Chapter 3 - Financial Statements, Cash Flows, and Taxes
- Financial Statements and Reports
Annual reports contain a narrative on how company is going. It also
contains four financial statements (Balance sheet, income statement,
statement of retained earnings, and statement of cash flows), to show
what is really happening. These both work together to tell us about the
company. - The Balance Sheet.
A balance sheet is a snapshot of a company, usually on the last day of
business for the year but can be done at any time. It will be different
for what ever day it is run.
The left side lists Assets (money or things that can be converted to cash
within a year). The right side will be liabilities and equity (money we
owe to others).
- Assets
- Money
- Quickly converted securities
- account receivable
- Inventories (LIFO and FIFO methods of accounting can affect the
numbers) - Depreciation of plant and equipment
- Liabilities
- Accounts Payable
- Notes Payable
- Long Term Bonds
- Preferred Stock Dividends
- Common Stock Dividends
- Retained Earnings
Total liabilities should be equal to total assets.
- Assets
- The Income Statement
Income statement shows numbers over the year. It will start with Net
Sales and will subtract form the the operating costs. This gives us
Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA).
After this, things are listed and removed from the EBITDA that will
affect tax payments (Depreciation and amortization). This is followed by
Interest and then Taxes. Preceded and then common dividends follow.
Lastly, information about per share numbers are posted. - Statement of Retained Earnings
This statement starts with what a company started with last year and
then adds in income for the year. It then subtracts dividends to give us
retained earnings for the year. - Net Cash Flow
Net Cash Flows are figured by the information from statements.
Net Cash Flow = Net Income - Noncash revenues + Noncash charges
Noncash charges would be depreciation and amortization. Noncash
revenues often net out as $0 so a good rewrite on the equation would
be
Net Cash Flow = Net Income + Depreciation and Amortization
Depreciation takes the cost of a machine and expenses it over the life
of the machine instead of just the year that it is purchased. It must be
added back here so that we can get a true net income. - Statement of Cash Flows
This statement summarizes where cash went throughout the year. It
contains:
- Operating Activities
- Investing Activities
- Financing Activities
Profits can be doctored in many ways but it would be difficult to do
so and have the statement of earnings still look good. - Modifying Accounting Data for Managerial Decisions
- Operating Assets and Total Net Operating Capital
Because two firms, or even two divisions in a company can use
different accounting methods, it is necessary to find ways to compare
them. To do so we compare operating income and operating assets.
First we need to modify total assets. It becomes Operating Assets
(necessary to run business) and non-operating assets (cash and short
term inventory above what is needed to run company).
Operating Assets are then further divided to operating current
assets (inventory) and long term operating assets (plans and
equipment) We will also have operating current liabilities (accrued
wages and taxes) so that:
Net Operating Working Capital = Operating Current Assets -
Operating Current Liabilities
We also have:
Total Net Operating Capital = Net Operating Working Capital - Long
Term Assets.
- Net Operating Profit After Taxes (NOPAT)
NOPAT = EBIT * (1 - Tax Rate)
EBIT is from the Income Statement (tax rate is listed there as
well).
- Free Cash Flows
Free Cash Flows (FCF) is cash flow actually available for
distribution to investors after investment in fixed
assets and working capital necessary to sustain operations have been
taken out.
- Calculating Free Cash Flows
FCF = NOPAT - Net investment in operating capital
Gross Investment in Operating Capital = Net Investment +
Depreciation
FCF = (NOPAT + Depreciation) - Gross Investment in Operating
Capital
- The Uses of FCF
- Pay Interest to debt holders
- Repay Debt holders (pay off debt)
- Pay dividends to stockholders
- Purchase Stock from shareholders
- Buy marketable securities or other non-operating assets
- FCF and Corporate Value
The value of a firm primarily depends on its expected FCF.
- Evaluating FCF, NOPAT, and Operating Capital
Negative FCF is not necessarily a bad thing. Staying negative for
a long rimland letting it continue could be. Negative FCF could be
due to investing in equipment for growth purposes. Also, if the NOPAT
and the FCF is both negative, this needs to be a warning. Check the
Return of Invested Capital (ROIC) to see if it is in the right range
of what an investor should be looking for, the Weighted Average Cost
of Capital. If ROIC is above WACC then it is usually a good
investment.
- Operating Assets and Total Net Operating Capital
- MVA and EVA
- Market Value Added (MVA)
MVA = Total Market Value - Total Capital
Total Market Value = (Market Value of Stock + Market Value of
Debt).
- Economic Value Added (EVA)
EVA = NOPAT - After Tax Dollar Cost of Capital Used to SUpport
Operations
EVA = EBIT * (1 - Tax Rate) - Net Operating Capital /WACC
EVA = (Operating Capital) * (ROIC - WACC)
EVA is an estimate of a business's true economic profit for the
year. There is a relationship between MVA and EVA but it is no t a
direct one. However, if one is either negative or positive, the other
is usually the same sign.
- Market Value Added (MVA)
- The Federal Tax System
- Corporate Income Taxes
Taxes are figured by income time the tax percentage charged by the
government.
- Interest and Dividend Income Received by a Corporation
A company can take 70% of income that it receives as a
dividend of another corporation and not have to pay taxes on it.
Also if a company pays out dividends to shareholders, those
share holders have to pay taxes on them on top of the taxes the
company paid. For that reason it may be worthwhile to invest in
another corporation and get a tax break and an income as well.
- Interest and Dividends Paid by a Corporation
Because debt reduces income before taxes, $1 paid to debt does
not equal $1 paid out as dividends, it is better to pay off debt
that to pay out dividends.
- Corporate Capital Gains
Laws used to be in favor of these but are now not longer that
way.
- Corporate Loss, Carry-Back and Carry-Forward
If a company takes a loss one year, then the losses can be
claimed against the previous two years (and get a refund from
them), and then what is left can be claimed on future taxes up
till 20 years from now.
- Inappropriate Accumulation to Avoid Payment of Dividends
The IRS does not want corporations to hold what would be paid
out in dividends. They set a limit of what could be held at
$250,000 unless a company has a good reason for doing so.
- Consolidated Corporate Tax Returns
When a company owns 80% of another company, the companies can
file taxes jointly so that losses from one company can help out
the more prosperous company.
- Interest and Dividend Income Received by a Corporation
- Taxation of Small Business Corporations
Small business that meet IRS rules may incorporate for protection
as an S corporation but still have the income distributed to the
owners at a pro-rated rate to ownership.
- Personal Taxes
This section deals with various taxes that must be paid and how
they affect personal income.
- Corporate Income Taxes
Posts
No comments:
Post a Comment