FIN 3331 Managerial Finance

Lecture 3

Financial statement, cash flow & taxes

20 October 2011

Lecture outline

Main purpose of financial statements. Understand in detail of financial statement. Income taxes for individuals and corporate

Recap lecture 2

Capital allocation process: Direct transfer, indirect transfer through investment banks; Indirect transfer through a financial intermediary. Financial market: Spot vs. Future; Money vs. Capital; Primary vs. Secondary; private vs. public. Financial institutions: investment banks; commercial banks; financial services corporations; mutual funds. 3 types of stock market transactions: share traded in secondary market; additional shares sold in primary market; IPO.
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Purpose of financial statements

Financial statements includes: balance sheet, income statement, statement of cash flows, statement of stockholders equity. Purpose: reflect the firms operating results and financial position help managers, investors, shareholders evaluate firms value for making decision.

Balance sheet

Show what assets the company owns and who has claim on those assets (liabilities) at a given date (e.g.at the end of a year). Assets side: Current assets: could be converted to cash within 1 year. Fixed/long-term assets: expected be used more than 1 year, e.g. plant and equipment is reported net of accumulated depreciation.

Balance sheet
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Liabilities side: Current liabilities: claim that must be paid off within 1 year. Long-term debt: debt that mature in more than 1 year.

- Shareholders equity: paid-in capital (amount shareholders paid to firm when they bought shares when firm sold to raise capital); retained earnings (earnings firm retained, not distributed over year).

Balance sheet
Shareholders equity = Paid in capital + Retained earnings
Shareholders equity = Total assets Total liabilities.

Income statement
Shows the firms sales/revenues, costs/ expenses & profits/net income during given past period (1 year). Show how profitable firm has been. Operating income (or EBIT) = Sales revenues operating costs Earning per share = EPS = Net Income/common shares outstanding Operating income: earnings from operation of firm, calculated before deducted interests & taxes.

Income statement

Depreciation: annual charge against income, reflect cost of assets used up in production process, not a cash outlay. Amortization: represents decline in value of intangible assets (copyrights, trademarks, goodwill), non cash change. EBITDA: earning before interests, taxes, depreciation, amortization, measure amount of cash firm generating

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Statement of cash flows

Show how much cash firm began the year with, how much cash it ended up with, and what it did to increase or decrease with cash. A statement of cash flows shows 3 main types of activities: Operating activities: items in normal ongoing operations (net income, depreciation,) Long-term investing activities: activities involving long-term assets (acquisition or sale of fixed assets)

Statement of cash flows

Financing activities: activities involving financial assets (loans) & payment of dividends to stockholders. - Summary: summarize changes in cash & cash equivalents over reported time. For all items: - Inflow cash: reported as positive amount. - Outflow cash: reported as negative amount.
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Statement of shareholder equity

Show the amount of equity stockholders had at the start of the year, items that increased or decreased equity, and equity at the end of the year. Reflect net income, cash dividends, additional retained earning used in the business.

Statement of shareholder equity: Example

Table 3-4 page 66 text book.

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Income taxes

Individual taxes Individual pay taxes on wages, salaries, investment income (dividends, interest, profit from sale of securities), profit from proprietorships and partnerships. Marginal tax rate: tax rate on the last dollar income, there is a threshold that individual pay zero tax if income less than threshold; above threshold level, one pays tax at different rate depending on amount of income. Average tax rate: taxes paid divided by taxable income.

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Example of marginal tax

Taxable income: $35,000 Calculate Tax: = $4,386.25 + ($35,000-31,835)*(0.25) = $5,173.75 Average tax rate: = $5,173.75/$35,000=14.78%

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Income taxes
Corporate taxes: - Similar to individual taxes, but different tax rates and threshold level. Example: Taxable income: $65,000 Taxes: = $7,500 + (%65,000 50,000)*(0.25) = $11,250

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Tutorial questions
Answer for tutorial questions lecture 2. Problems: 3-1, 3-2, 3-3, 3-4, 3-5, 3-6 pg. 76 text book.

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