d

2. Key Financial Statements
• Balance Sheet
• Income Statement
• Statement of Stockholders’
Equity
• Statement of Cash Flows
3-2
Understanding Financial
Statements

3.  Balance sheet – provides a snapshot of a
firm’s financial position at one point in
time.
 Income statement – summarizes a firm’s
revenues and expenses over a given
period of time.
 Statement of cash flows – reports the
impact of a firm’s activities on cash flows
over a given period of time.
 Statement of stockholders’ equity – shows
how much of the firm’s earnings were
retained, rather than paid out as
dividends.
3-3

4.  Snack food company that underwent
major expansion in 2014.
 So far, expansion results have been
unsatisfactory.
◦ Company’s cash position is weak.
◦ Suppliers are being paid late.
◦ Bank has threatened to cut off credit.
 Board of Directors has ordered that
changes must be made!
3-4
Example

5. 3-5
2016
7,282
632,160
1,287,360
1,926,802
1,202,950
263,160
939,790
2,866,592
2015
57,600
351,200
715,200
1,124,000
491,000
146,200
344,800
1,468,800
Cash
A/R
Inventories
Total CA
Gross FA
Less: Dep.
Net FA
Total Assets

6. 3-6
Accts payable
Accruals
Notes payable
Total CL
Long-term debt
Common stock
Retained earnings
Total Equity
Total L & E
2016
524,160
489,600
636,808
1,650,568
723,432
460,000
32,592
492,592
2,866,592
2015
145,600
136,000
200,000
481,600
323,432
460,000
203,768
663,768
1,468,800

7. 3-7
2016 2015
Sales $6,034,000 $3,432,000
COGS 5,528,000 2,864,000
Other expenses 519,988 358,672
Total oper. costs excl.
deprec. & amort. $6,047,988 $3,222,672
Depreciation and amortization 116,960 18,900
EBIT ($ 130,948) $ 190,428
Interest expense 136,012 43,828
EBT ($ 266,960) $ 146,600
Taxes (106,784) 58,640
Net income ($ 160,176) $ 87,960

8. No. of shares
EPS
DPS
Stock price
Lease pmts
3-8
2016
100,000
-$1.602
$0.11
$2.25
$40,000
2015
100,000
$0.88
$0.22
$8.50
$40,000

9. 3-9
Total
Common Stock Retained Stockholders’
Shares Amount Earnings Equity
Balances, 12/31/15 100,000 $460,000 $203,768 $663,768
2015 Net income (160,176)
Cash dividends (11,000)
Addition (subtraction)
to retained earnings (171,176)
Balances, 12/31/16 100,000 $460,000 $ 32,592 $492,592

10. 3-
10
Operating Activities
Net income ($160,176)
Depreciation and amortization 116,960
Increase in accounts payable 378,560
Increase in accruals 353,600
Increase in accounts receivable (280,960)
Increase in inventories (572,160)
Net cash provided by operating activities ($164,176)

11. 3-
11
Long
-
Term Investing Activities
Additions to property, plant,
& equipment ($711,950
)
Net cash used in investing activities ($711,950
)
Financing Activities
Increase in notes payable $436,808
Increase in long
-
term debt 400,000
Payment of cash dividends (11,000
)
Net cash provided by financing activities $825,808
Summary
Net decrease in cash ($ 50,318)
Cash at beginning of year 57,600
Cash at end of year $ 7,282

12.  Net cash from operations = -$164,176,
mainly because of negative NI.
 The firm borrowed $836,808 to meet its
cash requirements.
 Even after borrowing, the cash account
fell by $50,318.
3-
12

13. AT operating income = EBIT(1 – Tax
rate)
AT operating income14 = -$130,948(1 –
0.4)
= -$130,948(0.6)
= -$78,569
AT operating income13 = $114,257
3-
13

14. 3-
14
400
,
842
$
NOWC
042
,
913
$
)
808
,
636
$
568
,
650
,
1
($
)
360
,
287
,
1
$
160
,
632
$
282
,
7
($
NOWC
payable
Notes
s
liabilitie
Current
assets
Current
NOWC
13
14












 



15. 3-
15
Sales
AT oper. inc.
NOWC
Net income
2015
$6,034,000
-78,569
913,042
-160,176
2014
$3,432,000
114,257
842,400
87,960

16. 
















 NOWC
es
expenditur
Capital
on
amortizati
and
Depr.
T)
EBIT(1
FCF
3-
16
FCF14 = [-$130,948(1 – 0.4) +
$116,960] –
[($1,202,950 – $491,000) +
$70,642]
= -$744,201

17.  Accounting statements insufficient for
evaluating managers’ performance
because they do not reflect market values.
 Performance Measures
MVA = Difference between market value and
book value of a firm’s common equity.
(P0 x Number of shares) – Book value.
EVA = Estimate of a business’ true economic
profit for a given year.
3-
17
Total invested
capital
Cost of
capital
EBIT(1 – T) – x

18. MVA14 = ($2.25 x 100,000) – $492,592
= -$267,592
MVA13 = ($8.50 x 100,000) – $663,768
= $186,232
Shareholder wealth has been destroyed!
3-
18

19.  If EVA is positive, then AT 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 entire firm, while
EVA can be calculated on a divisional
basis as well.
3-
19

20.  Probably not.
 A/P increased 260%, over the past year,
while sales increased by only 76%.
 If this continues, suppliers may cut off
D’Leon’s trade credit.
3-
20

21.  NO, the negative after-tax operating
income and decline in cash position
shows that D’Leon is spending more on
its operations than it is taking in.
3-
21

22.  If competitors match terms, and sales remain
constant...
◦ A/R would .
◦ Cash would .
 If competitors don’t match, and sales double...
◦ Short-run: Inventory and fixed assets  to
meet increased sales. A/R , Cash .
Company may have to seek additional
financing.
◦ Long-run: Collections increase and the
company’s cash position would improve.
3-
22

23.  D’Leon financed its expansion with
external capital.
 D’Leon issued long-term debt which
reduced its financial strength and
flexibility.
3-
23

24.  YES, the company would still have to
finance its increase in assets. Looking to
the Statement of Cash Flows, we see that
the firm made an investment of $711,950
in net fixed assets. Therefore, they would
have needed to raise additional funds.
3-
24

25.  No effect on physical assets.
 Fixed assets on the balance sheet would
decline.
 Net income would decline.
 Tax payments would decline.
 Cash position would improve.
3-
25

26.  Donna Jamison, a recent graduate of the University with four years of banking
experience, was recently brought in as assistant to the chairman of the board of
Computer Industries, a manufacturer of electronic calculators.
 The company doubled its plant capacity, opened new sales offices outside its home
territory, and launched an expensive advertising campaign. Computer’s results were not
satisfactory, to put it mildly. Its board of directors, which consisted of its president and
vice-president plus its major stockholders (who were all local business people), was
most upset when directors learned how the expansion was going. Suppliers were being
paid late and were unhappy, and the bank was complaining about the deteriorating
situation and threatening to cut off credit. As a result, Al Watkins, Computer’s president,
was informed that changes would have to be made, and quickly, or he would be fired.
Also, at the board’s insistence Donna Jamison was brought in and given the job of
assistant to Fred Campo, a retired banker who was Computer’s chairman and largest
stockholder. Campo agreed to give up a few of his golfing days and to help nurse the
company back to health, with Jamison’s help.
 Jamison began by gathering financial statements and other data. Assume that you are
Jamison’s assistant, and you must help her answer the following questions for Campo.
 Mini

27.  Balance Sheets Assets 2014 2015
 Cash $ 9,000 $ 7,282
 Short-term investments. 48,600 20,000
 Accounts receivable 351,200 632,160
 Inventories 715,200 1,287,360
 total current assets $ 1,124,000 $ 1,946,802
 Gross fixed assets 491,000 1,202,950
 Less:
accumulated depreciation 146,200 263,160
 net fixed assets $ 344,800 $ 939,790
 Total assets $ 1,468,800 $ 2,886,592

28.  Liabilities and equity 2014 2015
 Accounts payable $ 145,600 $ 324,000
 Notes payable 200,000 720,000
 Accruals 136,000 284,960
 total current labilités $ 481,600 $ 1,328,960
 Long-term debt 323,432 1,000,000
 Common stock (100,000 shares)
 460,000 460,000
 Retained earnings 203,768 97,632
 total equity $ 663,768 $ 557,632
 Total $ 1,468,800 $ 2,886,592

29.  Income Statements 2014 2015
 Sales $ 3,432,000 $ 5,834,400
 Cost of goods sold 2,864,000 4,980,000
 Other expenses 340,000 720,000
 Depreciation 18,900 116,960
 total operating costs $ 3,222,900 $ 5,816,960
 EBIT $ 209,100 $ 17,440
 Interest expense 62,500 176,000
 EBT $ 146,600 $ (158,560)
 Taxes (40%) 58,640 (63,424)
 Net income $ 87,960 $ (95,136)
 Other data 2014 2015
 Stock price $ 8.50 $ 6.00
 Shares outstanding 100,000 100,000
 EPS $ 0.880 $ (0.951)
 DPS $ 0.220 $ 0.110

30.  Prepare a Cash Flow Statement using the Balance Sheet and the
income statement information in the above three slides and
answer the following questions:
1. What effect did the expansion have on sales and net income? What
effect did the expansion have on the asset side of the balance
sheet? What effect did it have on liabilities and equity?
2. What do you conclude from the statement of cash flows?
3. What is free cash flow? Why is it important? What are the five uses
of FCF?
4. What are operating current assets? What are operating current
liabilities? How much net operating working capital and total net
operating capital does Computer have?
5. What are Computer’s net operating profit after taxes (NOPAT)
and free cash flow (FCF)?