Finance class, January 28.
Second meeting of this class. We’re midway through Chapter 3. Skipped Chapter 2.
Talking about the Statement of Cash Flows. A statement of cash flows shows how a company’s
operating activities, investments, and financing activities affect its cash reserves over the
course of the accounting period.
Whenever a company purchases fixed assets for use over multiple years, that is considered a long
-term investment. Financing activities includes taking on debt to get cash and payment of
dividends.
There is a direct format and an indirect format for a statement of cah flows. The direct format
is less commonly used.
Sources of Cash include Depreciation, increases in accounts payable and other accounts.
How did the expansion affect net operating profit after taxes? (NOPAT)
NOPAT = Operating Income * (1-Tax Rate)
Net Operating Working Capital (NOWC) = Operating current assets + Non-interest bearing CL
Operating Capital = NOWC + Net Fixed Assets
Net Cash Flow = Net Income + Depreciation
Operating Cash Flow = NOPAT + Depreciation
Free Cash Flow is operating capital available to the company’s planners after all necessary
expenditures have been way.
FCF = NOPAT + Depreciation + Amortization – ( Capital Expenditures + change in Net Operating
Working capital)
Economic Value Added (EVA)
EVA = NOPAT – Annual Dollar Cost of Capital
Market Value Added shows how much value has been created for shareholders since the company was formed.
MVA = Market value of equity – equity supplied
Corporate and Personal Taxes
Both corporate and personal taxes have a progressive structure. Rates for corporation begin at 15% and rise to 35% for corporation with income over $10 million.
Interest paid is tax-deductible for corporations, but usually not for individuals. Interest income is usually fully taxable. Dividends are paid out of after-tax income. When dividends are received, most individuals pay 15% tax on them, maximum. A large portion of dividends received by a corporation is not taxed.
Capital Gains are profits from the sale of assets not normally transacted in the normal course of business. Normally, if an asset is purchased and resold within one year, it will be taxed at the normal income tax rate for the individual. If the asset is held for multiple years, it may be taxed at a lower rate. Corporations always pay their normal rate.
Tax Loss Carry-Back and Carry-Forward — Corporate incomes can fluctuate wildly. Corporations are allowed, in some circumstances, to carry losses in one year backward to offset profits in previous years or carry the losses forward to offset profits in future years.
Chapter 4 — Analysis of Financial Statements
Ratio Analysis — Ratios express the relationship between two numbers. For business purposes, ratios standardize number and facilitate comparisons between companies. Ratios can highlight strengths and weaknesses. Ratios also all trend analysis within a company and cross-comparison within an industry.
There are five major categories of ratios
- Liquidity — Can we make required payments?
- Asset Management — Do we have the right amount of assets for our sales?
- Debt Management
- Profitability
- Market Value
Liquidity Ratios: The Current Ratio is Current Assets / Current Liabilities. The Quick Ratio is (Current Assets – Inventories) / Current Liabilities. The Quick Ratio will always be lower than the Current Ratio. Both ratios measure the company’s ability to pay off all its existing liabilities.
Asset Management Ratios: The Inventory Turnover Ratio is Sales / Inventories. The Inventory Turnover Ratio expresses the efficiency of the company in moving its inventory. The Days Sales Outstanding (DSO) Ratio is Accounts Receivables / Average Sales per day. DSO Ratio expresses how long it will take the company to get paid after a sale. The Asset Turnover ratio is actually two ratios; the Fixed Asset Turnover Ratio and the Total Asset Turnover Ratio. The Fixed Asset Turnover Ratio is Fixed Assets / Sales. The Total Asset Turnover Ratio is Total Assets / Sales.
Debt Management Ratios: Debt Ratio is Total Debt / Total assets. It expresses how much of the company assets are financed by debt. The Times Interest Earned ratio is EBIT / Interest Expense. The EBITDA Coverage Ratio is (EBITDA + Lease Payments) / (Interest Expense + Lease Payments + Principal)
Profitability Ratios: Profit Margin Ratio is Net Income / Sales, and expresses how much profit is derived from each unit of sales. The Basic Earning Power Ratios is EBIT / Total Assets. Return on Assets Ratio is Net Income / Total Assets. The Return on Equity Ratio is Net Income / Total Common Equity.
Quiz next week based on homework. Probably about 3 questions from chapter 1, 3-4 from chapter 3. Homework is also due. Chapters 1 and 3. See website.