Vicentiu Covrig FIN303

Financial statements and

cash flow
(chapter 3)

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Sources of Information
Annual reports
Wall Street Journal
Internet
- www.yahoo.com
- www.smartmoney.com
Mergent online
SEC
- EDGAR
- 10K & 10Q reports

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The Annual Report

Balance sheet provides a snapshot of a firms
financial position at one point in time.
Income statement summarizes a firms
revenues and expenses over a given period of
time.
Statement of cash flows reports the impact of a
firms activities on cash flows over a given
period of time.
Statement of stockholders equity shows how
much of the firms earnings were retained, rather
than paid out as dividends.

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Overview of DLeon Inc.

Snack food company that underwent major
expansion in 2014.
So far, expansion results have been
unsatisfactory.
- Companys cash position is weak.
- Suppliers are being paid late.
- Bank has threatened to cut off credit.
Board of Directors has ordered that
changes must be made!

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Balance Sheet: Assets

2015 2014
Cash 7,282 57,600
A/R 632,160 351,200
Inventories 1,287,360 715,200
Total CA 1,926,802 1,124,000
Gross FA 1,202,950 491,000
Less: Dep. 263,160 146,200
Net FA 939,790 344,800
Total Assets 2,866,592 1,468,800

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Balance Sheet: Liabilities and Equity

2015 2014
Accts payable 524,160 145,600
Notes payable 636,808 200,000
Accruals 489,600 136,000
Total CL 1,650,568 481,600
Long-term debt 723,432 323,432
Common stock 460,000 + 460,000
Retained earnings 32,592 203,768
Total Equity 492,592 663,768
Total L & E 2,866,592 = 1,468,800

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Income Statement
2015 2014
Sales $6,034,000 $3,432,000
COGS 5,528,000 2,864,000
Other expenses 519,988 358,672
Total oper. costs excl.
deprec. & amort. $6,047,988 $3,222,672
Depreciation and amortization 116,960 18,900
EBIT ($ 130,948) $ 190,428
Interest expense 136,012 43,828
EBT ($ 266,960) $ 146,600
Taxes (106,784) 58,640
Net income ($ 160,176) $ 87,960

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Other Data
2015 2014
No. of shares 100,000 100,000
EPS -$1.602 $0.88
DPS $0.11 $0.22
Stock price $2.25 $8.50

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Did the expansion create additional
after-tax operating income?
AT operating income = EBIT(1 Tax rate)

AT operating income15 = -$130,948(1 0.4)

= -$130,948(0.6)
= -$78,569

AT operating income14 = $114,257

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What effect did the expansion have on
net operating working capital?
Current Current Notes
NOWC
assets liabilities payable

NOWC15 ($7,282 $632,160 $1,287,360)

($1,650,568 $636,808)
$913,042

NOWC14 $842,400

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What was the free cash flow (FCF) for
2015?
Depr. and Capital
FCF EBIT(1 T) NOWC
amortizati on expenditur es

FCF15 = [-$130,948(1 0.4) +

$116,960] [($1,202,950 $491,000) +
$70,642]
= -$744,201
Is negative free cash flow always a bad
sign?
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Performance Measures for Evaluating
Managers
Accounting statements insufficient for evaluating
managers performance because they do not reflect
market values.
Performance Measures
MVA = Difference between market value and
book value of a firms common equity.
P0 x Number of shares Book value.
EVA = Estimate of a business true economic
profit for a given year.
Investor-supplied Cost of
EBIT(1 T) x
capital capital

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What was DLeons MVA in 2014 and
2015?
MVA14 = ($8.50 x 100,000) $663,768
= $186,232.

MVA15 = ($2.25 x 100,000) $492,592

= -$267,592.

Shareholder wealth has been destroyed!

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Federal Income Tax System

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Corporate and Personal Taxes

Both have a progressive structure (the higher the
income, the higher the marginal tax rate).
Corporations
- Rates begin at 15% and rise to 35% for
corporations with income over $10 million,
although corporations with income between
$15 million and $18.33 million pay a marginal
tax rate of 38%.
- Also subject to state tax (around 5%).

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Tax treatment of various uses and
sources of funds
Interest paid tax deductible for corporations (paid
out of pre-tax income), but usually not for individuals
(interest on home loans being the exception).
Interest earned usually fully taxable (an exception
being interest from a (muni).
Dividends paid paid out of after-tax income.
Dividends received taxed as ordinary income for
individuals (double taxation). A portion of
dividends received by corporations is tax excludable,
in order to avoid triple taxation.

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Tax Treatment of Various Uses and
Sources of Funds
Dividends received: most investors pay 15% taxes.
- Investors in the 10% or 15% tax bracket pay 0% on
qualified dividends.
- Single individuals with incomes over $400,000 and
married couples filing jointly with incomes over
$450,000 pay 20% taxes on dividends.
- Dividends are paid out of net income which has
already been taxed at the corporate level, this is a form
of double taxation.
- A portion of dividends received by corporations is tax
excludable, in order to avoid triple taxation.

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More Tax Issues
Tax Loss Carry-Back and Carry-Forward since corporate
incomes can fluctuate widely, the Tax Code allows firms to
carry losses back to offset profits in previous years or
forward to offset profits in the future.
Capital gains defined as the profits from the sale of assets
not normally transacted in the normal course of business,
capital gains for individuals are generally taxed as ordinary
income if held for a year or less, and at the capital gains rate
if held for more than a year. Corporations face somewhat
different rules.
Most taxpayers pay 15% taxes on long-term capital gains.
Single individuals with incomes over $400,000 and married
couples filing jointly with incomes over $450,000 pay 20%
taxes on long-germ capital gains.

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Learning objectives
Annual report; Balance sheet; Income Statement items you see on the slides
You DO NOT need to know the Statement of Cash Flows (3.4)
Free Cash Flow
MVA and EVA (no numerical problems)
Taxes
All the numerical problems on the slides and recommended below from end of
chapter
You need to know to do After Tax Income problems and remember the formula
from page 81
Questions: ST-1, ST-2 a,b,c,d; 3-1 to 3-5; 3-7,3-9,3-10
Problems: 3-1, 3-2, 3-3, 3-5, 3-8,

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