Accounting for Financial Management

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Accounting for Financial Management

• Chapter 7

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Overview

• Value of any business asset (real or financial)
• Depends on usable expected after-tax CFs
• Maximize firm value
• Increase firms expected after-tax CFs
• How do we predict?
• Financial statements
• CFs vs accounting income
• Focus Interpret

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Mini Case Overview

• Donna Jamison was brought in as assistant to the
  chairman of the board of Computron Ind., a
  manufacturer of electronic calculators.
• The company doubled its plant capacity, opened
  new sales offices outside its home territory, and
  launched an expensive advertising campaign.
  Computrons results were not satisfactory. Its
  board was most upset when directors learned how
  the expansion was going. Suppliers were being
  paid late and the bank was complaining about the
  deteriorating situation and threatening to cut
  off credit.
• CEO was informed changes would have to be made
  quickly or he would be fired. You are Donna
  Jamisons assistant and you are going to help
  identify problems.

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Balance Sheet Assets
2003 2002 Cash 7,282 9,000 Short-term
inv. 20,000 48,600 AR 632,160 351,200 Inventories
1,287,360 715,200 Total CA 1,946,802 1,124,000
Gross FA 1,202,950 491,000 Less Depr.
263,160 146,200 Net FA 939,790 344,800 Total
assets 2,886,592 1,468,800
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Balance Sheet Liabilities and Equity
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Income Statement
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Other Data
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Statement of Retained Earnings
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Statement of Cash Flows
OPERATING ACTIVITIES Net Income (95,136) Adjustme
nts Depreciation 116,960 Change
in AR (280,960) Change in
inventories (572,160) Change in AP 178,400
Change in accruals 148,960 Net cash
provided by ops.
(503,936)
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Statement of Cash Flows
L-T INVESTING ACTIVITIES Investments in fixed
assets (711,950) FINANCING ACTIVITIES Change
in s-t investments 28,600 Change in notes
payable 520,000 Change in long-term
debt 676,568 Payment of cash
dividends (11,000) Net cash from
financing 1,214,168 Sum net change in
cash (1,718) Plus cash at beginning of
year 9,000 Cash at end of year 7,282
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Mini Case

• What do we see from statement of CF?
• Negative cash from operations (neg. NI)
• Firm _______ money and ______ s-t investments to
  meet cash needs
• Even after this, cash account fell by 1,718.
• In finance, it is important to separate financing
  and operating decisions

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Modifying Accounting Data

• Assets
• Operating assets
• Necessary to operate business
• Current or long-term
• Non-operating assets
• Cash, s-t investments, land, investments in
  subsidiaries, etc.
• Capital
• Most is supplied by investors (stocks, bonds,
  loans)
• Some capital comes from operations
• Accounts payable, accrued wages, accrued taxes
• Operating current liabilities
• Working capital?

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Net Operating Working Capital

• NOWC is working capital acquired with
  investor-supplied funds
• NOWC Oper. CA Oper. CL
• Working definitionNOWC (Cash AR Inv) (AP
  Accruals)
• Mini Case What effect did expansion have on
  NOWC?

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Capital Used in Operations

• Operating capital NOWC NFA
• Mini Case What effect did expansion have on
  capital used in operations?

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Net Operating Profit after Taxes

• NOPAT Amount of profit a company would generate
  if it had no debt and held no financial assets
• Operating performance
• NOPAT EBIT(1 Tax rate)
• Mini Case Did the expansion create additional
  net operating profits after tax?

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Initial Assessment of Expansion

• 2003 2002
• Sales 5,834,400 3,432,000
• NOPAT 10,464 125,460
• NOWC 1,317,842 793,800
• Operating capital 2,257,632 1,138,600

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Cash Flows

• NCF NI Depr OCF NOPAT Depr
• Mini Case What effect did the expansion have on
  NCF and OCF?

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Cash Flows

• Free Cash Flow
• Cash flow available for distribution to investors
  after the company has made ALL investments in
  fixed assets and working capital necessary to
  sustain ongoing operations
• FCF measures cash that is ACTUALLY available for
  distribution (i.e., free)
• Increase firm value by increasing FCF!!!!!
• Uses of FCF
• Pay interest on debt, pay principal on debt, pay
  dividends, buy back stock, buy non-operating
  assets (e.g., marketable securities)

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Cash Flows

• FCF NOPAT Net Capital Investment
• Mini Case What was the FCF? How did investors
  react?

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Economic Value Added

• EVA is an estimate of firms true economic profit
  for the year
• Measures residual income after ALL costs of
  capital have been deducted
• Including cost of equity capital
• Usually larger than cost of debt and doesnt
  appear on financial statements
• Is it free or does it have a cost?
• EVA assumes true economic depreciation equals
  book value of depreciation, so we wont add
  depreciated back in

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EVA

• EVA NOPAT (Operating Capital)(After-tax cost
  of capital)
• Mini Case Assume the firms after-tax cost of
  capital (WACC) was 10 for both years. What is
  companys EVA?

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Market Value Added

• S/H wealth is maximized by maximizing the
  difference between the market value of the firms
  stock and the amount of equity capital that was
  supplied by the s/h. Difference is MVA.
• MVA Market value of the firm Book value of
  the firm
• Where Market value ( shares outstanding)(stock
  price) Market value of debt
• Where Book value Total common equity Book
  value of debt
• If market value of debt is close to book value of
  debt, then
• MVA Market value of equity Book value of
  equity
• Where Market value of equity ( shares
  outstanding)(stock price)
• Where Book value of equity Total common equity
• Mini Case Stock price has decreased by 73 over
  last year, so what happened to MVA?

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MVA vs. EVA

• Both measure extent to which firm is adding s/h
  value
• MVA
• Depends more on expected future performance
  (stock price)
• One number for entire firm
• Measure value over life of firm
• EVA
• Better for evaluating managers
• One year or fixed time period not life of firm
• Can be used for divisions and/or units

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More on Mini Case

• What happens if fixed assets are depreciated over
  7 years (as opposed to current 10 years)?
• Physical asset?
• Fixed assets on b/s?
• Net income?
• Tax payments?
• Cash position?

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Taxes

• Ordinary versus Capital Gains
• Capital assets
• stocks, bonds, real estate
• generally taxed a _______ rate
• Why?
• Encourage people to invest so economy can grow

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Taxes

• Corporate Taxes
• Interest paid
• Deducted
• Dividends paid
• Not deducted
• Double taxed
• Corporate then individual
• Impact?
• Corporate capital gains
• No favorable tax treatment