Corporate Finance
Ronald F. Singer
FINA 4330
Finance and Accounting
Lecture 2
Fall, 2010
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FINA4330 Corporate Finance
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Financial Statements
• Generally Finance Professionals get their
information from Financial Statements
prepared by accountants.
• In general, Financial Statements are used to
determine how the firm “is doing,” in
particular, how it has done over some period
of time.
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Financial Statements
• Although we are also interested in the financial
health of companies; generally, financial statements
have to be modified in order to focus on our
objective.
• In general, the “focus of our objective” is cash flow
• Most corporations prepare three basic financial
statements:
Income Statement
Balance Sheet
Cash Flow Statements
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Focus of Finance
• Cash Flow!!!
• What is Cash Flow?
• It is the amount of cash generated and
available to security holders.
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Financial Statements
• Income Statement:
– A Listing of Revenue, Expenses, and Profits over a
period of time
• Balance sheet
– A listing of Assets, Liabilities, and Net Worth at a
single point in time. Generally in terms of Book
Value.
• Cash Flow Statement
– The Flow of Cash over a period of time
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Macintosh Enterprises
Balance Sheet
December 31, 2008
(BV $ thousands)
Assets
Liabilities and Stockholders Equity
Current Assets
Current Liabilities
Cash
1,000
Accounts payable
500
Accounts Receivable
1,000
Notes payable
75
Inventory
450
Accrued expenses
75
Other
50
Total Current Liabilities
650
Total Current Assets $2,500
Long term Liabilities
Fixed Assets
Deferred Taxes
1,000
Property, Plant & equip. 4,600
Long term debt
2,000
Less Accumulated Dep.
600
Total long term liability 3,000
Net PP&E
4,000
Intangible & Other assets 1,000
Stockholders’ Equity
???
Total Assets
$7,500
Total Liabilities and
Stockholders’ Equity
???
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Macintosh Enterprises
Balance Sheet
December 31, 2009
(BV $ thousands)
Assets
Liabilities and Stockholders Equity
Current Assets
Current Liabilities
Cash
800
Accounts payable
650
Accounts Receivable
1,200
Notes payable
25
Inventory
550
Accrued expenses
75
Other
150
Total Current Liabilities
750
Total Current Assets $2,700
Long term Liabilities
Fixed Assets
Deferred Taxes
1,000
Property, Plant & equip. 4,600
Long term debt
2,000
Less Accumulated Dep.
600
Total long term liability 3,000
Net PP&E
4,000
Intangible & Other assets 1,000
Stockholders’ Equity
???
Total Assets
$7,500
Total Liabilities and
Stockholders’ Equity
???
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Macintosh Enterprises
Pro-Forma Income Statement
(Year ending December 31, 2009)
($ thousand)
Sales
$5,000
Less: Operating Expenses (COGS)
2,000
Depreciation & Amortization
600
Selling, general and administrative exp.
300
Operating Income
$2,100
Other income
100
Earnings Before Interest and Taxes (EBIT)
2,200
Less: Interest Expense
770
Pretax (Taxable) Income
1,430
Less Tax (@ 40%)
572
Net Income (Earnings after Tax)
$858
Addition to retained earnings
58
Dividends
800
Earnings per Share (EPS) = Net Income/Shares = $0.858
Dividends per share (DPS) =
$0.80
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Transform income statement into Cash
Flow
Now we are ready to transform this income statement
into Cash Flow
Adjustments Necessary:
1. Changes in Fixed Assets: Depreciation and
Amortization is not a cash expense and thus should
not be subtracted from Cash Flow. But, New
Investment is a cash expense (when paid for) and
should be subtracted.
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Transform income statement into Cash
Flow
2. Cost of Goods Sold (COGS) is the DIRECT expense
associated with producing the goods that are sold in
the period.
Costs associated with goods that are produced but
will be sold in future periods are not counted.
If the firm pays for goods THAT ARE NOT SOLD, there
is a cash flow out which must be accounted for.
In order to account for this, we include changes in
Inventory in the Cash Flow statement.
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Transform income statement into Cash
Flow
• In general: Increases in Working Capital must be
subtracted from Earning to get Cash Flow
• In this case suppose:
Changes in Working Capital (+100)
Change in cash -200
a/c receivable +200
a/c payable +150
Inventory +100
Notes payable -50
Other S.T.A +100
Total change
200
100
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Macintosh Enterprises
Pro-Forma Cash Flow Statement
(Year ending December 31, 2006)
($ thousand)
Earnings Before Interest and Taxes (from Income Statement)
Less: Tax on Operations (@ 40% (Note: tax rate times EBIT not $572)
Operating Income after Tax (EBIT(1-t))
Plus: Non-Cash Expenses (Depreciation & Amortization)
500
Increase (decrease) in cash holdings
-200
increase (decrease) in accounts receivable
200
increase (decrease) in Inventory
100
increase (decrease) in other Short Term Assets
100
Change in Short Term Assets
200
Less: increase (decrease) in accounts payable
150
increase (decrease) in Short Term Liabilities
(50)
Changer in Short Term Liabilities
100
Less: Net Change in Working Capital
300
Free Cash Flow from Operations
Less: “After Tax” interest payments I(1-t) (note: = 770 (1-.40))
462
Less: Dividends to preferred stockholders
100
Less: Investment (net of capital gains tax)
400
Free Cash Flow to Common Stockholders
558
EBITDA
(2,200 + 500)
$2,200
880
1,320
1,820
300
$1,520
$2,700
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