Financial Statements, Taxes and Cash Flow

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Chapter
2
Financial Statements, Taxes and Cash Flow
2
Key Concepts and Skills

• Know the difference between book value and market
  value
• Know the difference between accounting income and
  cash flow
• Know the difference between average and marginal
  tax rates
• Know how to determine a firms cash flow from its
  financial statements

3
Balance Sheet

• The balance sheet snapshot of the firms assets
  and liabilities at a given point in time
• Assets listed in order of liquidity
• Ease of conversion to cash
• Without significant loss of value
• Balance Sheet Identity
• Assets Liabilities Stockholders Equity

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Balance Sheet
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TannerHater.com Balance Sheet
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Market Vs. Book Value

• Balance sheet provides the book value of the
  assets, liabilities and equity.
• Market value price at which the assets,
  liabilities or equity can actually be bought or
  sold.
• Market value and book value are often very
  different. Why?
• Which is more important to the decision-making
  process?

7
Income Statement

• The income statement flow statement for
  entire year or quarter
• Eye with extreme skepticism
• Understand how perfectly legal accounting changes
  can impact
• Understand the differences between income and
  cash flow

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TH.com Income Statement
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Accounting Manipulations

• LIFO vs. FIFO
• Inventory at beginning of year 100M units
• 50M purchased 19 months ago at 15 each
• 50M purchased 16 months ago at 25 each
• During the year, sold 50M units
• COGS with LIFO? NI?
• COGS with FIFO? NI?
• Inventory on Balance Sheet with FIFO?
• Inventory on Balance Sheet with LIFO?

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Depreciation

• Value Reduces taxable income,
• Reduces taxes,
• Increases CF
• 100K Earnings Before Interest Taxes
• t 30
• CF with and without 60K depreciation expense?

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Depreciation (no Debt)

• EBIT DA 100K
• -Depr 0
• EBIT Taxable 100K
• -Taxes 30K
• NI 70K
• CF (EBITDA-Tax) 70K

• 100K
• 60K
• 40K
• 12K
• 28K
• 88K

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Taxes

• Marginal vs. average tax rates
• Marginal the percentage paid on the next dollar
  earned
• Average the tax bill / taxable income

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Corporate Tax Rates (2007)

• Taxable Income
• 0-50K
• 50-75K
• 75-100K
• 100-335K
• 335K-10M
• 10-15M
• 15-18.3M
• 18.3M

• Tax Rate
• 15
• 25
• 34
• 39
• 34
• 35
• 38
• 35

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Example Marginal vs. Average

• Suppose your firm earns 330K in taxable income.
• What is the firms tax liability?
• What is the average tax rate?
• What is the marginal tax rate?
• If you are considering a project that will
  increase the firms taxable income by 1, what
  tax rate should you use in your analysis?

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The Concept of Cash Flow

• Cash flow one of the most important pieces of
  information from financial statements
• Cash Flow ? Net Income
• Sources and Uses?

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Statement of Cash Flows

• Sources of Cash
• increase in liability or equity account
• decrease in an asset account
• Uses of Cash
• decrease in a liability or equity account
• increase in an asset account

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Cash Flow From Assets

• Cash Flow From Assets (CFFA)
• 1. Operating Cash Flow EBIT Depr Taxes
  interest financing expense
• minus
• 2. Net Capital Spending purchases, sales of
  fixed assets (add depreciation back)
• minus
• 3. Changes in Net Working Capital net change in
  current assets current liabilities

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Cash Flow From Assets

• Where does Cash Flow From Assets (CFFA) go?
• Cash Flow From Assets
• 1. CF to Creditors Interest Principal Paid
  Net New Borrowing
• plus
• 2. CF to Stockholders Dividends Net New
  Equity

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Example TannerHater.com

• OCF (I/S) EBIT depreciation taxes 547
• NCS ( B/S and I/S) ending net fixed assets
  beginning net fixed assets depreciation 130
• Changes in NWC (B/S) ending NWC beginning NWC
  330
• CFFA 547 130 330 87
• CF to Creditors (B/S and I/S) interest paid
  net new borrowing 24
• CF to Stockholders (B/S and I/S) dividends paid
  net new equity raised 63
• CFFA 24 63 87

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Quick Quiz

• What is the difference between book value and
  market value? Which should we use for decision
  making purposes?
• What is the difference between accounting income
  and cash flow? Which do we need to use when
  making decisions?
• What is the difference between average and
  marginal tax rates? Which should we use when
  making financial decisions?
• How do we determine a firms cash flows?