3-1 3-1CHAPTER 3Financial Statements, Cash Flow, and TaxesKey Financial StatementsBalance sheet Income statementsStatement of retained earningsStatement of cash fowsAccounting income vs cash fowFederal tax system 3-2 3-2The annual re!ortBalance sheet " !rovides a sna!shot of a #rm$s #nancial !osition at one !oint in timeIncome statement " summari%es a #rm$s revenues and ex!enses over a given !eriod of timeStatement of retained earnings " shows how much of the #rm$s earnings were retained, rather than !aid out as dividendsStatement of cash fows " re!orts the im!act of a #rm$s activities on cash fows over a given !eriod of time 3-3 3-3Balance sheet& Assets

CashA'(InventoriesTotal CA)ross FA*ess& +e!,et FATotal Assets-../0,-1-23-,42.4,-10,32.4,5-2,1.-4,-.-,5/. -23,42. 535,05.-,122,/5--..6/0,2..3/4,-.. 04/,-..4,4-6,...654,... 462,-.. 366,1..4,621,1.. 3-4 3-4Balance sheet& *ia7ilities and 89uityAccts !aya7le,otes !aya7leAccrualsTotal C**ong:term de7tCommon stoc;(etained earningsTotal 89uityTotal * < 8-..//-6,42.232,1.1 615,2..4,2/.,/210-3,63-62.,... 3-,/5- 65-,/5--,122,/5--..646/,2..-..,... 432,...614,2..3-3,63-62.,... -.3,021 223,0214,621,1.. 3-5 3-5Income statementSalesC=)S=ther ex!enses8BIT+A+e!r < Amort8BITInterest 8x!8BTTaxes,et income-../2,.36,.../,/-1,... /45,511>43,511? 442,52.>43.,561? 432,.4->-22,52.? >4.2,016? >42.,402? -..63,63-,...-,126,... 3/1,20--.5,3-1 41,5..45.,6-1 63,1-1462,2.. /1,26.10,52. 3-6 3-6=ther data,o of shares8@S+@SStoc; !rice*ease !mts-../4..,...:A42.-A.44A--/A6.,...-..64..,...A.11A.--A1/.A6.,... 3-7 3-7Statement of (etained 8arnings >-../?Balance of retainedearnings, 4-'34'.6Add& ,et income, -../*ess& +ividends !aidBalance of retained earnings, 4-'34'./A-.3,021>42.,402?

>44,...?A3-,/5- 3-8 3-8Statement of Cash Flows >-../?=@8(ATI,) ACTIBITI8S,et incomeAdd >Sources of cash?&+e!reciationIncrease in A'@Increase in accrualsSu7tract >Cses of cash?&Increase in A'(Increase in inventories,et cash !rovided 7y o!s>42.,402?442,52.301,/2.3/3,2..>-1.,52.?>/0-,42.?>426,402? 3-9 3-9Statement of Cash Flows >-../?*:T I,B8STI,) ACTIBITI8SInvestment in #xed assetsFI,A,CI,) ACTIBITI8SIncrease in notes !aya7leIncrease in long:term de7t@ayment of cash dividend,et cash from #nancing,8T CDA,)8 I, CASD@lus& Cash at 7eginning of yearCash at end of year>044,5/.?632,1.16..,...>44,...?1-/,1.1>/.,341?/0,2..0,-1- 3-10 3-10Ehat can you conclude a7out +$*eon$s #nancial condition from its statement of CFsF,et cash from o!erations G :A426,402, mainly 7ecause of negative ,IThe #rm 7orrowed A1-/,1.1 to meet its cash re9uirements8ven after 7orrowing, the cash account fell 7y A/.,341 3-11 3-11+id the ex!ansion create additional net o!erating after taxes >,=@AT?F,=@ATG 8BIT >4 " Tax rate?,=@AT./G :A43.,561>4 " .6?G :A43.,561>.2?G :A01,/25,=@AT.6G A446,-/0 3-12 3-12,=EC G=!erating: ,on:interest current assets 7earing C*,=EC./ G >A0,-1- H A23-,42. H A4,-10,32.?" >A/-6,42. H A615,2..?G A543,.6-,=EC.6 G A16-,6..Ehat eIect did the ex!ansion have on net o!erating wor;ing ca!italF 3-13 3-13Ehat eIect did the ex!ansion have on o!erating ca!italF=!erating ca!ital G ,=EC H ,et Fixed Assets=!erating Ca!ital./ G A543,.6- H A535,05. G A4,1/-,13-=!erating Ca!ital.6 G A4,410,-.. 3-14 3-14Ehat is your assessment of the ex!ansion$s eIect on o!erationsFSales,=@AT,=EC=!erating ca!ital,et Income -../ A2,.36,...:A01,/25A543,.6-A4,1/-,13-:A42.,402-..6 A3,63-,...A446,-/0A16-,6..A4,410,-..A10,52. 3-15 3-15Ehat eIect did the ex!ansion have on net cash fow and o!erating cash fowF,CF./ G ,I H +e! G >A42.,402? H A442,52. G :A63,-42,CF.6 G A10,52. H A41,5.. G A4.2,12.=CF./ G ,=@AT H +e!reciation and amorti%ation G >A01,/25? H A442,52. G A31,354=CF.6 G A446,-/0 H A41,5.. G A433,4/0 3-16 3-16Ehat was the free cash fow >FCF? for -../F ++ = ,=ECes ex!enditurCa!ital:on amorti%atiand +e!r T? : >4 8BIT FCFFCF./G J:A43.,561>4 " .6? H A442,52.K " J>A4,-.-,5/. " A654,...? H A0.,26-KG :A066,-.4Is negative free cash fow always a 7ad signF 3-17 3-178conomic value added >8BA?8BA G ,=@AT " Annual dollar cost of ca!ital In order to generate !ositive 8BA, a #rm has to more than Lust cover o!erating costsIt must also !rovide a return to those who have !rovided the #rm with ca!ital8BA ta;es into account the total cost of ca!ital, which includes the cost of e9uity 3-18 3-18Ehat is the #rm$s 8BAF Assume the #rm$s after:tax !ercentage cost of ca!ital was 4.M in -..6 and 43M in -../8BA./G ,=@AT " >A:T cost of ca!ital? >Ca!ital?G :A01,/25 " >.43?>A4,1/-,13-?G :A01,/25 " A-6.,121G :A345,6308BA.6G A446,-/0 " >.4.?>A4,410,-..?G A446,-/0 " A441,0-.G :A6,623 3-19 3-19+id the ex!ansion increase or decrease NBAFNBA G Nar;et valueOO 89uity ca!italof e9uitysu!!lied+uring the last year, the stoc; !rice has decreased 03MAs a conse9uence, the mar;et value of e9uity has declined, and therefore NBA has declined, as well 3-20 3-20+oes +$*eon !ay its su!!liers on timeF@ro7a7ly notA'@ increased -2.M, over the !ast year, while sales increased 7y only 02MIf this continues, su!!liers may cut oI +$*eon$s trade credit 3-21 3-21+oes it a!!ear that +$*eon$s sales !rice exceeds its cost !er unit soldF,=, the negative ,=@AT and decline in cash !osition shows that +$*eon is s!ending more on its o!erations than it is ta;ing in 3-22 3-22Ehat if +$*eon$s sales manager decided to oIer 2.:day credit terms to customers, rather than 3.:day credit termsFIf com!etitors match terms, and sales remain constant PA'( would Cash would If com!etitors don$t match, and sales dou7le PShort:run& Inventory and #xed assets to meet increased salesA'( , Cash Com!any may have to see; additional #nancing*ong:run& Collections increase and the com!any$s cash !osition would im!rove 3-23 3-23Dow did +$*eon #nance its ex!ansionF+$*eon #nanced its ex!ansion with external ca!ital+$*eon issued long:term de7t which reduced its #nancial strength and fexi7ility 3-24 3-24Eould +$*eon have re9uired external ca!ital if they had 7ro;en even in -../ >,et Income G .?FQ8S, the com!any would still have to #nance its increase in assets*oo;ing to the Statement of Cash Flows, we see that the #rm made an investment of A044,5/. in net #xed assetsTherefore, they would have needed to raise additional funds 3-25 3-25Ehat ha!!ens if +$*eon de!reciates #xed assets over 0 years >as o!!osed to the current 4. years?F,o eIect on !hysical assetsFixed assets on the 7alance sheet would decline,et income would declineTax !ayments would declineCash !osition would im!rove 3-26 3-26Federal Income Tax System 3-27 3-27Cor!orate and @ersonal TaxesBoth have a !rogressive structure >the higher the income, the higher the marginal tax rate?Cor!orations(ates 7egin at 4/M and rise to 3/M for cor!orations with income over A4. million, although cor!orations with income 7etween A4/ million and A4133 million !ay a marginal tax rate of 31MAlso su7Lect to state tax >around /M?Individuals(ates 7egin at 4.M and rise to 3/M for individuals with income over A345,4..Nay 7e su7Lect to state tax 3-28 3-28Tax treatment of various uses and sources of fundsInterest !aid " tax deducti7le for cor!orations >!aid out of !re:tax income?, 7ut usually not for individuals >interest on home loans 7eing the exce!tion?Interest earned " usually fully taxa7le >an exce!tion 7eing interest from a RmuniS?+ividends !aid " !aid out of after:tax income+ividends received " Nost investors !ay 4/M taxes Investors in the 4.M tax 7rac;et !ay /M on dividends +ividends are !aid out of net income which has already 7een taxed at the cor!orate level, this is a form of Rdou7le taxationSA !ortion of dividends received 7y cor!orations is tax excluda7le, in order to avoid Rtri!le taxationS 3-29 3-29Nore tax issuesTax *oss Carry:Bac; and Carry:Forward " since cor!orate incomes can fuctuate widely, the Tax Code allows #rms to carry losses 7ac; to oIset !ro#ts in !revious years or forward to oIset !ro#ts in the futureCa!ital gains " de#ned as the !ro#ts from the sale of assets not normally transacted in the normal course of 7usiness, ca!ital gains for individuals are generally taxed as ordinary income if held for less than a year, and at the ca!ital gains rate if held for more than a yearCor!orations face somewhat diIerent rules