Balance Sheet

1
Balance Sheet

• The balance sheet is a snapshot of the firms
  assets and liabilities at a given point in time
• Assets are listed in order of liquidity
• Ease of conversion to cash
• Without significant loss of value
• Balance Sheet Identity
• Assets Liabilities Stockholders Equity

2
The Balance Sheet of the U.S. Composite
Corporation
Liabilities (Debt)
The assets are listed in order by the length of
time it normally would take a firm with ongoing
operations to convert them into cash. Clearly,
cash is much more liquid than property, plant and
equipment.
Assets
20X2
20X1
and Stockholder's Equity
20X2
20X1
Current assets
Current Liabilities
Cash and equivalents
140
107
Accounts payable
213
197
Accounts receivable
294
270
Notes payable
50
53
Inventories
269
280
Accrued expenses
223
205
Other
58
50
Total current liabilities
486
455
Total current assets
761
707
Long-term liabilities
Fixed assets
Deferred taxes
117
104
Property, plant, and equipment
1,423
1,274
Long-term debt
471
458
Less accumulated depreciation
-550
-460
Total long-term liabilities
588
562
Net property, plant, and equipment
873
814
Intangible assets and other
245
221
Stockholder's equity
Total fixed assets
1,118
1,035
Preferred stock
39
39
Common stock (1 per value)
55
32
Capital surplus
347
327
Accumulated retained earnings
390
347
Less treasury stock
-26
-20
Total equity
805
725
Total assets
1,879
1,742
Total liabilities and stockholder's equity
1,879
1,742
3
Balance Sheet Analysis

• When analyzing a balance sheet, the financial
  manager should be aware of three concerns
• Accounting liquidity
• Debt versus equity
• Value versus cost

4
Accounting Liquidity

• Refers to the ease and quickness with which
  assets can be converted to cash.
• Current assets are the most liquid.
• Some fixed assets are intangible.
• The more liquid a firms assets, the less likely
  the firm is to experience problems meeting
  short-term obligations.
• Liquid assets frequently have lower rates of
  return than fixed assets.

5
Debt versus Equity

• Generally, when a firm borrows it gives the
  bondholders first claim on the firms cash flow.
• Thus shareholders equity is the residual
  difference between assets and liabilities.

6
Net Working Capital and Liquidity

• Net Working Capital
• Current Assets Current Liabilities
• Positive when the cash that will be received over
  the next 12 months exceeds the cash that will be
  paid out
• Usually positive in a healthy firm
• Liquidity
• Ability to convert to cash quickly without a
  significant loss in value
• Liquid firms are less likely to experience
  financial distress
• But, liquid assets earn a lower return
• Trade to find balance between liquid and illiquid
  assets

7
Liabilities (Debt)
Assets
20X2
20X1
and Stockholder's Equity
20X2
20X1
Current assets
Current Liabilities
Cash and equivalents
140
107
Accounts payable
213
197
Accounts receivable
294
270
Notes payable
50
53
Inventories
269
280
Accrued expenses
223
205
Other
58
50
Total current liabilities
486
455
Total current assets
761
707
Here we see NWC grow to 275 million in 20X2 from
252 million in 20X1.
Long-term liabilities
Fixed assets
Deferred taxes
117
104
Property, plant, and equipment
1,423
1,274
Long-term debt
471
458
Less accumulated depreciation
-550
-460
Total long-term liabilities
588
562
Net property, plant, and equipment
873
814
Intangible assets and other
245
221
Stockholder's equity
Total fixed assets
1,118
1,035
Preferred stock
39
39
Common stock (1 par value)
55
32
Capital surplus
347
327
Accumulated retained earnings
390
347
This increase of 23 million is an investment of
the firm.
Less treasury stock
-26
-20
Total equity
805
725
Total assets
1,879
1,742
Total liabilities and stockholder's equity
1,879
1,742
8
The Income Statement

• The income statement measures performance over a
  specific period of time.
• The accounting definition of income is
• Revenue Expenses Income

9
U.S.C.C. Income Statement
U.S. COMPOSITE CORPORATION
Income Statement
20X2
(in millions)
Total operating revenues
2,262
The operations section of the income statement
reports the firms revenues and expenses from
principal operations
Cost of goods sold
- 1,655
Selling, general, and administrative expenses
- 327
Depreciation
- 90
Operating income
190
Other income
29
Earnings before interest and taxes
219
Interest expense
- 49
Pretax income
170
Taxes
- 84
Current 71
Deferred 13
Net income
86
Retained earnings
43
Dividends
43
10
U.S.C.C. Income Statement
U.S. COMPOSITE CORPORATION
Income Statement
20X2
(in millions)
Total operating revenues
2,262
The non-operating section of the income statement
includes all financing costs, such as interest
expense.
Cost of goods sold
- 1,655
Selling, general, and administrative expenses
- 327
Depreciation
- 90
Operating income
190
Other income
29
Earnings before interest and taxes
219
Interest expense
- 49
Pretax income
170
Taxes
- 84
Current 71
Deferred 13
Net income
86
Retained earnings
43
Dividends
43
11
U.S.C.C. Income Statement
U.S. COMPOSITE CORPORATION
Income Statement
20X2
(in millions)
Total operating revenues
2,262
Cost of goods sold
- 1,655
Selling, general, and administrative expenses
- 327
Depreciation
- 90
Operating income
190
Other income
29
Earnings before interest and taxes
219
Usually a separate section reports as a separate
item the amount of taxes levied on income.
Interest expense
- 49
Pretax income
170
Taxes
- 84
Current 71
Deferred 13
Net income
86
Retained earnings
43
Dividends
43
12
U.S.C.C. Income Statement
U.S. COMPOSITE CORPORATION
Income Statement
20x2
(in millions)
Total operating revenues
2,262
Cost of goods sold
- 1,655
Selling, general, and administrative expenses
- 327
Depreciation
- 90
Operating income
190
Other income
29
Earnings before interest and taxes
219
Interest expense
- 49
Net income is the bottom line.
Pretax income
170
Taxes
- 84
Current 71
Deferred 13
Net income
86
Retained earnings
43
Dividends
43
13
Taxes

• The one thing we can rely on with taxes is that
  they are always changing
• Marginal vs. average tax rates
• Marginal the percentage paid on the next dollar
  earned
• Average the tax bill / taxable income
• Other taxes

14
The Concept of Cash Flow

• Cash flow is one of the most important pieces of
  information that a financial manager can derive
  from financial statements
• The statement of cash flows does not provide us
  with the same information that we are looking at
  here
• We will look at how cash is generated from
  utilizing assets and how it is paid to those that
  finance the purchase of the assets

15
Cash Flow Summary
16
Financial Cash Flow of the U.S.C.C.
Operating Cash Flow EBIT 219 Depreciation
90 Current Taxes (71) OCF 238
Cash Flow of the Firm
Operating cash flow
238
(Earnings before interest and taxes
plus depreciation minus taxes)
Capital spending
(173)
(End net fixed assets minus beg. net
fixed assets plus depreciation)
Additions to net working capital
(23)
Total
42
Cash Flow of Investors in the Firm
Debt
36
(Interest minus change in
long-term debt financing)
Equity
6
(Dividends minus change
in equity financing)
Total
42
17
Financial Cash Flow of the U.S.C.C.
U.S. COMPOSITE CORPORATION
Financial Cash Flow
20X2
(in millions)
Cash Flow of the Firm
Operating cash flow
238
Capital Spending End Net Fixed Assets
1118 Begin Net Fixed Assets
(1035) Depreciation 90 Capital Spending 173
(Earnings before interest and taxes
plus depreciation minus taxes)
Capital spending
(173)
(End net fixed assets minus beg. net
fixed assets plus depreciation)
Change in net working capital
(23)
Total
42
Cash Flow of Investors in the Firm
Debt
36
(Interest minus change in
long-term debt financing)
Equity
6
(Dividends minus change
in equity financing)
Total
42
18
Financial Cash Flow of the U.S.C.C.
U.S. COMPOSITE CORPORATION
Financial Cash Flow
20X2
(in millions)
Cash Flow of the Firm
Operating cash flow
238
NWC grew from 275 million in 20X2 from 252
million in 20X1. This increase of 23 million is
the addition to NWC.
(Earnings before interest and taxes
plus depreciation minus taxes)
Capital spending
(173)
(End net fixed assets minus beg. net
fixed assets plus depreciation)
Change in net working capital
(23)
Total
42
Cash Flow of Investors in the Firm
Debt
36
(Interest minus change in
long-term debt financing)
Equity
6
(Dividends minus change
in equity financing)
Total
42
19
Financial Cash Flow of the U.S.C.C.
U.S. COMPOSITE CORPORATION
Financial Cash Flow
20X2
(in millions)
Cash Flow of the Firm
Operating cash flow
238
Cash Flow to Creditors Interest 49 Ending L.T.
Debt 471 Begin L.T. Debt 458 Net L.T. Debt
Issued (13) Total 36
(Earnings before interest and taxes
plus depreciation minus taxes)
Capital spending
(173)
(End net fixed assets minus beg. net
fixed assets plus depreciation)
Change in net working capital
(23)
Total
42
Cash Flow of Investors in the Firm
Debt
36
(Interest minus change in
long-term debt financing)
Equity
6
(Dividends minus change
in equity financing)
Total
42
20
Financial Cash Flow of the U.S.C.C.
U.S. COMPOSITE CORPORATION
Financial Cash Flow
20X2
(in millions)
Cash Flow of the Firm
Operating cash flow
238
Cash Flow to Stockholders Dividends
43 Repurchase of stock
6 Cash to Stockholders
49 Proceeds from new stock issue
(43) Total 6
(Earnings before interest and taxes
plus depreciation minus taxes)
Capital spending
(173)
(End net fixed assets minus beg. net
fixed assets plus depreciation)
Additions to net working capital
(23)
Total
42
Cash Flow of Investors in the Firm
Debt
36
(Interest minus change in
long-term debt financing)
Equity
6
(Dividends minus change
in equity financing)
Total
42
21
Note on Cash Flow to Shareholders

• The text is assuming that
• Change in treasury stock reflects share
  repurchases or distributions
• The net new stock issued is given by the change
  in the common stock account plus the change in
  the capital surplus account
• I dont believe that will always be reliable

22
Financial Cash Flow of the U.S.C.C.
U.S. COMPOSITE CORPORATION
Financial Cash Flow
20X2
(in millions)
Cash Flow of the Firm
The cash from received from the firms assets
must equal the cash flows to the firms creditors
and stockholders
Operating cash flow
238
(Earnings before interest and taxes
plus depreciation minus taxes)
Capital spending
(173)
(Acquisitions of fixed assets
minus sales of fixed assets)
Additions to net working capital
(23)
Total
42
Cash Flow of Investors in the Firm
Debt
36
(Interest plus retirement of debt
minus long-term debt financing)
Equity
6
(Dividends plus repurchase of
equity minus new equity financing)
Total
42
23
Statement of Cash Flows

• Statement that summarizes the sources and uses of
  cash
• Changes divided into three major categories
• Operating Activity includes net income and
  changes in most current accounts
• Investment Activity includes changes in fixed
  assets
• Financing Activity includes changes in notes
  payable, long-term debt and equity accounts as
  well as dividends

24
Sources and Uses

• Sources
• Cash inflow occurs when we sell something
• Decrease in asset account
• Increase in liability or equity account
• Uses
• Cash outflow occurs when we buy something
• Increase in asset account
• Decrease in liability or equity account

25
U.S.C.C. Cash Flow from Operating Activities
U.S. COMPOSITE CORPORATION
Cash Flow from Operating Activities
20X2
(in millions)
To calculate cash flow from operations, start
with net income, add back noncash items like
depreciation and adjust for changes in current
assets and liabilities (other than cash).
26
U.S.C.C. Cash Flow from Investing Activities
U.S. COMPOSITE CORPORATION
Cash Flow from Investing Activities
20X2
(in millions)
Cash flow from investing activities involves
changes in capital assets acquisition of fixed
assets and sales of fixed assets (i.e. net
capital expenditures.
27
U.S.C.C. Cash Flow from Financing Activities
U.S. COMPOSITE CORPORATION
Cash Flow from Financing Activities
20X2
(in millions)
Cash flows to and from creditors and owners
include changes in equity and debt.
28
U.S.C.C. Statement of Cash Flows
The statement of cash flows is the addition of
cash flows from operations, cash flows from
investing activities, and cash flows from
financing activities.
29
Statement of Cash Flows versus Cash Flow from the
Firm

• Since interest paid is deducted as an expense
  when net income is calculated (and not deducted
  under financing activities) there is a difference
  between cash flow from operations and total cash
  flow to the firmthe difference is interest
  expense.

30
Examples

• Suppose that inventories decrease by 5,000,
  accounts receivables by 3,000 and accounts
  payables by 2,000. Calculate the increase or
  decrease net working capital given these changes
  to current assets and current liabilities.

31
Examples

• Calculate the EBIT for a firm with 4 million
  total revenues, 3.5 million cost of goods sold,
  500,000 depreciation expense, and 120,000
  interest expense.

32
Examples

• What is the marginal tax rate for a corporation
  with 60,000 taxable income and an average tax
  rate of 16.67 if the next-lowest marginal tax
  rate of 15 covers taxable incomes up to 50,000?

33
Examples

• If net income 46,750, depreciation expense
  20,000, interest expense 10,000, and the tax
  rate 15, what is operating cash flow?

34
Examples

• Given the following information from MoreMoney,
  Inc.'s 1999 financial statements, calculate cash
  flow from assets operating cash flow 284,500,
  net fixed assets declined by 8,000, depreciation
  expense 13,000, and net working capital
  increased by 1,500.