income and EPS.Net Income = 0.4 x $20,000 = $_______EPS = $______ / 100,000 = $_______Income StatementNet Sales- Cost of Goods Sold (COGS)= Gross Profit- Operating Expenses (excluding Depreciation)= Earnings Before Interest, Tax and Depreciation (EBITDA)16- Depreciation expenses= Earnings Before Interest and Tax (EBIT)- Interest Expense= Earnings Before Taxes (EBT)-Taxes= Earnings (= Dividend Payout + Addition to Retained Earnings)Income Statement: ExamplesBook Problem 2.4: Ruppert, Inc. (a hardware retail company), 2006Book Problem 2.5: Appully Company (a clothing retailer), 200617Balance Sheet☺ The Balance sheet is also called☺ Statement of Financial Position☺ Categorizes the company’s resources as:☺ Assets18☺ Liabilities☺ Shareholders’ Equity on a specific date (e.g., December 31, 2006)☺ A stock measure (snapshot)☺ Each value on the balance sheet is