Chapter 13 Business Organization and Financial Data © 2011 John Wiley and Sons

2 Chapter O utcomes n Describe the three major forms of business organization n Provide a brief description of the income statement n Provide a brief description of the balance sheet n Provide a brief description of the statement of cash flows

3 Chapter Outcomes (Continued) n Identify the goal and functions of financial management n Describe the agency relationships in a business organization and their implications for financial management

4 The Mission or Vision Statement n Indicates firm’s target market(s) n Identifies goods/services the firm will produce, distribute, or sell n Will guide major decisions n Supported by business and financial plans to implement strategy n Periodically reviewed and revised

5 Forms of Business Organization in the U.S. n Proprietorships n Partnerships –Limited partnership n Corporation –Subchapter S corporation –Limited liability company n Financial implications of organizational form (Table 13.1)

6 Annual Report n Information source for corporate shareholders n Contains –Discussions of operating and financial information of past year –Future opportunities –Financial statements

7 Accounting Principles n Public firm’s statements must conform to Generally Accepted Accounting Principles n Footnotes n “Accrual” accounting versus cash flows

8 Table 13.2 Comparison of Accounting and Financial Perspectives Accounting Focus Finance Focus Matching RevenueIdentifying cash inflows and Expenses (accrual concept) and outflows Use of different accounting Track the cash flows to can lead to manipulation of financial assess the “quality” of statements and earnings Seek to Measure Firm ProfitabilityMeasure cash usage Emphasis is historical Looks forward Attempts to track assets and Market value of assets depreciate them

9 Income Statement ($ millions) Net revenues or sales$63,335 Cost of goods sold 44,747 Gross profit 18,588 Operating expenses: Selling, general and admin. 14,366 Depreciation 975 Operating income 3,247 Interest 83 Other expenses (income) 0 Income before taxes 3,164 Income taxes 1,158 Net income $2,006

10 Balance Sheet--Assets ($ millions) Cash and marketable securities $2,587 Accounts receivable 2,496 Inventories 6,789 Other current assets 177 Total current assets 12,049 Net plant and equipment 10,802 Other Long-term Assets 2,291 Total assets $25,142

11 Balance Sheet--Liabilities & Equity Accounts payable $ 4,308 Notes payable 15 Other current liabilities 2,446 Total current liabilities 6,769 Long-term debt 2,336 Other Liabilities 1,661 Total liabilities $10,766 Common equity and retained earnings 14,376 Total stockholders’ equity $14,376 Total liabilities and equity $25,142

12 Statement of Cash Flows n 3 sections: –Cash flows from operating activities –Cash flows from investing activities –Cash flows from financing activities n Their sum equals the change in the firm’s cash balance over the year

13 Financial Statements of Different Companies n Learn differences in how companies operate n Compare composition of assets and liabilities, current versus long-term n How they generate earnings, characteristics of their industries n Common-size financials allow comparison of different-sized firms

14 Common Size Balance Sheet--Assets ALLGREENSTINYSOFTBIGOIL PERCENT OF ASSETS Cash & Marketable Securities8.9%61.6%6.1% Accounts Receivable8.9%6.5%13.9% Inventories36.8%0.8%5.1% Other Current Assets1.1%5.1%1.2% Total Current Assets55.7%74.1%26.4% Net Fixed Assets43.3%2.8%60.2% Other Long Term Assets0.9%23.1%13.4% TOTAL ASSETS100.0%

15 Common Size Balance Sheets: Liabilities and Equity ALLGREENS TINYSOFT BIGOIL Accounts Payable18.2%2.0%8.8% Short Term Debt0.0% 2.7% Other Current Liabilities11.8%15.6%10.5% Total Current Liabilities30.0%17.6%22.0% Long Term Debt0.0% 2.7% Other Liabilities6.9%5.8%23.7% TOTAL LIABILITIES36.9%23.3%48.4% Preferred Equity0.0% Common Stockholders' Equity63.1%76.7%51.6% TOTAL LIABILITIES & EQUITY100.0%

16 Common Size Income Statements ALLGREENSTINYSOFTBIGOIL PERCENT OF REVENUE Revenue100.0% Cost of Goods Sold71.9%13.2%60.9% GROSS PROFIT28.1%86.8%39.1% Selling, General & Admin.21.4%26.8%23.9% Depreciation1.1%4.5%4.2% Research & Development0.0%14.5%0.0% OPERATING INCOME5.7%41.1%10.9% Interest Expense0.0% 0.1% Other Expenses (Income)-0.1%-4.7%-4.2% INCOME BEFORE TAXES5.8%45.8%15.0% Income Taxes2.2%14.7%5.2% NET INCOME3.6%31.0%9.8%

17 Goal of a Firm n GOAL: MAXIMIZE SHAREHOLDER WEALTH SHAREHOLDER WEALTH = Common Stock Price X Number Of Common Shares Outstanding

18 Why Shareholder Wealth? n Market is efficient; common stock price reflects available information and investor expectations n In a competitive global economy, market directs capital to most efficient use with best risk/expected return features n Need to treat customers, workers properly before shareholders benefit

19 Other Shareholder Wealth Issues n Market Value Added: wealth created by firm’s managers, net of capital invested n Peer review: compare firm’s wealth performance with competitors to determine strategy’s financial success or failure n Criterion for non-public firms

20 What about ethics? n Deceitful practices will enhance virtually any financial or non- financial performance measure n Poor ethics: short-term gain, long- term pain –Management careers ruined –Company name, reputation ruined –Shareholder wealth ruined n Needed: adequate training, controls, oversight

21 Corporate Governance n Owners Managers n ShareholdersProfessional Mgt. n PrincipalAgents n The Principal-Agent Problem –Can be compounded by: –Weak Board oversight of Management –Management perks –Fighting takeover attempts, poison pills

22 Agency costs n Explicit Agency Costs –Financial statement audits –Director and officer liability insurance –Monitoring of management by Board, consultants –Inflated salaries, perks n Implicit Agency Costs –Restrictions on management actions –Loan covenants

23 Ways to reduce the agency problem n Align management incentives with those of shareholders –Stock options –Restricted stock n Sufficient oversight and accountability –Additional independent directors –Sarbanes-Oxley Act of 2002

24 Some Provisions of Sarbanes-Oxley n Public Company Accounting Oversight Board –Registers auditors –Sets audit, ethics, quality standards –Audits the auditors n Auditor independence –Auditor reports to Board’s audit committee –Firm performing audit restricted from doing other accounting-related services for the firm

25 More Sarbanes-Oxley Provisions n CEO/CFO certify financial statements conform n Reduce investment banker conflicts of interest –Separate stock research from investment bank personnel –Stock analysts cannot be paid from investment banking fees –Stock analyst research reports must disclose if they own securities in the firm for which they have made an investment recommendation

26 Finance in the Organizational Chart n Chief Financial Officer (CFO) –Treasury function –Controller function n Compensation n Finance and the Balance Sheet Structure –Capital budgeting question –Capital structure question –Operations or net working capital question

27 Learning Extension 13A Federal Income Taxation Tax rates, married filing jointly 2010 Taxable Marginal income tax rate $0–16,75010% 16,750–68, ,000–137, ,300–209, ,250–373,65033 Over 373,65035

28 Tax rates, single 2010 Marginal Taxable income tax rate $0–8,37510% 8,375–34, ,000–82, ,400–171, ,850–373,65033 Over 373,65035

29 Proprietor, married, $50,000 income Compute the tax bill: 0.10 x $16,750 = $1, x $33,250 = 4, $50,000 $ 6, Marginal tax rate: 15% Average tax rate =$6,662.50/$50,000 =13.3%

30 Concepts n Ordinary taxable income n Unrealized capital gains/losses n Realized capital gains/losses

31 Corporate tax rates Taxable income Tax rate $1--50,00015% 50, , , , , , , ,000, ,000, ,000, ,000, ,333,33338 over $18,333,33335

32 Depreciation Basics n Depreciation : –a non-cash expense –reduces taxable income –reduces tax bill (“depreciation tax shield”) –conserves cash as tax outflow is less

33 Example: The benefits of depreciation WITHWITHOUT Income before depr. and income taxes$100,000$100,000 Less: Depreciation 20,000 0 Income before taxes 80, ,000 Less: Income taxes 30%) 24,000 30,000 Net income$ 56,000 $ 70,000

34 MACRS Percentages PERCENTAGE DEPRECIATION ALLOWED BY CLASS OF ASSET LIFE RECOVERY YEAR3-YEAR5-YEAR %20.00%

35 Example: $10,000 asset in 5-year class DEPREC DEPREC YR PERCENTAGEAMOUNT 1$10,000x0.2000=$2, ,000x0.3200= 3, ,000x0.1920= 1, ,000x0.1152= 1, ,000x0.1152= 1, ,000x0.0576= 576 Total $10,000

36 Web Links governance.org