Financial Management Basics: Key Concepts and Calculations

1. Intro to Financial Management Understanding Financial Statements and Cash Flows

2. Review Homework What are spot and future markets? What is a spread? What are nominal rates? What are real rates? What types of risk are involved in interest rates? How do you calculate real returns? How do you calculate simple, one-period, future values? What is liquidity? What is the Yield Curve?

3. The Income StatementCalculates the firm’s profit Amount Sales $100 COGS 45 _ Gross profit 55 Sales, General & Admin. 28 R&D 7 _ Operating income (EBITDA) 20 Interest, taxes, depreciation 15 _ Net income 5

4. The Income StatementCalculates the firm’s profit AmountPct. of Sales Sales $100 100% COGS 45 45% _ Gross profit 55 55% Sales, General & Admin. 28 28% R&D 7 7% _ Operating income (EBITDA) 20 20% Interest, taxes, depreciation 15 15% _ Net income 5 5%

5. The Income StatementCalculates the firm’s profit Sales COGS Gross profit Sales, General & Admin. R&D Operating income (EBITDA) Interest taxes depreciation Net income Operations run by COO Finance run by CFO

6. Income Statement Common-sized statement Gross profit margin Operating profit margin (EBIT) Net profit margin Earnings Earnings per share

7. Balance SheetShows what a company is worth Amount Assets Current Assets Cash $20 Accounts Receivable 45 Inventory 135 Long-term Assets (Fixed) Plant & Equipment 1,000 Liabilities & Owners Equity Current liabilities Short-term loans 15 Accounts Payable 35 Long-term Liabilities Long-term debt 500 Stockholders’ Equity Capital 150 Retained Earnings 500

8. Balance SheetShows what a company is worth AmountPct. of Assets Assets Current Assets Cash $20 2% Accounts Receivable 45 4% Inventory 135 11% Long-term Assets (Fixed) Plant & Equipment 1,000 83% Liabilities & Owners Equity Current liabilities Short-term loans 15 1% Accounts Payable 35 3% Long-term Liabilities Long-term debt 500 42% Stockholders’ Equity Capital 150 12% Retained Earnings 500 42%

9. Balance Sheet Common-sized Book value Gross working capital = current assets Net working capital = current assets – current liabilities Debt ratio Leverage ratio

10. Cash Flows • Profits are not cash • Free cash flow = cash after operations • Cash flow statement • Cash flows • From operations = net income – chg in A/R – chg assets – chg inventory • From investing in fixed assets • From financing • Borrowing (cash in) • Selling stock (cash in) • Dividends (cash out) • Working capital = current assets – current liabilities

11. Cash Flow Statement Amount Net income (from Income Statement) $5 Adjustments from operations Depreciation 6 Cash from investing Investment in plant, property, & equipment (10) Cash from financing Debt issued 10 Dividends (9) Net Change in Cash 2

12. Income Taxes and Finance • Taxable income • Operating income • Capital gains • Gain (loss) from sale of assets • Tax deductions • Interest expense • Depreciation expense • Not dividend payments • Marginal tax rates • Tax rate on the next dollar earned

13. Marginal vs. Average Rates • Example: • If tax rates are: • $0 - $9,999 0% • $10,000 - $24,999 10% • $25,000 - $40,000 20% • You earn $28,000 • How much tax do you pay? • What are your marginal and average tax rates? • ALWAYS use marginal rates for financial decisions.

14. In Class Excel Exercise • Create a common sized income statement and balance sheet • Change • Revenues • Some expense • Asset

15. Equity • Types of equity • Common stock • Preferred stock • Retained earnings • Free cash flow = cash after operations = net income - change in A/R - change in assets - change in inventory Can you do it? P. 68