Chapter 13 Business Organization and Financial Data © 2003 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 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 Profitability Measure 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$24,623.0 Cost of goods sold 17,779.7 Gross profit 6,843.3 Operating expenses: Selling, general and admin. 5,175.8 Depreciation Operating income 1,398.3 Interest 3.1 Other expenses (income) (27.5) Income before taxes 1,422.7 Income taxes Net income $ 885.6

10 Balance Sheet--Assets ($ millions) Cash and marketable securities$ 16.9 Accounts receivable Inventories 3,482.4 Other current assets 96.3 Total current assets 4,393.9 Net plant and equipment 4,345.3 Other Long-term Assets 94.6 Total assets$ 8,833.8

11 Balance Sheet--Liabilities & Equity Accounts payable $ 1,546.8 Notes payable Other current liabilities 1,024.1 Total current liabilities 3,011.6 Long-term debt 0.0 Other Liabilities Total liabilities $ 3,626.6 Common equity $ Retained earnings 4,530.9 Total stockholders’ equity $5,207.2 Total liabilities and equity $ 8,833.8

12 Statement of Cash Flows n 3 sections: –Cash flows from operations –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 Goal of a Firm n GOAL: MAXIMIZE SHAREHOLDER WEALTH SHAREHOLDER WEALTH = Common Stock Price X Number Of Common Shares Outstanding

15 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

16 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 n What about ethics?

17 Corporate Governance n Owners Managers n ShareholdersProfessional Mgt n PrincipalAgents n The Principal-Agent Problem n Agency costs n Ways to reduce the agency problem

18 Finance in the Organizational Chart n Chief Financial Officer (CFO) –Treasury function –Controller function n Compensation: Figure 13.2 n Finance and the Balance Sheet Structure –Capital budgeting question –Capital structure question –Operations or net working capital question

19 Learning Extension 13A Federal Income Taxation Tax rates, married filing jointly 2001 Marginal Taxable incometax rate $0 – 45, % 45, , , , , , over 297,

20 Tax rates, single 2001 Marginal Taxable incometax rate $0 - 27, % 27,051-65, , , , , over 297,

21 Proprietor, single, $50,000 income Compute the tax bill: 0.15 x $27,050 = $4, x $22,950 = 6, $10, Marginal tax rate: 27.5% Average tax rate =$10,368.75/$50,000 =20.7%

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

23 Corporate tax rates Taxable income Tax rate $0-50,00015% 50,001-75, , , , , , million34 10 million-15 million35 15 million-18,333,33338 over $18,333,33335

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

25 Example: The benefits of depreciation WITHWITHOUT Income before depreciation 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

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

27 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