Finance and Accounting Lecture 2

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Finance and Accounting Lecture 2
Corporate FinanceRonald F. SingerFINA 4330

• Fall, 2009

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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
  
• Cash 1,000 Short-term debt
  900
• Inventory 500
  Accounts payable 600
  
• Accounts Rec. 1,000 Long-term debt
  3,000
• Plant equip. 4,000
• 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, 2008
• (Book value thousands)
• Assets Liabilities
  and Stockholders Equity
  
• Cash 1,000 Short-term debt
  900
• Inventory 500
  Accounts payable 600
  
• Accounts Rec. 1,000 Long-term debt
  3,000
• Plant equip. 4,000
• Other assets 1,000
  Stockholders Equity 3,000
• Total Assets 7,500 Total
  Liabilities and
  Stockholders Equity 7,500
• Number of Shares 1,000,000 gt Book
  Value /Share 3

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Macintosh Enterprises

• Pro-Forma Income Statement
• (Year ending December 31, 2008)
• ( thousand)
• Sales 5,000
• Less Operating Expenses (COGS)
  2,000
• Depreciation Amortization
  500
• Allocated G A Costs
  300
• Operating Income (EBIT)
  2,200
• Less Interest Expense
  770
• Earnings Before Tax(taxable income)
  1,430
• Less Tax (_at_ 40) 572
• Net Income (Earnings after Tax)
  858
• Earnings per Share (EPS) Net Income/Shares
  0.858

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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

• Cash Revenue is not the same as Sales.
• An increase in Receivables must be subtracted
  from Sales to get Cash Revenues.
• A decrease in Receivables must be added to
  Sales to get Cash Revenues.

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Transform income statement into Cash Flow

• 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 (300)
• a/c receivable 200 a/c payable 150
• Inventory 100 S.term liabil
  -50
• Other S.T.A 100
• Total change 400
  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) 2,200
• Less Tax on Operations (_at_ 40 (Note
  tax rate times EBIT not 572)
  880
• Operating Income after Tax (EBIT(1-t))
  1,320
• Plus Non-Cash Expenses (Depreciation
  Amortization)
  500 1,820
• Less increase (decrease) in Working Capital
  (WC change)
• increase (decrease) in accounts receivable
  200
• increase (decrease) in Inventory
  100
• increase (decrease) in other
  Short Term Assets 100
• increase (decrease) in accounts
  payable 150
• increase (decrease) in
  Short Term Liabilities (50)
• Change in Working Capital
  300
  300
• Free Cash Flow from Operations 1,520
• 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