Beruflich Dokumente
Kultur Dokumente
Rushen Chahal
CHAPTER 2
CHAPTER OUTLINE
I. Basic Financial Statements A. The Income Statement 1. 2. The income statement reports the results from operating the business for a period of time, such as a year. It is helpful to think of the income statement as comprising five types of activities: a. b. c. Selling the product The cost of producing or acquiring the goods or services sold The expenses incurred in marketing and distributing the product or service to the customer along with administrative operating expenses The financing costs of doing business: for example, interest paid to creditors and dividend payments to the preferred stockholders The taxes owed based on a firms taxable income
d.
e. 3.
An example of an income statement is provided in Table 2-1 for the Harley-Davidson Corporation.
(2) (3)
b.
The liabilities and owners equity indicate how the assets are financed. (1) (2) The debt consists of such sources as credit extended from suppliers or a loan from a bank. The equity includes the stockholders investment in the firm and the cumulative profits retained in the business up to the date of the balance sheet.
2.
The balance sheet is not intended to represent the current market value of the company, but rather reports the historical transactions recorded at their costs. Balance sheets for the Harley-Davidson Corporation are presented in Table 2-2.
3. II
Computing a Companys Taxes A. Types of taxpayers 1. Sole proprietors a. b. 2. a. b. Report business income on personal tax returns Pay taxes at personal tax rate The partnership reports income but does not pay taxes Each partner reports his or her portion of income and pays the corresponding taxes.
Partnerships
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Computing Taxable Income Taxable income is based on gross income less tax-deductible expenses a. b. 2. a. b. Interest expense is tax deductible Dividend payments are not tax deductible Modified accelerated cost recovery system used for computing depreciation for tax purposes We use straight-line depreciation to reduce complexity.
Depreciation
C.
Computing Taxes Owed 1. 2. 3. 4. Taxes paid are based on corporate tax structure. Tax rates used to calculate tax liability are marginal tax rates, or the rate applicable to the next dollar of income. Average tax rate is calculated by dividing taxes owed by the firms total income Marginal tax rate is used in financial decision making
III.
Measuring Free Cash Flows A. While an income statement measures a companys profits, profits are not the same as cash flows; profits are calculated on an accrual basis rather than a cash basis. In measuring cash flows, we could use the conventional accountants presentation called a statement of cash flows. However, we are more interested in considering cash flows from the perspective of the firms shareholders and its investors, rather than from an accounting view. We will instead measure the cash flow that is free and available to be distributed to the firms investors, both debt and equity investors, or what we will call free cash flows. The cash flows that are generated through a firms operations and investments in assets will always equal its cash flows paid to or received from the companys investors (both creditors and stockholders).
B.
C.
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4.
Investments in fixed assets includes the change in gross fixed assets and any other balance sheet assets not already considered.
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2. 3.
Free cash flow from an asset perspective must equal free cash flow from a financing perspective. Free cash flows from a financing perspective are simply the net cash flows received by the firms investors, or if negative, the cash flows that the investors are paying into the firm. In the latter situation where the investors are putting money into the firm, it is because the firms free cash flow from assets is negative, thereby requiring an infusion of capital by the investors.
IV.
Financial Statements and International Finance A. Many countries have different guidelines for firms to use in preparing financial statements. For example, a $1 of earnings in the United States is not the same as 1.10 Euro (the equivalent of a U.S. dollar based on the exchange rate). The differences are due to the two countries having different Generally Accepted Accounting Principles which guide their firms financial reporting. As a result of this situation, the International Accounting Standards Committee (IASC), a private body supported by the worldwide accounting profession, is trying to develop international financial-reporting standards that will minimize the problem. In spite of the work to standardize accounting practices around the world, the U.S. accounting profession has rejected efforts toward international standards. At this time, foreign companies seeking to list their shares in the United States must follow U.S. accounting standards.
B.
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2-2.
Gross profits is sales less the cost of producing or acquiring the firms product or service. Operating profits is the gross profits less the operating expenses, which consist of distributing the product or service to the customer (namely, marketing expenses) and any general and administrative expenses in operating the business. Net income is operating profits less financing costs (interest expenses and preferred stock dividends) and less income taxes. Interest expense is the cost of borrowing money from a banker or another lender. There typically is a fixed interest rate so that the interest expense is computed as the interest rate times the amount borrowed. If we borrow $500,000 at an interest rate of 12 percent, then our interest expense will be $60,000. While interest is paid for the use of debt capital, dividends are paid to the firms stockholders. Preferred stock typically has a fixed dividend rate, so that the preferred stockholder gets a constant dividend each year. Common stockholders, on the other hand, usually receive dividends only if management decides to pay a dividend instead of reinvesting the firms profits. However, typically once a dividend has been paid to common stockholders, management is reluctant to decrease it or cease paying a dividend.
2-3.
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2.5
2-7. 2-8.
Belmond, Inc. Income Statement For the Year Ended December 31, 2003 Sales Cost of goods sold Gross profits General & admin expense Depreciation expense Total operating expense Operating income (EBIT) Interest expense Earnings before taxes Taxes Net income 16 $ 12,800 5,750 $ 7,050 $ 850 500 $ 1,350 $ 5,700 900 $ 4,800 1,440 $ 3,360
$ 100,000 90,000 $ 190,000 160,000 $ 350,000 $ 320,000 100,000 20,000 $ 440,000 $ 790,000
Sharpe Mfg. Company Income Statement For the Year Ended December 31, 2003 Sales Cost of goods sold Gross profits Operating expense Net income (Assume no interest accrued or taxes) $ 800,000 500,000 $ 300,000 280,000 $ 20,000
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2-4A. Potts, Inc. - Corporate Income Tax Sales Cost of goods sold and cash operating expenses Operating profit Interest expense Taxable Income Tax Liability: $50,000 25,000 25,000 235,000 35,000 $370,000 x x x x x 0.15 0.25 0.34 0.39 0.34 = = = = = $7,500 6,250 8,500 91,650 11,900 $125,800 $ 6,000,000 5,600,000 $ 400,000 30,000 $ 370,000
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Note: The dividends were computed by comparing net income against the change in retained earnings. Net income was $180,000, but retained earnings increased only by $100,000; thus the balance was distributed in the form of dividends. Pamplin, Inc. had an after-tax operating cash flow of $440,000. Additionally, Pamplin acquired further financing though increasing short-term debt by $150,000. This cash was mainly used to purchase fixed assets of $400,000. The remainder was used to decrease payables to suppliers by $50,000, pay interest of $60,000, and pay dividends back to the investors of $80,000.
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$ (15,100)
$ (14,000) $ 53,800
T.P. Jarmon had a successful year, generating an after-tax cash flow of $82,900. To increase cash flow further, noninterest-bearing debt increased by $8,000. Part of this cash was consumed when current assets were increased by $23,100 (of which inventory increased by $33,000). Fixed assets of $14,000 were also purchased. The substantial part of the cash flow, however, was distributed back to the investors. Debt was decreased, both long-term and short-term, by $12,000. Interest of $10,000 was also paid on this debt. Finally, investors were paid $31,800 in dividends. 20
$ 11,000 6,000 (12,000) $ 5,000 $ 5,000 (5,000) $ $ (5,000) $ 73,000 $ (73,000) $ (14,000)
Free cash flows from a financing perspective: Interest paid to investors $ (4,000) Less change in interest payable Interest received by investors Decrease in long-term debt (mortgage payable) Increase in preferred stock Preferred stock dividends Common stock dividends Financing free cash flows
Abrams generated cash through an after-tax operating profit of $64,000 and issuing preferred stock of $120,000. This cash was primarily used to pay down debt of $70,000 and purchase fixed assets of $73,000. Investors also received cash back through dividends of $32,000 and interest of $4,000. Abrams also increased current assets in total by $5,000 by increasing cash and accounts receivable while decreasing inventory.
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$ 102,000 75,000 53,000 7,900 $ 237,900 334,000 $ 571,900 $ 289,000 262,900 $ 551,900 $1,123,800
Warner Company Income Statement For the Year Ended December 31, 2003 Sales Cost of goods sold Gross profits General & admin expense Depreciation expense Total operating expense Operating income (EBIT) Interest expense Earnings before taxes Taxes Net income 23 $ 573,000 297,000 $ 276,000 $ 79,000 66,000 $ 145,000 $ 131,000 4,750 $ 126,250 50,500 $ 75,750
90,000 90,000 $ 180,000 160,000 $ 340,000 $ 320,000 84,000 70,000 $ 474,000 $ 814,000
Sabine Mfg. Company Income Statement For the Year Ended December 31, 2003 Net Sales Cost of goods sold Gross profits Operating expense Net income $ 900,000 550,000 $ 350,000 280,000 $ 70,000
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2-4B. Rose, Inc. - Corporate Income Tax Sales Cost of goods sold and cash operating expenses Operating profit Interest expense Taxable Income Tax Liability: $50,000 25,000 25,000 235,000 25,000 $ 360,000 x x x x x 0.15 0.25 0.34 0.39 0.34 = = = = = $ 7,500 6,250 8,500 91,650 8,500 $122,400 $7,000,000 6,600,000 $400,000 40,000 $ 360,000
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After-tax cash flows from operations of $422,000 and an increase in notes payable of $115,000 were used to pay down the accounts payable by $135,000 and increase our inventory and fixed assets by $50,000 and $300,000, respectively. Interest of $60,000 and common stock dividends of $62,000 were paid to investors. 26
1,000 200 (4,000) (100) 43,000 $ 40,100 $ 7,000 (1,000) $ 6,000 $ (34,100) $ 34,000 $ (34,000) $ 54,800
Free cash flows from a financing perspective: Interest expense $ (10,000) Less change in interest payable Interest paid to lenders Decrease in notes payable Decrease in long-term debt Common stock dividends Financing free cash flows
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$ (19,000) 6,000 (22,000) $ (35,000) $ (5,000) (5,000) $ (10,000) $ 25,000 $ 63,000 $ (63,000) $ 35,000
Free cash flows from a financing perspective: Interest expense $ (5,000) Less change in interest payable Interest paid to lenders Decrease in mortgage payable Increase in preferred stock Preferred stock dividends Common stock dividends Financing free cash flows 28
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