Financial statements, taxes and cash flow Chapter 2.
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Transcript of Financial statements, taxes and cash flow Chapter 2.
Financial statements, taxes and cash flow
Chapter 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 firm’s cash flow
from its financial statements
2-2 Copyright © 2011 McGraw-Hill Australia Pty LtdPPTs t/a Essentials of Corporate Finance 2e by Ross et al.Slides prepared by David E. Allen and Abhay K. Singh
Chapter outline
• The balance sheet• The income statement• Taxes• Cash flow
2-3 Copyright ©2011 McGraw-Hill Australia Pty LtdPPTs t/a Essentials of Corporate Finance 2e by Ross et al.Slides prepared by David E. Allen and Abhay K. Singh
The balance sheet
• The balance sheet is a snapshot of a firm’s assets and liabilities at a given point in time.
• Assets: The left-hand side:− Current or fixed− In order of decreasing liquidity
• Liabilities and owners’ equity: The right-hand side:– Current or long term– In ascending order of when due to be paid
• Balance sheet identity
Assets = Liabilities + Shareholders’ equity
2-4 Copyright ©2011 McGraw-Hill Australia Pty LtdPPTs t/a Essentials of Corporate Finance 2e by Ross et al.Slides prepared by David E. Allen and Abhay K. Singh
The balance sheet (cont.) Figure 2.1
2-5 Copyright ©2011 McGraw-Hill Australia Pty LtdPPTs t/a Essentials of Corporate Finance 2e by Ross et al.Slides prepared by David E. Allen and Abhay K. Singh
The balance sheet (cont.)
• Net working capital– Current assets minus current liabilities– Usually positive for a healthy firm
• Liquidity− Speed and ease of conversion to cash without
significant loss of value− Valuable in avoiding financial distress
• Debt versus equity− Shareholders’ equity = Assets - Liabilities
2-6 Copyright ©2011 McGraw-Hill Australia Pty LtdPPTs t/a Essentials of Corporate Finance 2e by Ross et al.Slides prepared by David E. Allen and Abhay K. Singh
Oz Company balance sheetTable 2.1
Visit au.finance.yahoo.com for more financial statements and balance sheets
2-7 Copyright ©2011 McGraw-Hill Australia Pty LtdPPTs t/a Essentials of Corporate Finance 2e by Ross et al.Slides prepared by David E. Allen and Abhay K. Singh
Market value vs book value
• Market value is the price at which assets, liabilities or equity can actually be bought or sold.• The balance sheet provides the book value
of assets, liabilities and equity.• Market value and book value are often very
different. Why?• Which is more important to the decision-
making process?
2-8 Copyright © 2011 McGraw-Hill Australia Pty LtdPPTs t/a Essentials of Corporate Finance 2e by Ross et al.Slides prepared by David E. Allen and Abhay K. Singh
Battler CompanyExample 2.2
Battler Company
Balance sheets
Book value versus market value
Book Market Book Market
Assets Liabilities and Shareholders’ equity
NWC 400 600 LTD 500 500
NFA 700 1 000 SE 600 1 100
$1 100 $1 600 $1 100 $1 600
2-9 Copyright ©2011 McGraw-Hill Australia Pty LtdPPTs t/a Essentials of Corporate Finance 2e by Ross et al.Slides prepared by David E. Allen and Abhay K. Singh
The income statement
• The income statement measures performance over a specified period of time (period, quarter, year).
• Report revenues first and then deduct any expenses for the period.
• End result = Net income = ‘Bottom line’– Dividends paid to shareholders– Addition to retained earnings
• Income statement equation:
Net income = Revenue - Expenses
2-10 Copyright ©2011 McGraw-Hill Australia Pty LtdPPTs t/a Essentials of Corporate Finance 2e by Ross et al.Slides prepared by David E. Allen and Abhay K. Singh
OZ Company income statementTable 2.2
2-11 Copyright © 2011 McGraw-Hill Australia Pty LtdPPTs t/a Essentials of Corporate Finance 2e by Ross et al.Slides prepared by David E. Allen and Abhay K. Singh
The income statement (cont.)
• AAS and the income statement– The matching principle• Recognise revenue when it is fully earned. • Matching expenses required to generate
revenue to the period of recognition
• Non-cash items– Expenses charged against revenue that do
not affect cash flow.–Most important of these is depreciation.
2-12 Copyright © 2011 McGraw-Hill Australia Pty LtdPPTs t/a Essentials of Corporate Finance 2e by Ross et al.Slides prepared by David E. Allen and Abhay K. Singh
The income statement (cont.)
• Time and costs– Fixed or variable costs– Not obvious on income statement
• Earnings management–Smoothing earnings–Wriggle room
2-13 Copyright © 2011 McGraw-Hill Australia Pty LtdPPTs t/a Essentials of Corporate Finance 2e by Ross et al.Slides prepared by David E. Allen and Abhay K. Singh
Example: Work the Web
• Most Australian companies post their annual reports on their websites. Look for them in the investor or shareholder areas.
• Go to companies’ websites and see what kinds of financial reports you can find.
• Example: Virgin Blue
2-14 Copyright ©2011 McGraw-Hill Australia Pty LtdPPTs t/a Essentials of Corporate Finance 2e by Ross et al.Slides prepared by David E. Allen and Abhay K. Singh
Taxes• The one thing we can rely on with taxes is that they
are always changing.• Tax bill depends on tax code, which can be
amended by political will.• Corporate tax in Australia and New Zealand– Flat rate tax (currently 30%)
• Marginal vs average tax rates– Marginal–the percentage paid on the next dollar
earned– Average–the tax bill/taxable income
• Other taxes
2-15 Copyright ©2011 McGraw-Hill Australia Pty LtdPPTs t/a Essentials of Corporate Finance 2e by Ross et al.Slides prepared by David E. Allen and Abhay K. Singh
Personal tax rates (2009/2010)Table 2.3
2-16 Copyright ©2011 McGraw-Hill Australia Pty LtdPPTs t/a Essentials of Corporate Finance 2e by Ross et al.Slides prepared by David E. Allen and Abhay K. Singh
Example: Marginal vs average tax rates
• Bony Bushman has a taxable income in Australia of $96 000. – What is his tax bill?– What is his average tax rate ?– What is his marginal tax rate?
2-17 Copyright ©2011 McGraw-Hill Australia Pty LtdPPTs t/a Essentials of Corporate Finance 2e by Ross et al.Slides prepared by David E. Allen and Abhay K. Singh
Example: Marginal vs average tax rates
Total 96000 23930
Average tax rate 24.9270833%Marginal tax rate 38%
Personal tax rateTaxable income Rate
$0-6000 Nil6001-35000 15%
35001-80000 30%80001-180000 38%
180001- 45%
Tax calculationTaxable income Tax liability
6000 029000 435045000 1350016000 6080
2-18 Copyright ©2011 McGraw-Hill Australia Pty LtdPPTs t/a Essentials of Corporate Finance 2e by Ross et al.Slides prepared by David E. Allen and Abhay K. Singh
Taxation of dividends: An imputation system
• Major effect is that the double taxation of company profits is negated.
• Company advises the shareholder of the amount of company tax already paid on the dividend.
• Shareholder then adds this amount of tax to the cash dividend that they have received and pays personal tax on the grossed-up amount.
• Shareholder receives a tax (franking) credit equivalent to the amount of tax paid by the company.
2-19 Copyright ©2011 McGraw-Hill Australia Pty LtdPPTs t/a Essentials of Corporate Finance 2e by Ross et al.Slides prepared by David E. Allen and Abhay K. Singh
Effect of a $700 dividend fully franked at 30% tax rate—Example 2.5
2-20 Copyright © 2011 McGraw-Hill Australia Pty LtdPPTs t/a Essentials of Corporate Finance 2e by Ross et al.Slides prepared by David E. Allen and Abhay K. Singh
Cash flow
• Cash flow is some of the most important information that a financial manager can derive from financial statements.
• The difference between the number of dollars that come in and the number that go out.
• The statement of cash flows does not provide us with the same information that we are looking at here.
• Cash flow identity
Cash flow from assets = Cash flow to creditors + Cash flow to shareholders
2-21 Copyright © 2011 McGraw-Hill Australia Pty LtdPPTs t/a Essentials of Corporate Finance 2e by Ross et al.Slides prepared by David E. Allen and Abhay K. Singh
Cash flow (cont.)
• Cash flow from assets = Operating cash flow – Net capital spending – Changes in net working capital.
• Operating cash flow– Cash generated from a firm’s normal business
activities• Capital spending– Money spent on fixed assets less money received from
the sale of fixed assets• Change in net working capital– Net increase in current assets over current liabilities
2-22 Copyright ©2011 McGraw-Hill Australia Pty LtdPPTs t/a Essentials of Corporate Finance 2e by Ross et al.Slides prepared by David E. Allen and Abhay K. Singh
Cash flow (cont.)• Free cash flow– Different from cash flow from assets– Cash that the firm is free to distribute to creditors
and shareholders because it is not needed for working capital or fixed asset investments
• Cash flow to creditors– A firm’s interest payments to creditors less net
new borrowings• Cash flow to shareholders– Dividends paid out by a firm less net new equity
raised
2-23 Copyright ©2011 McGraw-Hill Australia Pty LtdPPTs t/a Essentials of Corporate Finance 2e by Ross et al.Slides prepared by David E. Allen and Abhay K. Singh
OZ Company example• 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 borrowings = $24• CF to stockholders (B/S and I/S) = Dividends paid –
Net new equity raised = $63• CFFA = 24 + 63 = $87
2-24 Copyright © 2011 McGraw-Hill Australia Pty LtdPPTs t/a Essentials of Corporate Finance 2e by Ross et al.Slides prepared by David E. Allen and Abhay K. Singh
Cash flow summaryTable 2.5
2-25 Copyright ©2011 McGraw-Hill Australia Pty LtdPPTs t/a Essentials of Corporate Finance 2e by Ross et al.Slides prepared by David E. Allen and Abhay K. Singh
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?
2-26 Copyright © 2011 McGraw-Hill Australia Pty LtdPPTs t/a Essentials of Corporate Finance 2e by Ross et al.Slides prepared by David E. Allen and Abhay K. Singh
Quick quiz (cont.)
• What is the difference between average and marginal tax rates? – Which should we use when making financial
decisions?
• How do we determine a firm’s cash flows? – What are the equations and where do we find
the information?
2-27 Copyright ©2011 McGraw-Hill Australia Pty LtdPPTs t/a Essentials of Corporate Finance 2e by Ross et al.Slides prepared by David E. Allen and Abhay K. Singh
Apple Isle example
2-28 Copyright ©2011 McGraw-Hill Australia Pty LtdPPTs t/a Essentials of Corporate Finance 2e by Ross et al.Slides prepared by David E. Allen and Abhay K. Singh
Apple Isle (cont.)Operating cash flow
2-29 Copyright © 2011 McGraw-Hill Australia Pty LtdPPTs t/a Essentials of Corporate Finance 2e by Ross et al.Slides prepared by David E. Allen and Abhay K. Singh
Apple Isle (cont.)Cash flow from assets, cash flow to stockholders
and creditors
2-30 Copyright © 2011 McGraw-Hill Australia Pty LtdPPTs t/a Essentials of Corporate Finance 2e by Ross et al.Slides prepared by David E. Allen and Abhay K. Singh
Chapter 2
END
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