2-1 CHAPTER 2 Financial Statements, Cash Flow, and Taxes Balance sheet Income statement Statement of cash flows Accounting income vs. cash flow MVA and EVA Federal tax system

2-2 The Annual Report Balance sheet – provides a snapshot of a firm’s financial position at one point in time. Income statement – summarizes a firm’s revenues and expenses over a given period of time. Statement of retained earnings – shows how much of the firm’s earnings were retained, rather than paid out as dividends. Statement of cash flows – reports the impact of a firm’s activities on cash flows over a given period of time.

2-3 Balance Sheet: Assets Cash A/R Inventories Total CA Gross FA Less: Dep. Net FA Total Assets , ,160 1,287,360 1,926,802 1,202, , ,790 2,866, , , ,200 1,124, , , ,800 1,468,800

2-4 Balance sheet: Liabilities and Equity Accts payable Notes payable Accruals Total CL Long-term debt Common stock Retained earnings Total Equity Total L & E , , ,600 1,650, , ,000 32, ,592 2,866, , , , , , , , ,768 1,468,800

2-5 Income statement Sales COGS Other expenses EBITDA Depr. & Amort. EBIT Interest Exp. EBT Taxes Net income ,034,000 5,528, ,988 (13,988) 116,960 (130,948) 136,012 (266,960) (106,784) (160,176) ,432,000 2,864, , ,328 18, ,428 43, ,600 58,640 87,960

2-6 Statement of Retained Earnings (2002) Balance of retained earnings, 12/31/01 Add: Net income, 2002 Less: Dividends paid Balance of retained earnings, 12/31/02 $203,768 (160,176) (11,000) $32,592

2-7 Statement of Cash Flows (2002) OPERATING ACTIVITIES Net income Add (Sources of cash): Depreciation Increase in A/P Increase in accruals Subtract (Uses of cash): Increase in A/R Increase in inventories Net cash provided by ops. (160,176) 116, , ,600 (280,960) (572,160) (164,176)

2-8 Statement of Cash Flows (2002) L-T INVESTING ACTIVITIES Investment in fixed assets FINANCING ACTIVITIES Increase in notes payable Increase in long-term debt Payment of cash dividend Net cash from financing NET CHANGE IN CASH Plus: Cash at beginning of year Cash at end of year (711,950) 436, ,000 (11,000) 825,808 (50,318) 57,600 7,282

2-9 Net operating profit after taxes (NOPAT)? NOPAT = EBIT (1 – Tax rate) NOPAT 02 = -$130,948(1 – 0.4) = -$130,948(0.6) = -$78,569 NOPAT 01 = $190,428(1 – 0.4) = $190,428(0.6) = $114,257 - This is the after-tax profit a company would have if it had no debt and no non-operating assets and is thus a better measure of operating performance than is net income

2-10 Net operating working capital? NOWC = Current - Non-interest assets bearing CL NOWC 02 = ($7,282 + $632,160 + $1,287,360) – ( $524,160 + $489,600) = $913,042 NOWC 01 = $842,400 - The working capital acquired with investor-supplied funds

2-11 Operating capital? Operating capital = NOWC + Net Fixed Assets Operating Capital 02 = $913,042 + $939,790 = $1,852,832 Operating Capital 01 = $1,187,200

2-12 Net cash flow and operating cash flow? NCF 02 = NI + Dep = ($160,176) + $116,960 = -$43,216 NCF 01 = $87,960 + $18,900 = $106,860 OCF 02 = NOPAT + Dep = ($78,569) + $116,960 = $38,391 OCF 01 = $114,257 + $18,900 = $133,157

2-13 What is the free cash flow (FCF)? The cash flow actually available for distribution to all investors (stockholders and debt holders) after the company has made all the investments in fixed assets, new products, and working capital necessary to sustain ongoing operations. FCF = NOPAT – Net (investment in) operating capital FCF = OCF - Gross (investment in) operating capital* * Gross (investment in) operating capital = Net (investment in) operating capital+ Dep or

2-14 What was the free cash flow (FCF) for 2002? FCF 02 = NOPAT – Net (investment in) operating capital = -$78,569 – ($1,852,832 -$1,187,200) = -$744,201 - OR - FCF 02 = OCF-(Gross (investment in) operating capital) = OCF - ( Net (investment in) operating capital+ Dep. ) = $38,391 – ($1,852,832 -$1,187, ,960) = -$744,201

2-15 Economic Value Added (EVA) An estimate of the value created by management during the year, and it differs substantially from accounting profit because no charge for the use of equity capital is reflected in accounting profit.

2-16 Economic Value Added (EVA) EVA = After-tax __ After-tax Operating Income Capital costs = Funds Available __Cost of to Investors Capital Used = NOPAT – After-tax Cost of Capital

2-17 EVA Concepts In order to generate positive EVA, a firm has to more than just cover operating costs. It must also provide a return to those who have provided the firm with capital. EVA takes into account the total cost of capital, which includes the cost of equity.

2-18 What is the firm’s EVA? Assume the firm’s after-tax percentage cost of capital was 10% in 2001 and 13% in 2002 EVA 02 = NOPAT – (A-T cost of capital) (Capital) = -$78,569 – (0.13)($1,852,832) = -$78,569 - $240,868 = -$319,437 EVA 01 = $114,257 – (0.10)($1,187,200) = $114,257 - $118,720 = -$4,463

2-19 Did the expansion increase or decrease MVA? MVA = Market value __Equity capital of equity supplied =( Shares o/s x Stock price) - Common Equity MVA – reflects shareholders wealth relative to what they supplied the company with.

2-20 How can one finance its expansion? With external capital which will dilute ownership By issuing long-term debt which will reduce financial strength and flexibility.

2-21 Jamaican Tax System

2-22 Corporate and Personal Taxes Corporations Rates at 33 1/3% Individuals Rates at 25% for individuals whose income over $120,432 p.a.

2-23 Tax treatment of various uses and sources of funds Interest paid – tax deductible for corporations (paid out of pre-tax income Interest earned – usually fully taxable at source (withholding tax) Dividends paid – paid out of after-tax income. Dividends received – no longer taxed

2-24 More tax issues Tax Loss Carry-Forward – since corporate incomes can fluctuate widely, companies can carry losses forward to offset profits in the future.