Slide 1Balance SheetBalance Sheet – Financial ConcernsA Typical Balance SheetBalance Sheet – Financial ConcernsIncome StatementAn Income StatementAn Income StatementAn Income StatementIncome Statement – Key FactsAverage Tax RateTax RatesNet Working CapitalBalance Sheet and Change in NWCFinancial Cash FlowCalculating Financial Cash FlowFinancial Cash FlowsFinancial Cash FlowsFinancial Cash FlowsFinancial Cash FlowsFinancial Cash FlowsFinancial Cash FlowsAccounting Statement of Cash FlowCash Flow from Operating ActivitiesCash Flow from Investing ActivitiesCash Flow from Financing ActivitiesCash Flows in Accounting & FinanceStatement of Cash Flows© J. David Miller 2017Accounting ValueChapter 2 Finance 357Balance SheetBalance Sheet – Snapshot of accounting value on a specific dateAssets on left sideLiabilities and Stockholder’s equity on right sideAssets = Liabilities + Stockholder’s Equity2Balance Sheet – Financial ConcernsAccounting Liquidity – quickness with which assets can be converted to cashCurrent Assets are the most liquid (Cash, short-term notes)Accounts Receivable is next with payments forthcoming and ability to factor themInventory is more difficult to convert to cash as it must be sold firstFixed Assets are most difficult to convert to cash as they usually aren’t meant to be resold3A Typical Balance SheetBalance Sheet – Financial ConcernsDebt versus EquityDebt requires fixed payments of interest and principle over time. First claim in bankruptcyEquity only has a residual claim on firm assets and does not require any ongoing payments. Behind debt holders in bankruptcyValue versus CostGenerally, GAAP requires that financial statements carry assets at costCan be very misleading because market values of assets often vary from their original costIn Finance, Value implies market value not cost5Income StatementIncome Statement – measures performance over specific time periodImportant Income Statement ValuesOperating IncomeEarnings before interest and taxes (EBIT)Earnings per share (EPS)6Total operating revenuesCost of goods soldSelling, general, and administrative expensesDepreciationOperating incomeOther incomeEarnings before interest and taxesInterest expensePretax incomeTaxes Current: $71 Deferred: $13Net income Addition to retained earnings $43 Dividends: $43The operations section of the income statement reports the firm’s revenues and expenses from principal operations.$2,262 1,655 327 90$190 29$219 49$170 84$86An Income StatementTotal operating revenues $2,262Cost of goods sold 1,655Selling, general, and administrative expenses 327Depreciation 90Operating income $190Other income29Earnings before interest and taxes $219Interest expense 49Pretax income $170Taxes 84 Current: $71 Deferred: $13Net income $86 Addition to retained earnings: $43 Dividends: $43The non-operating section of the income statement includes all financing costs, such as interest expense.An Income StatementTotal operating revenuesCost of goods soldSelling, general, and administrative expensesDepreciationOperating incomeOther incomeEarnings before interest and taxesInterest expensePretax incomeTaxes Current: $71 Deferred: $13Net income Retained earnings: $43 Dividends: $43Net income is the “bottom line.”$2,262 1,655 327 90$19029$219 49$170 84$86An Income StatementIncome Statement – Key FactsImportant points to rememberIncome is reported when it is earned, not when it is collectedNon-cash items are included in the income statementDepreciationDeferred TaxesFootnotes to income statement may provide important details not explicitly explained in the statement itself10Average Tax RateAverage Tax RateThe Average Tax rate is the tax bill divided by taxable incomeTaxable Income $10,000,000Taxes Paid $ 3,500,000Average Tax Rate = 3,500,000 / 10,000,000 = 35%11Tax RatesMarginal Tax RateThe Marginal Tax rate is the tax rate that would be paid on one more dollar of incomeIn decision making, Marginal Tax Rate is most importantTaxable Income $ 250,00050,000 X 15% = $7,500(75,000-50,000) X 25% = $6,250(100,000-75,000) X 34% = $8,500(250,000-100,000) X 39% = $58,500Taxes Due = $80,750Average Tax Rate = ($80,750 / $250,000) = 32.3%Marginal Tax Rate = 39%12Net Working CapitalNet Working Capital = Current Assets – Current LiabilitiesNWC usually grows with the firm132014 2013 2014 2013Current assets: Current Liabilities: Cash and equivalents $198 $157 Accounts payable $486 $455 Accounts receivable 294 270 Inventories 269 280 Total current liabilities$486 $455 Total current assets $761 $707Long-term liabilities:Fixed assets: Deferred taxes $117 $104 Property, plant, and equipment $1,423 $1,274 Long-term debt 471 458 Less accumulated depreciation (550) (460 Total long-term liabilities $588 $562 Net property, plant, and equipment 873 814 Intangible assets and other 245 221 Stockholder's equity: Total fixed assets $1,118 $1,035 Preferred stock $39 $39 Common stock ($1 par value) 55 32Here we see NWC grow to $275 million in 2014 from $252 million in 2013. This increase of $23 million is an investment of the firm.$23 million$275m = $761m- $486m$252m = $707- $455Balance Sheet and Change in NWCFinancial Cash FlowCalculation of Financial Cash FlowStatement of Cash Flow is helpful, but Financial Cash Flows are the basis of firm valueFinancial Cash Flow not the same as Net Working Capital (Cash & Inventory both Current Assets)Financial Cash Flow FormulaCF from (Assets) = CF to (Bondholders) + CF to (Stockholders)Cash generated by operations is used to pay debts and provide return to shareholders.15Calculating Financial Cash FlowStep 1 – Cash Flows to FirmOperating Cash FlowMinus Capital SpendingMinus Additions to Net Working CapitalStep 2 – Cash Flow to InvestorsCash Flow to Debt HoldersCash Flow to Equity Investors16Cash Flow of the FirmOperating cash flow$238 (Earnings before interest and taxes plus depreciation minus taxes)Capital spending -173 (Acquisitions of fixed assets minus sales of fixed assets)Additions to net working capital -23 Total $42Cash Flow of Investors in the FirmDebt $36 (Interest plus retirement of debt minus long-term debt