Engineering Management 452 Advanced Financial Management

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Engineering Management 452 Advanced Financial
Management
Chapter 2 Financial Statements, Cash Flows, and
Taxes
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Annual reports

• Controlled propaganda by firm
• Will focus on strengths and opportunities
• Financial data has to fit standards
• Footnotes are valuable and more telling
• Any negative words in the auditors report are
  highly unusual.
• Annual reports are easy to get
  www.sec.gov/edgarhp.htm

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Accounting Principles

• Transactions - double-entry system
• Balance equations of B/S and I/S
• Point of view of the firm
• Based on historical (documentable) costs
• Match revenue with costs - accrual
• Full disclosure of material information

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Financial Statements

• Balance Sheet (basis of all the others)
• organized by timing, most current first
• Income Statement (profit and loss)
• org core business functions first
• Statement of Retained Earnings
• Removes dividends from earning to retain
• Statement of Cash Flows
• Where is the cash coming from and going?

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Balance Sheet

• Assets
• Cash 15
• Securities 65
• A/R 315
• Inventory 415
• Total current 810
• Net plant eq. 870
• Total assets 1680

• Liabilities Equity
• A/P 30
• N/P 60
• Accruals 130
• Long term debt 415
• Total liability 635
• Equity 945
• Total liab. eq. 1680

These balance
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Assets

• Assets are the economic resources controlled by
  an entity that are expected to provide future
  benefits.
• Such as
• Cash, inventory, financial instruments,
• equipment, buildings, etc.

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Current Assets (less than a year)

• Cash cash and equivalents
• Securities short term investments in other
  firms, priced at cost
• Accounts receivables A/R trade credit given to
  customers, priced at cost
• Inventory raw material, sub-assemblies, work in
  progress, finished goods that will become part of
  product sold, priced at (FIFO, LIFO) cost

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Capital Assets (more than a year)

• Net Plant Equipment production equipment at
  cost less accumulated depreciation (straight
  line, accelerated)
• Goodwill premium paid for asset above its book
  value less accumulated amortization
• Prepaid expenses such as pension expense
• Customer financing term of sale that lends
  money to the customer

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Liabilities

• Liabilities are obligations of an entity to
  transfer assets or provide services to other
  entities in the future as a result of past
  transactions or events. (i.e. Resources provided
  by creditors.)
• Such as
• Loans, IOUs, wages due, taxes due, amounts owed
  to suppliers.

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Liability accounts

• Accounts payables A/P trade credit we owe our
  suppliers at cost (no interest)
• Notes payable funds lent to us that is due in
  less than a year at cost plus interests
• Accruals wages earned but not paid, and taxes
  withheld but not paid, due to timing of payments
• Long term debt portion of debt due in more than
  a year
• Deferred payments, such as taxes

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Equity

• Common stock initial investment in our firm by
  investors, at cost
• Retained earnings R/E accumulation of profits
  generated that are not distributed to the
  stockholders through dividends
• Preferred stock less risky form of equity,
  hybrid between equity and debt (not common)
• Net worth common stock retained earnings, or
  total assets total liabilities preferred stock

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Basic Accounting Equations

• Equity Assets - Liabilities
• Liabilities Assets - Equity

T-account
Assets
Liabilities Equity Liab. Equity
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Income Statement (PL)

• Net sales 3000
• Operating costs (2716)
• Earnings before int. taxes 284
• less interest (88)
• Earnings before taxes 196
• less taxes (78)
• Net income (profit after tax) 118
• less dividends (62)
• Addition to retained earnings 56

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Income (Revenue)

• Revenues are increases in equity resulting from
  the exchange of goods, services, or other
  activities involving the entitys central
  operation.
• Such as
• Sales revenue, service income, rent income

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Expenses

• Expenses are decreases in equity resulting from
  the process of earning revenues.
• Such as
• Cost of goods sold, cost of services rendered,
  salary expenses, training expense

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P/L (profit loss) accounts

• Net sales revenue from sales less discounts for
  volume or returns
• Less operating costs and expenses
• Cost of Goods Sold cost of finished goods
  inventory that was sold that includes material,
  labor other operating expenses
• Depreciation, amortization
• Less selling and distribution costs
• Less general administrative expenses
• Income from operations EBIT

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P/L Accounts (continued)

• Income from Operations EBIT
• Less interest expense
• Plus interest income
• Plus foreign exchange gain
• Income before taxes Profit before taxes, PBT
• Less taxes
• Net income (loss) Profit after taxes, PAT
• Less dividends
• Retained Earnings

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Statement of Cash Flows

• Excellent assessment tool that looks at more than
  just profit.
• Look for the largest numbers and let them tell
  you the story of what is happening.
• Critical for high growth and smaller businesses.
• Breaks down business by activities

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Net Operating Working Capital

• Is the difference between operating current
  assets(CA less short term investments) and
  operating current liabilities(CL less short term
  notes). This is a measure of working capital
  acquired by investor supplied funds.

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NOPAT

• NOPAT is the operating profits after tax and is
  calculated as EBIT(1-T). It is the amount of
  after tax profit a firm would have if it had no
  debt and no investment in nonoperating assets. A
  better measure of operating performance than net
  income.

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Free Cash Flow

• Amount of cash flow remaining after a company
  makes the asset investment necessary to support
  operations. The amount available for distribution
  to investors. It is defined as NOPAT minus the
  net investment in operating capital.

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Market Value Added(MVA)

• The difference between the total market value of
  the firm and the total amount of investor
  supplied capital. If value of pfd stock and debt
  equals value reported on financial statements
  then MVA equals market value of stock minus total
  common equity.

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Economic Value Added (MVA)

• The difference between after tax operating profit
  and the total dollar cost of capital, including
  cost of equity capital. It is a measure of value
  created by mgt during the year.