CHAPTER 3 Financial Statements Cash Flow and Taxes

CHAPTER 3 Financial Statements, Cash Flow, and Taxes n Key Financial Statements n n n Balance sheet Income statements Statement of retained earnings Statement of cash flows Accounting income vs. cash flow Federal tax system 3 -1

Video: Olson Smart Finance 3 -2

The annual report n n Balance sheet – provides a snapshot of a firm’s financial position at one point in time. Income statement – summarizes a firm’s revenues and expenses over a given period of time. Statement of retained earnings – shows how much of the firm’s earnings were retained, rather than paid out as dividends. Statement of cash flows – reports the impact of a firm’s activities on cash flows over a given period of time. 3 -3

Balance sheet: Assets Cash A/R Inventories Total CA Gross FA Less: Dep. Net FA Total Assets 2005 7, 282 632, 160 1, 287, 360 1, 926, 802 1, 202, 950 263, 160 939, 790 2, 866, 592 2004 57, 600 351, 200 715, 200 1, 124, 000 491, 000 146, 200 344, 800 1, 468, 800 3 -4

Balance sheet: Liabilities and Equity 2005 Accts payable 524, 160 Notes payable 636, 808 Accruals 489, 600 Total CL 1, 650, 568 Long-term debt 723, 432 Common stock 460, 000 Retained earnings 32, 592 Total Equity 492, 592 Total L & E 2, 866, 592 2004 145, 600 200, 000 136, 000 481, 600 323, 432 460, 000 203, 768 663, 768 1, 468, 800 3 -5

Income statement Sales COGS Other expenses EBITDA Depr. & Amort. EBIT Interest Exp. EBT Taxes Net income 2005 6, 034, 000 5, 528, 000 519, 988 (13, 988) 116, 960 (130, 948) 136, 012 (266, 960) (106, 784) (160, 176) 2004 3, 432, 000 2, 864, 000 358, 672 209, 328 18, 900 190, 428 43, 828 146, 600 58, 640 87, 960 3 -6

Other data No. of shares EPS DPS Stock price Lease pmts 2005 100, 000 -$1. 602 $0. 11 $2. 25 $40, 000 2004 100, 000 $0. 88 $0. 22 $8. 50 $40, 000 3 -7

Statement of Retained Earnings (2005) Balance of retained $203, 768 earnings, 12/31/04 Add: Net income, 2005 (160, 176) (11, 000) Less: Dividends paid Balance of retained $32, 592 earnings, 12/31/05 3 -8

Statement of Cash Flows (2005) OPERATING ACTIVITIES Net income Add (Sources of cash): Depreciation Increase in A/P Increase in accruals Subtract (Uses of cash): Increase in A/R Increase in inventories Net cash provided by ops. (160, 176) 116, 960 378, 560 353, 600 (280, 960) (572, 160) (164, 176) 3 -9

Statement of Cash Flows (2005) L-T INVESTING ACTIVITIES Investment in fixed assets (711, 950) FINANCING ACTIVITIES Increase in notes payable Increase in long-term debt Payment of cash dividend Net cash from financing 436, 808 400, 000 (11, 000) 825, 808 NET CHANGE IN CASH (50, 318) Plus: Cash at beginning of year Cash at end of year 57, 600 7, 282 3 -10

What can you conclude about D’Leon’s financial condition from its statement of CFs? n n n Net cash from operations = -$164, 176, mainly because of negative NI. The firm borrowed $825, 808 to meet its cash requirements. Even after borrowing, the cash account fell by $50, 318. 3 -11

Did the expansion create additional net operating after taxes (NOPAT)? NOPAT = EBIT (1 – Tax rate) NOPAT 05 = -$130, 948(1 – 0. 4) = -$130, 948(0. 6) = -$78, 569 NOPAT 04 = $114, 257 3 -12

What effect did the expansion have on net cash flow and operating cash flow? NCF 05 = NI + Dep = ($160, 176) + $116, 960 = -$43, 216 NCF 04 = $87, 960 + $18, 900 = $106, 860 OCF 05 = NOPAT + Depreciation and amortization = ($78, 569) + $116, 960 = $38, 391 OCF 04 = $114, 257 + $18, 900 = $133, 157 3 -13

What was the free cash flow (FCF) for 2005? FCF 05 = [-$130, 948(1 – 0. 4) + $116, 960] – [($1, 202, 950 – $491, 000) + $70, 642] = -$744, 201 Is negative free cash flow always a bad sign? 3 -14

Economic value added (EVA) EVA = NOPAT – Annual dollar cost of capital n n In order to generate positive EVA, a firm has to more than just cover operating costs. It must also provide a return to those who have provided the firm with capital. EVA takes into account the total cost of capital, which includes the cost of equity. 3 -15

What is the firm’s EVA? Assume the firm’s after-tax percentage cost of capital was 10% in 2004 and 13% in 2005. EVA 05 = = NOPAT – (A-T cost of capital) (Capital) -$78, 569 – (0. 13)($1, 852, 832) -$78, 569 – $240, 868 -$319, 437 EVA 04 = $114, 257 – (0. 10)($1, 187, 200) = $114, 257 – $118, 720 = -$4, 463 3 -16