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.
Why do We Need Financial Statements? Creditors and investors need them to make informed financial decisions about whether to lend and invest in the company.
Managers need them to operate their business efficiently.
Taxing authorities (Government) need them to assess taxes in a reasonable way. A Typical Balance Sheet Stockholders Equity
Paid-in capital - money raised from investors; paid-in capital represents external financing.
Retained earnings that part of the profit which is not distributed to investors as dividends, but instead is reinvested in the business; it provides the most important source of financing for the corporations growth internal financing.
Stockholders Equity = Paid-in capital + Retained earnings
BS Equation Stockholders equity represents a residual claim; Residual is whatever is left from the assets after all the liabilities are satisfied. This means that stockholders have a claim after everybody else has been completely satisfied;
From the the BS equation, we can calculate stockholders equity as a residual:
Stockholders equity = Total assets - Total liabilities Working Capital Current assets are often called working capital
Net working capital = Current assets Current Liabilities
Distinction between free liabilities (accruals and accounts payable) and interest-bearing liabilities (notes payable)
NOWC = Current assets (Current liabilities Notes Payable) Income Statement EBIT (operating profit) = Sales revenues Operating costs
EBITDA = Sales revenues Operating costs except depreciation and amortization
Depreciation it simply means a loss of value of an asset because of normal use (in accounting we use the term wear and tear); similar to depreciation is amortization with the only difference that it is associated with intangible assets; firms often used accelerated depreciation for tax purposes and straight-line depreciation for stockholder reporting.
Statement of Stockholders Equity It simply has 2 main components paid-in capital and retained earning. Stockholders Equity: Beg. Balance + in Retained Earnings = Ending Balance Net income and dividends jointly give you the change in retained earnings for the current year. Retained Earnings: Beg. Balance (accumulated retained earnings until last year) + Net Income Dividends = Ending Balance Paid-in Capital: Beg. Balance + Stock issuance/issue Stock buyback/repurchase = Ending Balance
Cash Flow Statement Cash flows from operating activities
Cash flows from investing activities
Cash flows from financing activities
A Typical Cash Flow Statement I. Operating activities Net Income 117,5 Depreciation & Amortization 100 Increase in inventories -200 Increase in accounts receivable -60 Increase in accounts payable 30 Increase in accrued wages and taxes 10 Net cash provided by (used in) operating activities -2,5 II. Long-Term Investing Activities Additions to property, plant and equipment -230 Net cash from (used in) investing activities -230
III. Financing Activities Increase in notes payable 50 Increase in bonds 170 Payment of dividends to stockholders -57,5 Net cash from (used in) Financing activities 162,5
IV. Summary Net increase/decrease in cash and cash equivalents (Net sum of I, II and III) -70 Cash & cash equivalents at the beginning of the period 80 Cash & cash equivalents at the end of the period 10 Free Cash Flow FCF is the amount of cash that could be withdrawn from the firm without harming its ability to operate and to produce future cash flows. FCF is equal to whatever is left from the operating profit after you satisfy the government and then you take care of your short-term capital needs (operating needs) and long-term capital needs (investment needs). It is available to satisfy debtholders and stockholders and can be used to pay down debt, interest, dividends, to repurchase stock (in any way to satisfy liabilities).
EBIT (1-T) = after-tax profit; it is often referred to as NOPAT (net operating profit after taxes) Is it possible a rapidly growing business that is very profitable and produce high CFs to have a negative FCF?
Performance Measures Market Value Added (MVA) is the difference between the market value of a firms equity and its book value.
Economic Value Added (EVA) is the excess of NOPAT over capital costs
EVA = NOPAT Annual dollar cost of capital = = EBIT(1-T) (Total Investor-supplied operating capital * After-tax percentage cost of capital)
EVA is an estimate of business true economic profit for a given year and it differs sharply from accounting net income. Relationship between EVA and MVA If EVA is positive, then after-tax operating income > cost of capital needed to produce that income.
Positive EVA on annual basis helps to ensure MVA is positive.
MVA is applicable to entire firm, while EVA can be calculated on a divisional basis as well.
Individual Taxes Individual taxes (on wages and salaries, on investment income and on profits of proprietorships and partnerships) have a progressive structure (the higher the taxable income, the higher the marginal tax rate). Taxable income gross income less a set of exemptions and deductions. Marginal tax rate the tax rate on the last unit of income (begin at 10% and rise to 39,6% for 2013) Average tax rate taxes paid divided by taxable income. Interest income received by individuals is added to their income for tax purposes. Capital gains and losses short-term ones are added to ordinary income, long-term are treated differently (they are usually taxed at a lower rate than regular income). Dividends are classified either as ordinary dividends or as qualified dividends. Ordinary dividends are taxed at ordinary tax rates for whatever tax bracket you are in. Qualified dividends are taxed at the long-term capital gains tax rates of zero percent, 15% or 20% rates.
Tax Rate Example Taxable Income You Pay This Amount on the Base of the Bracket Plus This Percentage on the Excess over the Base (Marginal Rate) $0 to $8 925 0 10,0% $8 925 to $36 250 892,5 15,0% $36 250 to $87 850 4 991,25 25,0% $87 850 to $183 250 17 891,25 28,0% $183 250 to $398 350 44 603,25 33,0% $398 350 to $400 000 115 586,25 35,0% $400 000 and up 116 163,75 39.6% If you earn $100,000 per year, how much tax you would owe? What are you marginal and average tax rates?
You would owe 10% of $8,925, 15% of $27,325 (the difference between the top and the threshold of the second tax bracket), 25% of $51,600, and 28% of $12,150 (the difference between your income and the threshold of the third tax bracket).That calculation results in $21,293, or an effective (not marginal) tax rate of 21.3%. Corporate Taxes Corporate income taxes have a progressive tax structure. Interest earned: usually fully taxable at regular tax rates (an exception being interest from a muni). Dividends received: A portion of dividends (up to 100% depending on the percentage of ownership) is excluded from taxable income, while the remaining is taxed at the ordinary tax rate, the purpose being to avoid triple taxation. Capital gains - U.S. corporations face the same tax rate on capital gains as on ordinary income. Interest paid: tax deductible for corporations (paid out of pre-tax income). Dividends are paid out of net income which has already been taxed at the corporate level, this is a form of double taxation.
Corporate Tax Rates Taxable Income You Pay This Amount on the Base of the Bracket Plus This Percentage on the Excess over the Base (Marginal Rate) $0 to $50 000 0 15,0% $50 000 to $75 000 7 500 25,0% $75 000 to $100 000 13 750 34,0% $100 000 to $335 000 22 250 39,0% $335 000 to $10 000 000 113 900 34,0% $10 000 000 to $15 000 000 3 400 000 35,0% $15 000 000 to $ 18 333 333 5 150 000 38,0% $18 333 333 and up 6 416 667 35,0% Average Tax Rate at Top of Bracket 15% 18,3% 22,3% 34,0% 34,0% 34,3% 35,0% 35,0% What is the average tax rate at top of each tax bracket? 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. 2011 2012 Original taxable income $3 000 000 $2 000 000 Carry-back credit -3 000 000 -2 000 000 Adjusted profit $ 0 $ 0 Taxes previously paid (40%) 1 200 000 800 000 Tax refund $ 1 200 000 $ 800 000 Total refund received in 2014: $1 200 000 + $800 000 = $2 000 000 Amount of loss carry-forward available for use in 2014-2034: 2013 loss $6 000 000 Carry-back losses used $5 000 000 Carry-forward losses still available $1 000 000