CHAPTER 2
Financial Statements, Cash
Flow, and Taxes
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
Balance sheet
Income statement
Statement of cash flows
Accounting income vs. cash flow
MVA and EVA
Federal tax system
2-1
The Annual Report

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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.
2-2
Balance Sheet: Assets
Cash
A/R
Inventories
Total CA
Gross FA
Less: Dep.
Net FA
Total Assets
2002
7,282
632,160
1,287,360
1,926,802
1,202,950
263,160
939,790
2,866,592
2001
57,600
351,200
715,200
1,124,000
491,000
146,200
344,800
1,468,800
2-3
Balance sheet:
Liabilities and Equity
2002
Accts payable
524,160
Notes payable
636,808
Accruals
489,600
Total CL
1,650,568
Long-term debt
723,432
Common stock
460,000
Retained earnings
32,592
Total Equity
492,592
Total L & E
2,866,592
2001
145,600
200,000
136,000
481,600
323,432
460,000
203,768
663,768
1,468,800
2-4
Income statement
Sales
COGS
Other expenses
EBITDA
Depr. & Amort.
EBIT
Interest Exp.
EBT
Taxes
Net income
2002
6,034,000
5,528,000
519,988
(13,988)
116,960
(130,948)
136,012
(266,960)
(106,784)
(160,176)
2001
3,432,000
2,864,000
358,672
209,328
18,900
190,428
43,828
146,600
58,640
87,960
2-5
Statement of Retained
Earnings (2002)
Balance of retained
$203,768
earnings, 12/31/01
Add: Net income, 2002 (160,176)
(11,000)
Less: Dividends paid
Balance of retained
$32,592
earnings, 12/31/02
2-6
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)
116,960
378,560
353,600
(280,960)
(572,160)
(164,176)
2-7
Statement of Cash Flows
(2002)
L-T INVESTING ACTIVITIES
Investment in fixed assets
(711,950)
FINANCING ACTIVITIES
Increase in notes payable
Increase in long-term debt
Payment of cash dividend
Net cash from financing
436,808
400,000
(11,000)
825,808
NET CHANGE IN CASH
(50,318)
Plus: Cash at beginning of year
Cash at end of year
57,600
7,282
2-8
Net operating profit after taxes (NOPAT)?
-
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
NOPAT
= EBIT (1 – Tax rate)
NOPAT02 = -$130,948(1 – 0.4)
= -$130,948(0.6)
= -$78,569
NOPAT01 = $190,428(1 – 0.4)
= $190,428(0.6)
= $114,257
2-9
Net operating working capital?
-
The working capital acquired with investor-supplied funds
NOWC = Current - Non-interest
assets
bearing CL
NOWC02 = ($7,282 + $632,160 + $1,287,360)
– ( $524,160 + $489,600)
= $913,042
NOWC01 = $842,400
2-10
Operating capital?
Operating capital = NOWC + Net Fixed Assets
Operating Capital02 = $913,042 + $939,790
= $1,852,832
Operating Capital01 = $1,187,200
2-11
Net cash flow and operating cash flow?
NCF02 = NI + Dep
= ($160,176) + $116,960 = -$43,216
NCF01 = $87,960 + $18,900 = $106,860
OCF02 =
=
=
OCF01 =
=
NOPAT + Dep
($78,569) + $116,960
$38,391
$114,257 + $18,900
$133,157
2-12
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*
or
* Gross (investment in) operating capital
= Net (investment in) operating capital+ Dep
2-13
What was the free cash flow
(FCF) for 2002?
FCF02
= NOPAT – Net (investment in) operating capital
= -$78,569 – ($1,852,832 -$1,187,200)
= -$744,201
- OR FCF02 =
OCF-(Gross (investment in) operating capital)
= OCF -(Net (investment in) operating capital+ Dep.)
= $38,391 – ($1,852,832 -$1,187,200 + 116,960)
= -$744,201
2-14
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.
2-15
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
2-16
EVA Concepts
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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.
2-17
What is the firm’s EVA? Assume the firm’s
after-tax percentage cost of capital was
10% in 2001 and 13% in 2002
EVA02 =
=
=
=
NOPAT – (A-T cost of capital) (Capital)
-$78,569 – (0.13)($1,852,832)
-$78,569 - $240,868
-$319,437
EVA01 = $114,257 – (0.10)($1,187,200)
= $114,257 - $118,720
= -$4,463
2-18
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.
2-19
How can one finance its
expansion?
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With external capital which will dilute
ownership
By issuing long-term debt which will
reduce financial strength and flexibility.
2-20
Jamaican Tax System
2-21
Corporate and Personal Taxes
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Corporations
 Rates at 33 1/3%
Individuals
 Rates at 25% for individuals whose income
over $120,432 p.a.
2-22
Tax treatment of various uses
and sources of funds
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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
2-23
More tax issues
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Tax Loss Carry-Forward – since corporate
incomes can fluctuate widely, companies can
carry losses forward to offset profits in the
future.
2-24