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Fin. Mgt. Quiz 4
Class 2135 Financial Management
Type Reviewer - Quiz
CB Rnoux
Financial Statements, Cash Flow, and Taxes
Annual Report—contains two types of information first, it contains a verbal section often presented as a letter from the chairperson describing the firm’s operating results during the past year and discussing new developments that will affect future operations this is what public corporations are required to provide to shareholders to describe their operations and financial conditions ; shows financial highlights, letter to the shareholders, narrative text, graphics and photos, management’s discussion and analysis, financial statements, notes to FS, auditor’s report, a summary of financial data, and corporate information second, it contains the 4 basic financial statements; balance sheet, income statement/statement of comprehensive income, statement of stockholder’s equity, and statement of cash flows The four (4) basic Financial Statements Balance Sheet shows what assets the company owns and who has claims on those assets as of a given date a ‘snapshot’ of a firm’s position at a specific point in time can observe the firm’s level of assets and the manner in which the company has used debt and equity to fund the said assets Typical balance sheet:
Stockholder’s Equity can be thought of in two (2) ways: first, as the amount that stockholders paid to the company when they bought shares that the company sold to raise capital, in addition to all the earnings the company has retained over the years; stockholder’s equity = paid-in capital + retained earnings second, as retained earnings, the cumulative total of all the earnings the company has earned and retained during its life; SHE can also be thought of as a ‘residual’ ; stockholder’s equity = total assets - total liabilities
Additional Points to be noted on Balance Sheet
Cash vs Other Assets a. Only cash and equivalents account - actual spendable money b. Accounts receivable - credit sales not yet collected
c. convertible bonds - debt securities that give the bondholder an option to exchange their bonds for shares of common stocks d. during bankruptcy, debt is paid off first, comes second are the preferred stocks, then common stocks coming in last Depreciation an annual charge against income that reflects the estimated dollar cost of the capital equipment and other tangible assets that were depleted in the production process Market vs Book Values Market Value - the price at which assets, liabilities, or equity can actually be bought or sold in the company market small cap (firms with a market capitalization of <$2billion) medium cap (firms with market capitalization >$2billion <$10billion) large cap (firms with market capitalization >$10billion) Book Value - historical costs (GAAP + FASB vs IFRS + IASB) Time Dimension financial accounting periods, or the dates of sales transactions Liquidity - ability to convert cash quickly without a significant loss in value Benefits liquid firms are less likely to experience financial distress use of funds (opportunity cost) Detriments liquid assets typically earn a lower return Trade-off to find a balance between liquid and illiquid assets
Income Statement/Statement of Comprehensive Income
shows the firm’s sales and costs (profits) during the past period
summary of the revenues and expenses over an accounting period the ‘bottom line’ of it is the net income that gives an indication of its operating ability Additional Information: Operating Income - derived from the firm’s regular core business; also known as EBIT or Earnings before interest and taxes OI/EBIT = Sales revenues - Operating costs Depreciation - annual charge again income that reflects the estimated dollar cost of the capital equipment and other tangible assets that were depleted in the production process Amortization - amounts to the same thing except that it represents the decline in value of intangible assets such as patents, copyrights, trademarks, and goodwill
Statement of Cash Flows
shows how much cash the firm began the year with, how much cash it ended up with, and what it did to increase/decrease its cash information from the balance sheet and income statement accounting report that shows how much cash the firm is generating Three Functional Areas:
- Operating
- Investing
- Financing Cash uses termed as ‘outflows’ and sources termed as ‘inflows’ can tell a lot about the management of the firm tells where the cash to run the firm is coming from Operating Activities deals with items that occur as part of normal ongoing operations; like—
c. cash equivalents at the end of the year Concept of Cash Flow the most important piece of information that a financial manager can derive from financial statements cash flow vs profits accounting vs finance Statement of Stockholder’s Equity shows the amount of equity the stockholders had at the start of the year, the items that increased/ decreased equity, and the equity at the end of the year takes the previous year’s balance of RE, adds the current year’s net income, then subtracts dividends paid to common stockholders to get the new balance of RE RE are claims against assets; summarizes the impact of operations cash flow, etc into impact on shareholders RE, beginning(prev year) + Net income(current yr) - Dividends paid = RE, ending(new balance for the year)
Free Cash Flow
amount of cash that could be withdrawn without harming a firm’s ability to operate and produce future cash flows FCF = [EBIT(1-T) + Depreciation and Amortization] - [Capital Expenditures + ΔNOWC] Operating Cash Flow - the amount of cash generated by a company’s normal business operations OCF = EBIT + Depreciation + Taxes OCF = EBIT(1-T) + Depreciation EBIT(1-T) → net operating profit after taxes (NOPAT); represents the amount of cash that the firm generates from its current operations
MVA and EVA / Market Value Added and Economic Value Added
MVA or Market Value Added
accounting statements are insufficient for evaluating a manager’s performance because they do not reflect market values performances measures: MVA = the difference between the market of the firm’s equity(found through stock price x no. of outstanding shares) and the book value shown on the balance sheet MVA = (P0 x #OS shares) - book value = firm’s equity - book value
EVA or Economic Value Added
an estimate of a business's true economic profit for a given year takes into account the total dollar cost of all capital(includes both costs of debt and equity capital) EVA = EBIT(1-T) - (Total invested capital x Cost of capital) EVA = net operating profit after taxes - annual dollar cost of capital = EBIT(1-T) - (total invested capital x after-tax percentage cost of capital)
Relationship between EVA and MVA
if EVA is positive, then After-tax operating income > cost of capital needed to produce that income positive EVA on annual basis helps to ensure MVA is positive MVA is applicable to the entire firm, while EVA can be calculated on a divisional basis
