Ch. 2 - Understanding
Financial Statements, Taxes,
and Cash Flows
 2002, Prentice Hall, Inc.
Chapter 2 Game Plan
► Overview
of Accounting Statements
 What are profits?
 What is a company’s book value?
► Corporate
Taxes
► Free Cash Flow Measurement
 How cash flow differs from accounting profits.
 (cash flow example info & notes posted under
next Wed’s lecture)
Principles of the Week
► Principle
4: Cash is king.
► Principle 7: Agency Relationships. How to
insure management is acting in the
stockholders best interests.
Income Statement
SALES
- EXPENSES
= PROFIT
Income Statement
SALES
- EXPENSES
= PROFIT
Revenue
Income Statement
SALES
- EXPENSES
= PROFIT
•Cost of Goods Sold
•Operating Expenses
(marketing, administrative)
•Financing Costs
•Taxes
SALES
- Cost of Goods Sold
Income
Statement
GROSS PROFIT
- Operating Expenses
OPERATING INCOME (EBIT)
- Interest Expense
EARNINGS BEFORE TAXES (EBT)
- Income Taxes
EARNINGS AFTER TAXES (EAT)
- Preferred Stock Dividends
- NET INCOME AVAILABLE
TO COMMON STOCKHOLDERS
SALES
- Cost of Goods Sold
Income
Statement
GROSS PROFIT
- Operating Expenses
OPERATING INCOME (EBIT)
- Interest Expense
EARNINGS BEFORE TAXES (EBT)
- Income Taxes
EARNINGS AFTER TAXES (EAT)
- Preferred Stock Dividends
- NET INCOME AVAILABLE
TO COMMON STOCKHOLDERS
SALES
- Cost of Goods Sold
Income
Statement
GROSS PROFIT
- Operating Expenses
OPERATING INCOME (EBIT)
- Interest Expense
EARNINGS BEFORE TAXES (EBT)
- Income Taxes
EARNINGS AFTER TAXES (EAT)
- Preferred Stock Dividends
- NET INCOME AVAILABLE
TO COMMON STOCKHOLDERS
Harley-Davidson, Inc.
Annual Income Statement
Millions of U.S. Dollars
31-Dec-2001
Sales--Core Business
31-Dec-2000
31-Dec-1999
3,545.0
3,046.5
2,585.7
3,545.0
3,046.5
2,585.7
2,303.7
2,018.5
1,722.3
578.8
513.0
447.5
0.0
0.0
0.0
2,882.5
2,531.5
2,169.8
662.5
515.0
415.9
0.0
0.0
0.0
11.0
33.6
4.9
673.5
548.6
420.8
235.7
200.8
153.6
Income After Taxes
437.7
347.7
267.2
Net Income
437.7
347.7
267.2
Total Sales
Cost of Goods Sold
SG&A Expense
Other Operating Expense
Total Expenses
Operating Income
Interest Expense, Non-Oper
Other--Net
Pre-Tax Income
Income Taxes
Balance Sheet
Total Assets
=
Outstanding
Debt
+
Shareholders’
Equity
Balance Sheet
Assets
Current Assets
Cash
Marketable Securities
Accounts Receivable
Inventories
Prepaid Expenses
Fixed Assets
Machinery &
Equipment
Buildings and Land
Other Assets
Investments &
patents
Liabilities (Debt) & Equity
Current Liabilities
Accounts Payable
Accrued Expenses
Short-term notes
Long-Term Liabilities
Long-term notes
Mortgages
Equity
Preferred Stock
Common Stock (Par value)
Paid in Capital
Retained Earnings
Assets
► Current
Assets: assets that are
relatively liquid, and are expected to
be converted to cash within a year.
Assets
► Current
Assets: assets that are
relatively liquid, and are expected to
be converted to cash within a year.
 Cash, marketable securities, accounts
receivable, inventories, prepaid
expenses.
Assets
► Current
Assets: assets that are
relatively liquid, and are expected to
be converted to cash within a year.
 Cash, marketable securities, accounts
receivable, inventories, prepaid
expenses.
► Fixed
Assets: machinery
and equipment, buildings,
and land.
Assets
► Current
Assets: assets that are
relatively liquid, and are expected to be
converted to cash within a year.
 Cash, marketable securities, accounts
receivable, inventories, prepaid expenses.
► Fixed
Assets: machinery and
equipment, buildings, and land.
► Other Assets: any asset that is not a
current asset or fixed asset.
 Intangible assets such as patents and
copyrights.
Harley-Davidson, Inc.
Annual Balance Sheet
Millions of U.S. Dollars
31-Dec-2001
31-Dec-2000
31-Dec-1999
Assets
Cash & Equivalents
439.4
419.7
183.4
Other Short-Term Investments
196.0
0.0
0.0
Accounts Receivable
775.3
629.2
542.7
Inventory
181.1
191.9
168.6
Prepayments & Advances
34.4
28.1
24.9
Other Current Assets
39.0
28.3
29.4
1,665.3
1,297.3
949.0
1,705.4
1,424.6
1,236.2
-813.5
-670.4
-554.4
891.8
754.1
681.7
49.7
54.3
55.4
511.7
330.7
425.9
3,118.5
2,436.4
2,112.1
Total Current Assets
Property Plant & Equipment
Accum Depr. & Amort.
Property Plant & Equipment, Net
Goodwill/Intangibles
Other Long-Term Assets
Total Assets
Financing
► Debt
Capital: financing provided by a
creditor.
► Short-term debt: borrowed money
that must be repaid within the next
12 months.
 Accounts payable, other payables such
as interest or taxes payable, accrued
expenses, short-term notes.
► Long-term
debt: loans from banks or
other sources that lend money for
longer than 12 months.
Financing
► Equity
Capital: shareholders’
investment in the firm.
► Preferred Stockholders: received
fixed dividends, and have higher
priority than common stockholders in
event of liquidation of the firm.
► Common Stockholders: residual
owners of a business. They receive
whatever is left after creditors and
preferred stockholders are paid.
Harley-Davidson’s Liabilities
Liabilities
Accounts Payable
194.7
169.8
137.7
0.0
0.0
0.0
Curr. LT Debt and CLOs
217.1
89.5
181.2
Other Current Liabilities
304.4
238.4
199.3
716.1
497.7
518.2
380.0
355.0
280.0
17.8
15.6
12.0
248.3
162.4
140.8
1,362.2
1,030.7
951.0
3.2
3.2
3.2
359.2
285.4
234.9
1,833.3
1,431.0
1,113.4
-425.5
-314.0
-188.0
-13.9
0.0
-2.4
Total Shareholders' Equity
1,756.3
1,405.7
1,161.1
Total Liabilities + Shareholders' Equity
3,118.5
2,436.4
2,112.1
Short-Term Debt
Total Current Liabilities
Long-Term Debt
Deferred Taxes
Other Long-Term Liabilities
Total Liabilities
Stockholders' Equity
Common Stock
Additional Paid in Capital
Retained Earnings
Treasury Stock
Other Equity
Corporate Income Taxes
► Corporate
deductions from income: operating
expenses, depreciation, interest expense.
► Dividends paid are NOT deductible.
► Interest and capital gain income is fully taxable.
► 30% (in general) of Dividend income is taxable.
► Losses can be carried back 2 years and carried
forward up to 20 years
Corporate Income Tax
Rates
Taxable Income
Since 1993
Corporate Tax Rate
$1 - $50,000
$50,001 - $75,000
$75,001 - $100,000
$100,001 - $335,000
$335,001 - $10,000,000
$10,000,001 - $15,000,000
$15,000,001 - $18,333,333
over $18,333,333
15%
25%
34%
39%
34%
35%
38%
35%
Tax Example:
Corporate Tax Example
► Space
Cow Computer has sales of $32
million, cost of goods sold at 60% of sales,
cash operating expenses of $2.4 million,
and $1.4 million in depreciation expense.
The firm has $12 million in 9.5% bonds
outstanding. The firm will pay $500,000 in
dividends to its common stock holders.
► Calculate the firm’s tax liability.
Free Cash Flows
Free cash flow: cash flow that is free and
available to be distributed to the firm’s
investors (both debt and equity
investors)
Free Cash Flows
Firm’s Operating
Free cash
flows
Cash flows generated
through the firm’s
operations and
investments in assets
=
=
Firm’s Financing
Free cash flows
Cash flows paid to - or
received by - the
firm’s investors
(creditors &
stockholders)
Calculating Free Cash Flows:
An Operating Perspective
After-tax cash flow
from operations
less
investment in net
operating
working capital
less
investments in
fixed and other
assets
Calculating Free Cash Flows:
An Operating Perspective
After-tax cash flow
from operations
less
investment in net
operating
working capital
less
investments in
fixed and other
assets
Operating income
+ depreciation
- cash tax payments
Calculating Free Cash Flows:
An Operating Perspective
After-tax cash flow
from operations
less
investment in net
operating
working capital
less
investments in
fixed and other
assets
[Change in current
assets]
-
[change in non-interest
bearing current
liabilities*]
*Accounts payable and
accruals
Calculating Free Cash Flows:
An Operating Perspective
After-tax cash flow
from operations
less
investment in net
operating
working capital
less
investments in
fixed and other
assets
Change in gross fixed
assets, and any other
assets that are on the
balance sheet.
Calculating Free Cash
Flows:
A Financing Perspective
Interest payments to creditors &
Dividends paid to stockholders
-
change in debt principal
-
change in stock
=
Financing Free Cash Flows