Financial Statements

DrakeDRAKE UNIVERSITY

Fin 200

Financial Statements, Cash Flows, and Taxes

Fin 200

DrakeDrake University

Fin 200Balance Sheet

Pont in time summary of:What is owned by the firm,What is owed by the firmEquity of the firm

Basic idea:Assets = Liabilities + Shareholder Equity


Fin 200Balance Sheet

AssetsCurrent Assets

Life < 1yrFixed Assets

Life > 1 yr

Liabilities and EquityCurrent Liabilities

Life <1yrLong Term Debt

Life > 1yrShareholder Equity

Assets – Liabilities


Fin 200Net Working Capital

NWC = Current Assets – Current Liabilities

Cash to be received is greater than the cash to be paid out.


Fin 200

Who uses the Balance sheet?

Creditors look at liquidity and financial leverageInternal managers track inventory and cash on hand.Does the Balance sheet provide a good measure of the value of the firm?


Fin 200Market vs. Book Value

The balance sheet presents the Book Value of the firm based on GAAP principles, Market Value is differentAre there other things that do not show up on the Balance Sheet that add value to the firm?


Fin 200Income Statement

Measure of the firms performance over a given period of time.Based on the basic idea that Revenues - Expenses = Income.Provides a report on operations over a period of time, not a point in time like the Balance Sheet.


Fin 200Basic Income Statement

Revenues-Operating Costs

Earnings B-4 Interest Taxes Deprec. & Amort. (EBITDA)

-Depreciation and AmoritzationEarnings Before Interest and Taxes (EBIT)

-Interest PaymentsTaxable Income

-TaxesNet Income


Fin 200EPS

Net income is often expressed as Earnings Per Share (EPS)

Net Income Total Shares Outstanding


Fin 200Note:

1. Revenues are recorded at the time of sale as are expenses

2. Both short term costs and long term costs are included on the income statement.

3. Net Income does not equal cash flow


Fin 200Cash Flow vs. Accounting Earnings

GAAP is based on accrual accountingRevenues are realized at the time of the sale, not when cash is received (Expenses are realized at the time acquired, not when paid forOperating ExpendituresProduce benefits only in the current period

Capital Expendituresproduce benefits over multiple periods

Non - Cash Charges (depreciation etc)Reduce accounting income, but cash exists


Fin 200Cash Flow

Cash Flow represents the movement of actual cashSimple definition

The amount of cash flowing into the firm minus the amount of cash flowing out of the firm.


Fin 200Why Cash Flows?

Cash represents the ability of the firm to operate (you can’t spend earnings)

Accounting earnings are often manipulated to impress shareholders.


Fin 200Cash Flow Identity

CF to Creditors = Interest Paid-Net new borrowing

CF to Stockholders = Dividends Paid –Net New Equity

rsStockholde

toFlowCash

Creditors

toFlowCash

Assets From

FlowCash


Fin 200Cash Flow From Assets

Three ComponentsOperating Activities - Net income, depreciation, changes in net working capital other than cash and short term debtInvesting Activities - Investment in or sale of fixed assetsFinancing Activities – cash raised from ST debt, LT debt and stock, Cash distributed to shareholders, buy backs of outstanding stock and bonds.


Fin 200Cash Flow Statement

Net Income Before Dividends+ Sources of Cash (additions of cash)- Uses of Cash (subtractions of cash)

Net Cash Provided by operating activities

- Cash Used to Acquire Fixed Assets (including Dep)

+ Increase in notes payable+ Increase in bonds- Payment of common and pref. Dividends

Net Cash from Financing Activities-Net decrease in cash and marketable securities +Cash and Securities at beginning of year

Cash and Securities at the end of the year.

Operating Activities

Invest

Financing Activities


Fin 200A closer look at Cash Flows

Sources of CashActivities by a firm that generate cash

Uses of CashActivities by a firm that spends cash


Fin 200Sources of Cash

Increases on the RHS of Balance sheetIncrease in Accounts payableIncrease in Common StockIncrease in Retained Earnings

Decreases on the LHS of the balance sheet

Decrease in Current or Fixed AssetsDecrease in Accounts ReceivableDecrease in Inventory

Depreciation and Amortization


Fin 200Uses of Cash

Decreases on the RHS of Balance sheetDecrease in Notes payableDecrease in Long Term Debt

Increases on the LHS of the balance sheet

Increases in Current or Fixed AssetsIncreases in Accounts ReceivableIncreases in Inventory


Fin 200Net Cash Flow

Net Cash Flow represents the actual net amount of cash a firm generates during a specified period.

Primary noncash items are depreciation and amortization, so net cash flow can be approximated:

Charges

Noncash

Revenues

Noncash

Income

Net

FlowCash

Net

onAmortizati andon DepreciatiIncome

Net

FlowCash

Net


Fin 200Operating Cash Flow

Cash Flow that results from daily activities

Op CF = EBIT – Taxes + (Deprec. and Amort.)

Note: In accounting circles Interest expense is often included in the calculation of Op CF. In Finance we assume that interest is a financing expense and do not include it.


Fin 200NOPAT

Net Operating Profit After Taxes (NOPAT) can be thought of as the amount of operating profit a company would have if it had no debt and held no nonoperating assets.NOPAT = EBIT(1-Tax rate) = EBIT – EBIT(Tax Rate) = EBIT – Taxes


Fin 200

Operating Cash Flow vs. NOPAT

Operating Cash flow is based off of the Net Operating profit after taxes (NOPAT).If two firms had identical operations, but different debt, there performance for the period would be the same but they would have different net income. NOPAT attempts to measure the true performance of operations.


Fin 200

Operating CF and NOPAT calculations.

Previously we defined Operating Cash flow as: Op CF = EBIT – Taxes + (Deprec. and Amort.)

Previously we defined NOPAT asNOPAT = EBIT(1-Tax rate) = EBIT – TaxesCombining the two it is easy to see that:

onAmortizati

andon DepreciatiNOPAT

FlowCash

Operating


Fin 200Capital Spending

Net Capital Spending is the amount spent on fixed assets minus the amount of money received from the sale of fixed assets.


Fin 200

Standardizing Financial Statements

Comparing across Firms and in one firm across years is often difficult. Therefore it is often convenient to standardize financial statements

1. Common Size Financial Statements2. Common Base Year3. Common Size and Year


Fin 200Common Size

Balance SheetUsually Presented as a % of assets

Income StatementPresented as a % of sales

Cash Flow StatementNo Convention


Fin 200Example

Current Assets 1999 2000Cash 230 250Accounts Receivable 340 370Inventory 400 410

Fixed AssetsNet Plant and Equip 1,000 1100

Total Assets 1970 2130


Fin 200Example

Current Assets 2001 % of AssetsCash 230Accounts Receivable 340Inventory 400

Fixed AssetsNet Plant and Equip 1,000

Total Assets 1970

230/1970 = .116340/1970 =.173400/1970 = .203

1,000/1970 = .5081.00


Fin 200Example

Current Assets 1999 2000 1999 2000

Cash 230 230 .116 .107Accounts Rec 340 390 .173 .183Inventory 400 410 .203 .192

Fixed AssetsNet Plant & Eq 1,000 1,100

.508 .516Total Assets 1,970 2130 1.00

1.00


Fin 200Common Base Year

You want to set all changes relative to a base year.For each entry you divide the entry for that year by the corresponding entry for the base year.This allows you to look for trends over time.


Fin 200Example 2

Current Assets 1999 2000 2000 Base YearCash 230 230Accounts Rec 340 390Inventory 400 410

Fixed AssetsNet Plant & Eq 1,000 1,100

Total Assets 1,970 2130

230/230=1.0

390/340=1.14

410/400 =1.025

1100/1000=1.1

2130/1970=1.08


Fin 200

Combined Common Size and Base Year

Find the common size balance sheet first, as assets grow so will most entries.

Then calculate base year.


Fin 200Example

Com Size BseYr Comb

CurrAssets 1999 2000 1999 2000 2000Cash 230 230 .116 .107 1.0Accts Rec 340 390 .173 .183 1.14Inventory 400 410 .203 .192 1.025

Fixed AssetsNet P& E 1,000 1,100 .508 .5161.10

Total Assets 1,970 2130 1.00 1.00 1.08

.922

1.058

.946

1.016

1.000


Fin 200Tax Terms

Average Tax Rate Your tax bill divided by your taxable income (the percentage of taxable income you pay in taxes)

Marginal Tax RateThe tax rate you would pay on an additional dollar of income


Fin 200Ratio Analysis

Designed to allow comparison across firms

Each Ratio addresses specific questions about the firms financial position.Basic idea:


Fin 200Basic Questions

1. How is it computed?2. What is it intended to Measure?3. What is the unit of measurement?4. What does a high or low value tell us?5. Are there problems using it?6. Could it be improved?


Fin 200Liquidity Ratios

Measure the ability of the firm to meet its short term obligations.Also termed short term solvency ratiosOf interest to short term creditorsFocus on current assets and current liabilities


Fin 200Current Ratio

Generally, the higher the current ratio the better.

Is it possible that an extremely high ratio may be bad? Can a low ratio be good?

Do you see any problems?

sLiabilitieCurrent

AssetsCurrent RatioCurrent


Fin 200Quick Ratio

Generally, the higher the ratio the better.Inventory is less liquid than cash

Manpower Wal Mart Current Ratio 1.68 1.34Quick Ratio 1.68 0.20

sLiabilitieCurrent

Inventory - AssetsCurrent RatioQuick


Fin 200Cash Ratio

Generally, the higher the ratio the better.

More important to very short term creditor

sLiabilitieCurrent

CashRatioCash


Fin 200NWC to Total Assets


Measure of liquidity

Assets Total

NWCAssets Total toNWC


Fin 200Interval Measure


Measures the number of days the firm could survive if it was not receiving any cash

Costs OperatingDaily Average

AssetsCurrent IM


Fin 200Long Term Solvency

Also considered leverage ratios

Measure the level of indebtedness and the ability to service debt


Fin 200Total Debt Ratio

Takes into account all debt of all maturitiesMeasures the percentage of debt for each dollar in assetsn, There is (1-total debt ratio) dollars in equity for every dollar in assets

Assets Total

Equity Total- assets TotalRatioDebt Total


Fin 200Equity Multiplier

Equity Multiplier, Debt Equity and Total Debt all report the same thing – given one you can calculate the other two.

Equity Total

Assets TotalMultiplierEquity

Equity Total

Debt TotalRatioEquity Debt


Fin 200Long Term Debt Ratio

Denominator is the total capitalization

Short term changes quickly this is more stable

Equity Total Debt Term Long

Debt Term - LongRatioDebt LT


Fin 200Times Interest Earned

Generally, the higher the ratio the better.Measures how many times the firm can

cover its interest expenseIs this a good measure of Cash availabe to

spend?

Interest

EBITTIE


Fin 200Cash Coverage

Generally, the higher the ratio the better.Measures how many times the firm can

cover its interest expenseNumerator measures the firms ability to

generate income from operations

Interest

onDepreciati EBITCoverageCash


Fin 200Asset Management

Intended to describe how intensively a firm uses its assets to generate sales


Fin 200Inventory Turnover


The number of times the firsm turns over its inventory

Inventory

Sold Goods ofCost TurnoverInventory


Fin 200Days Sales in Inventories

Represents how many days inventory sits on the self prior to being sold.

TurnoverInventory

Days 365


Fin 200Receivables Turnover

Number of times the firm collects its credit accounts and reloaned the money

Receivable Accounts

Sales


Fin 200Days’ Sales in Receivables

Also called average collection period

Represents how long it takes the firm on average to collect on its payables

Turnover sReceivable

Days 365


Fin 200Asset Turnover Ratios

NWC

SalesTurnover NWC

Assets FixedNet

SalesTurnoverAsset Fixed

Assets Total

SalesTurnoverAsset Total


Fin 200Profitability Measures

Most widely used ratios

Focus is Net Income

Measure the ability of the firm to control expenses generated in order to make sales


Fin 200Profit Margin

Generally, the higher the ratio the better.Measures the amount in profit that is

generated for each dollar of incomeCan profit Margin decrease and total profit

increase?

Sales

IncomeNet MarginProfit


Fin 200Return on Assets

Measures the profit per dollar of assets

Also called return on investment

Sales

IncomeNet ROA


Fin 200Return on Equity

Measures how the shareholders did over the course of the data

Both ROA and ROE are accounting returns

Equity Total

IncomeNet ROE


Fin 200Market Value Measures

gOutstandin Shares

IncomeNet EPS

shareper Earnings

SharePer PriceRatio PE

Shareper Book value

SharePer ValueMarket

book Market to


Fin 200Dupont Identity

Assets

Assets

Equity Total

IncomeNet ROE

MultiplierEquity ROA

Equity Total

Assets

Assets

IncomeNet ROE

Equity Total

Assets

Assets

IncomeNet

Sales

SalesROE


Fin 200

Equity Total

Assets

Assets

IncomeNet

Sales

SalesROE

Multiplier

Equity

Turnover

Asset Total

Margin

Profit

Equity Total

Assets

Assets

Sales

Sales

IncomeNet ROE


Fin 200Decomposition

The Dupont Identity breaks the ROE into three parts

1. Operating Efficiency (Profit Margin)2. Asset Use Efficiency (Total Asset

Turnover)3. Financial Leverage (Equity Multiplier)


Fin 200

Why Evaluate Financial Statements

Internal UsesCompare across divisionsCompensation

External UsesSuppliers and CreditEvaluate CompetitionM&A


Fin 200Choose a Benchmark

Time Trend AnalysisWhat has happened over the last 5 or 10 years?

Peer Group AnalysisSIC CodesIndustry Averages


Fin 200Problems

No theory relating to choice of benchmarks or which ratios are important

Consolidated Firms

Global Accounting Standards

Financial Statements

Economy & Finance

Transcript of Financial Statements