Accounting Statements & Cash Flow Chapter 2

The Balance Sheet

The balance sheet is an accountants snapshot of the firms accounting value on a particular date.
What the firms owns and how it is financed Assets = Liabilities + Stockholders equity (this equation must always hold) Stockholders equity = Assets Liabilities (equity is what the stockholders would have remaining after the firm discharged its obligations)

Analyzing A Balance Sheet Concerns

Liquidity Debt Versus Equity Value Versus Cost

The Income Statement

The income statement measures performance over a specific period of time Revenue Expense = Income Operations Section: Revenues & Expenses Earnings Before Interest & Taxes (EBIT): Earnings before taxes and financing cost Net Income (frequently expressed per share of common stock, i.e. Earnings per share (EPS)

The Income Statement

Generally Accepted Accounting Principles (GAAP) Noncash Items:
Depreciation Deferred Taxes

Time & Costs

Variable Costs (raw material costs) Fixed Costs (manufacturing overheads, property taxes) Period Costs: Are allocated to a time period (selling, general, & administrative expenses)

Net Working Capital

Current Assets Current Liabilities=NWC Positive when current assets are greater than current liabilities The change in networking capital is investment in net working capital by a firm (usually positive in a growing firm)
Current Assets Current Liabilities Net Working Capital ($ million) ($ million) ($ million) 2012 761 486 275 2011 707 455 252 The change in net working capital=$23 million

Financial Cash Flow

Cash flow of the firm: a)Operating Cash Flow = EBIT + Depreciation Taxes b) Capital Spending = Acquisitions of Fixed Assets Sale of Fixed Assets c) Additions to Net Working Capital Cash flow to investors in the firm: Debt = Interest + Retirement of Debt L T Debt Financing Equity = Dividends + Repurchase of Equity New Equity Financing

Financial Cash Flow

Cash Flows received from the firms assets = Cash Flows to the firms creditors & equity investors CF(A) = CF(B) +CF(S) The Statement of Cash Flows Explains the change in accounting cash and equivalents

The Accounting Statement of Cash Flows

Cash Flow from Operating Activities Net Income + Noncash expenses (Depreciation) + Adjust for changes in current assets & current liabilities (other than cash)

Cash Flow from Investing Activities

Changes in Capital Assets Purchases of fixed assets (cash outflow) and sales of fixed assets (cash inflow) Net Capital Expenditure

Cash Flow from Financing Activities

Retirement of debt is Cash Outflow Proceeds from long-term debt sales is Cash Inflow

Dividends is Cash Outflow

Repurchase of stock is Cash Outflow Proceeds from new stock issue is Cash Inflow

USC CORPORATION Balance Sheet 2010 & 2009 ($ in millions)

Assets Current assets: Cash & equivalents Accounts receivables Inventories Other Total Fixed Assets: Property, plant & equip. 2010 2009 Liabilities & Stockholders Equity Current liabilities: Accounts payable 2010 2009

140 294 269 58 761

107 270 280 50 707

263 223 486 117 471 588 39 55 347 390 - 26 805

250 205 455 104 458 562 39 32 327 347 -20 725

1,423 Less accumulated depreciation -550 Net property, plant & equip 873 Intangible assets & others 245 Total fixed assets 1,118

Total Assets

1,879

Accrued expenses Total Long-term liabilities: Deferred taxes 1,274 Long-term debt - 460 Total 814 Stockholders equity: 221 Preferred stock 1,035 Common stock ($1 par value) Capital Surplus Accumulated retained earning Less treasury stock Total equity Total liabilities and 1,742 stockholders equity

1,879 1,742

USC CORPORATION Income Statement 2010 ($ in million)

Total operating revenues Cost of goods sold Selling, general, & administrative expenses Depreciation Operating income Other income EBIT Interest expense Pretax income Taxes Current: $71 Deferred: $13 Net income Addition to retained earnings: Dividends: 2,262 1,655 327 90 190 29 219 49 170 84

86 43 43

U.S. Composite Corporation Financial Cash Flow 2010

($ in millions)

Cash flow of the firm Operating cash flow (EBIT + depreciation taxes) Capital spending (Acquisitions of fixed assets sales of fixed assets) Additions to net working capital Total Cash flow to investors in the firm Debt (Interest + retirement of debt long term debt financing) Equity (Dividends plus repurchase of equity new equity financing) Total

238
-173

- 23 42
36 6 ____ 42

Operating cash flow (cash flow from operations) EBIT (Earnings before interest and taxes) $219 Depreciation 90 Current taxes - 71 Operating cash flow $238 Capital spending (cash flow used for capital spending) Acquisition of fixed assets $198 Sales of fixed assets - 25 Capital spending $173 ($149 + 24 = increase in property, plant, and equipment + increase in intangible assets) Capital Spending = Ending net fixed assets Beginning net fixed assets + Depreciation Additions to net working capital $23

Cash Flow Paid to Creditors ($ in millions)

Interest Retirement of debt Debt service 49 73 122

Proceeds from long-term debt sales - 86 36 Cash flow paid to creditors = Interest Net new debt
Net new debt = Ending long-term debt Beginning long-term debt

Cash Flow to Stockholders ($ in millions)

Dividends Repurchase of stock Cash to stockholders Proceeds from new stock issue 43 6 49 - 43 6

Cash flow to stockholders = Dividends paid Net new equity raised Net new equity raised = Stock sold Stock repurchased

Question No 1
The following table presents the long-term liabilities & stockholders equity of ICM of one year ago

During the past year, ICM issued $10 million of new common stock. The firm generated $5 million of net income and paid $ 3 million of dividends. Construct todays balance sheet reflecting the changes that occurred at ICM during the year.

Solution
No change in long-term debt No change in preferred stock
Common stock increased by $10,000,000 (new issue) 100,000,000 + 10,000,000 = $110,000,000 Net Income Dividends = Retained Earnings (5,000,000 3,000,000 = 2,000,000) Retained earning increased by $ 2,000,000 20,000,000 + 2,000,000 = 22,000,000

Todays Balance Sheet

(Long-term debt & stockholders equity)

Long-term debt Preferred stock Common stock Retained earnings

$50,000,000 30,000,000 110,000,000 22,000,000

Question No 2
During 2011, the ST Limited had gross sales of $ 1 million. The firms cost of goods sold and selling expenses were $ 300,000 and $ 200,000 respectively. These figures do not include depreciation. ST also had notes payable of $ 1 million. These notes carried an interest rate of 10%. Depreciation was $ 100,000. STs tax rate was 35% in 2011.

Question No 2
What was the firms net operating income? What were the firms earnings before taxes? What was the firms net income?

What was the firms cash flow from operating activities?

Solution
Gross Sales Cost of goods sold Selling expenses Depreciation $ 1,000,000 (300,000) (200,000) (100,000) $ 400,000

Net operating Income =

Solution
Earnings before tax = Net operating income Interest expense $ 400,000 100,000 = $ 300,000 (Interest Expense = 1,000,000 x 0.1) Net Income = EBT Tax Tax = EBT x Tax Rate = 300,000 x .35 = 105,000 NI = 300,000 105,000= $195,000 OR NI=EBT x (1- Tax Rate) NI = 300,000 x (1-0.35) = 300,000 x 0.65 = $ 195,000

Solution
Operating Cash Flow = Net Income + Depreciation $ 195,000 + 100,000 = $ 295,000

Question No 3
The Stancil Corporation provided the following current information Proceeds from long-term borrowing $ 19,000 Proceeds from the sale of common stock $ 3,000 Purchases of fixed assets $15,000 Purchases of inventories $ 1,500 Payment of dividends $ 19,500 Calculate the cash flow from the firm & the cash flows to investors of the firm

Solution
Cash flows from the firm: Capital spending Additions to NWC Cash flows from the firm $ $ (15,000) (1,500) (16,500)

Cash flows to investors of the firm Sale of long-term debt $ Sale of common stock Dividends paid Cash flows to investors of the firm$

(19,000) (3,000) 19,500 (2,500)