CHAPTER 2 Financial Statements, Cash Flow, and Taxes

1. CHAPTER 2Financial Statements, Cash Flow, and Taxes Balance sheet Income statement Statement of cash flows Accounting income vs. cash flow MVA and EVA Federal tax system

2. The Annual Report • 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. 2002 7,282 632,160 1,287,360 1,926,802 1,202,950 263,160 939,790 2,866,592 2001 57,600 351,200 715,200 1,124,000 491,000 146,200 344,800 1,468,800 Balance Sheet: Assets Cash A/R Inventories Total CA Gross FA Less: Dep. Net FA Total Assets

4. 2002 524,160 636,808 489,600 1,650,568 723,432 460,000 32,592 492,592 2,866,592 2001 145,600 200,000 136,000 481,600 323,432 460,000 203,768 663,768 1,468,800 Balance sheet: Liabilities and Equity Accts payable Notes payable Accruals Total CL Long-term debt Common stock Retained earnings Total Equity Total L & E

5. Income statement Sales COGS Other expenses EBITDA Depr. & Amort. EBIT Interest Exp. EBT Taxes Net income 2002 6,034,000 5,528,000 519,988 (13,988) 116,960 (130,948) 136,012 (266,960) (106,784) (160,176) 2001 3,432,000 2,864,000 358,672 209,328 18,900 190,428 43,828 146,600 58,640 87,960

6. Statement of Retained Earnings (2002) Balance of retained earnings, 12/31/01 Add: Net income, 2002 Less: Dividends paid Balance of retained earnings, 12/31/02 $203,768 (160,176) (11,000) $32,592

7. Statement of Cash Flows (2002) 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)

8. Statement of Cash Flows (2002) (711,950) 436,808 400,000 (11,000) 825,808 (50,318) 57,600 7,282 L-T INVESTING ACTIVITIES Investment in fixed assets FINANCING ACTIVITIES Increase in notes payable Increase in long-term debt Payment of cash dividend Net cash from financing NET CHANGE IN CASH Plus: Cash at beginning of year Cash at end of year

9. Net operating profit after taxes (NOPAT)? - This is the after-tax profit a company would have if it had no debt and no non-operating assets and is thus a better measure of operating performance than is net income NOPAT = EBIT (1 – Tax rate) NOPAT02 = -$130,948(1 – 0.4) = -$130,948(0.6) = -$78,569 NOPAT01= $190,428(1 – 0.4) = $190,428(0.6) = $114,257

10. Net operating working capital? - The working capital acquired with investor-supplied funds NOWC = Current - Non-interest assets bearing CL NOWC02 = ($7,282 + $632,160 + $1,287,360) – ( $524,160 + $489,600) = $913,042 NOWC01 = $842,400

11. Operating capital? Operating capital = NOWC + Net Fixed Assets Operating Capital02 = $913,042 + $939,790 = $1,852,832 Operating Capital01 = $1,187,200

12. Net cash flow and operating cash flow? NCF02 = NI + Dep = ($160,176) + $116,960 = -$43,216 NCF01 = $87,960 + $18,900 = $106,860 OCF02 = NOPAT + Dep = ($78,569) + $116,960 = $38,391 OCF01 = $114,257 + $18,900 = $133,157

13. What is the free cash flow (FCF)? The cash flow actually available for distribution to all investors (stockholders and debt holders) after the company has made all the investments in fixed assets, new products, and working capital necessary to sustain ongoing operations. FCF = NOPAT – Net (investment in) operating capital or FCF =OCF - Gross (investment in) operating capital* * Gross (investment in) operating capital = Net (investment in) operating capital+ Dep

14. What was the free cash flow (FCF) for 2002? FCF02= NOPAT – Net (investment in) operating capital = -$78,569 – ($1,852,832 -$1,187,200) = -$744,201 - OR - FCF02 = OCF-(Gross (investment in) operating capital) = OCF -(Net (investment in) operating capital+ Dep.) = $38,391 – ($1,852,832 -$1,187,200 + 116,960) = -$744,201

15. Economic Value Added (EVA) An estimate of the value created by management during the year, and it differs substantially from accounting profit because no charge for the use of equity capital is reflected in accounting profit.

16. Economic Value Added (EVA) EVA = After-tax __ After-tax Operating Income Capital costs = Funds Available __ Cost of to Investors Capital Used = NOPAT – After-tax Cost of Capital

17. EVA Concepts • 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.

18. What is the firm’s EVA? Assume the firm’s after-tax percentage cost of capital was 10% in 2001 and 13% in 2002 EVA02 = NOPAT – (A-T cost of capital) (Capital) = -$78,569 – (0.13)($1,852,832) = -$78,569 - $240,868 = -$319,437 EVA01 = $114,257 – (0.10)($1,187,200) = $114,257 - $118,720 = -$4,463

19. Did the expansion increase or decrease MVA? MVA = Market value __ Equity capital of equity supplied =(Shares o/s x Stock price) - Common Equity MVA – reflects shareholders wealth relative to what they supplied the company with.

20. How can one finance its expansion? • With external capital which will dilute ownership • By issuing long-term debt which will reduce financial strength and flexibility.

21. Jamaican Tax System

22. Corporate and Personal Taxes • Corporations • Rates at 33 1/3% • Individuals • Rates at 25% for individuals whose income over $120,432 p.a.

23. Tax treatment of various uses and sources of funds • Interest paid – tax deductible for corporations (paid out of pre-tax income • Interest earned – usually fully taxable at source (withholding tax) • Dividends paid – paid out of after-tax income. • Dividends received – no longer taxed

24. More tax issues • Tax Loss Carry-Forward – since corporate incomes can fluctuate widely, companies can carry losses forward to offset profits in the future.