Chapter 2 Cash Flow and Financial Statement Analysis Learning Objectives Interpret information contained in the balance sheet, income statement, and statement of cash flows. Explain why income differs from cash flow. Measure and interpret financial rations. Understand the essential features of the taxation of corporate income. Topics Covered The Balance Sheet The Income Statement Measuring Cash Flow & The Statement of Cash Flows Financial Ratio Analysis Corporate Taxes 1
The Balance Sheet Definition Financial statements that show the value of the firm s assets and liabilities at a particular point in time (from an accounting perspective). A snapshot of a company s financial position. The Balance Sheet The Main Balance Sheet Items Current Assets Cash & Securities Receivables Inventories + Fixed Assets Tangible Assets Intangible Assets = Current Liabilities Payables Short-term Debt + Long-term Liabilities + Shareholders Equity Staples Balance Sheet ($ Thousands) Current assets Jan 31, 2004 Feb 1, 2003 Cash & Equivalents $457,465 $495,889 ST Investments 934,275 100,175 Receivables 410,330 364,419 Inventories 1,465,989 1,555,205 Other current assets 210,845 201,788 Total current assets $3,478,904 $2,717,476 Fixed assets Property, plant and equipment $1,505,301 $1,447,752 Goodwill 1,202,007 1,207,824 Intangible assets 253,768 267,841 Other assets 63,066 80,495 Total Non-Current Assets $3,024,142 $3,003,912 Total assets $6,503,046 $5,721,388 2
Staples Liabilities & Stockholders Equity ($ Thousands) Current liabilities Jan 31, 2004 Feb 1, 2003 Payables and Accrued Expenses $1,933,084 $1,874,655 Short Term and Current Long Term 190,150 327,671 Total current liabilities $2,123,234 $2,175,326 Deferred Taxes Long term Debt 907 567,433 793 732,041 Total long-term liabilities $568,340 $732,834 Other 149,479 155,129 Total liabilities $2,841,053 $3,063,289 Shareholders equity Common Stock $316 $299 Retained Earnings 2,209,302 1,719,091 Treasury Stock (561,099) (556,812) Capital Surplus 1,933,379 1,484,833 Other Stockholder Equity 81,002 11,481 Total Stockholder Equity $3,662,900 $2,658,892 Total liabilities & stockholders equity $6,503,953 $5,722,181 The Income Statement Definition Financial statement that shows the revenues, expenses, and net income of a firm over a period of time (from an accounting perspective). Staples Income Statement ($ Thousands) Jan 31, 2004 Feb 01, 2003 Total Revenue $13,181,222 $11,596,075 Cost of Revenue (9,559,123) (8,652,593) Gross Profit $3,622,099 $2,943,482 Operating/Selling 2,282,092 1,795,428 General/Admin. Expenses 524,094 451,501 Non Recurring 9,639 8,746 Other 7,986 2,135 Operating income $798,288 $682,672 Earnings Before Interest and Taxes $798,288 $682,672 Interest Expense 20,176 20,609 Income Tax Expense 287,901 215,963 Net Income from Continuing $490,211 $446,100 Operations Net income $490,211 $446,100 3
Accounting Income vs. Cash Flow An Income Statement Sales Cost of Goods Sold Selling & Gen. Adm. Exp Depreciation Interest Exp Taxable Income Taxes Net Income Do all items reflect all cash collected and paid? NO!!! Income statement is on an accrued basis. What is and who is depreciation? Sources and Uses of Corporate Cash Sources Uses Decrease in any asset Increase in any liability Net profits after taxes Depreciation and other non-cash charges Sale of stock Increase in any asset Decrease in any liability Net loss Dividends paid Stock repurchase or retirement Statement of Cash Flows Shows how the firm used and raised cash during the year. Reconciles the Income Statement by the changes in the Balance Sheet from the beginning of the year to the end of the year 4
Parts of Statement of Cash Flows Cash Flow from Operations = net cash income from income statement: net income, Depreciation,change in A/R, Inv, Other CA, A/P, Accruals (Wages & Taxes), Other CL Cash Flow from Investments = Purchases and Sales of long-term real assets & investments and short-term investments Cash Flow from Financing = issuances and payments of debt and stock: L-T Debt, Common and Preferred Stock, Notes Payable & Dividends Paid Staples Statement Of Cash Flows ($ Thousands) Cash Flow From Operating Activities Jan 31,2004 Feb 1,2003 Net income (net profit after tax) $490,211 $446,100 Depreciation 282,811 267,209 Adjustments to Net Income 22,709 35,993 Changes in Account Receivables (4,218) 62,460 Changes in Liabilities 81,123 121,943 Changes in Inventories 80,721 80,721 Changes in Other Operating Activities (34) (3,574) Cash Flows from Operating Activities $1,019,732 $914,350 Cash Flow from Investment Activities Capital Expenditures ($280,703) ($1,435,879) Other Cash Flows from Investing Activities (831,190) (100,175) Cash Flows From Investing Activities ($1,114,803) ($1,536,401) Staples Statement Of Cash Flows ($Thousands) Jan 31, 2004 Feb 1, 2003 Cash Flow From Financing Activities Sale (Purchase) of Stock $385,506 $78,421 Net Borrowings (350,235) 635,662 Net Cash Provided by Financing Activities $35,271 $714,038 Effect of exchange rate changes on cash 21,376 9,033 Net (decrease) increase in cash ($38,424) $101,065 Cash and Cash Equivalents, End of Period $457,465 $495,889 5
Staples Cash Flows Fiscal 2003-2004 ($Thousands) 1500000 1000000 500000 0-500000 -1000000 Operating Investing Financing Change in Cash -1500000-2000000 2003 2004 Key Measures of Cash Flow Cash Flow from Operations Total cash generated Operating Cash Flow Cash flow before repaying lenders 17 Free Cash Flow Cash flow that firm could distribute to investors. Specific Cash Flow Definitions Operating Cash Flow (OCF) = cash generated from the firm s operations OCF = Earnings Before Interest and Taxes (EBIT) Taxes + Depreciation Staples 2004 OCF = 798,288 287,901 + 282,811 = 793,198 Free Cash Flow (FCF) = Cash available to the firm s investors after firm meets operating and investment needs FCF = OCF FA ( CA A/P Accruals) Staples 2004 FCF = 793,198 303,041 (761,428 58,429) = -212,842. due to large increase in ST investments 6
Ratio Analysis Examines firm s management of various facets of the company s business through its financial statements. Scales balance sheet and income statement information for easy comparison across time or to other companies. Two common approaches Trend Analysis - looks at changes in one company s ratios over time. Benchmarking: Comparison or Industry Analysis - compares company s ratios against a similar company or against industry-wide ratios. To illustrate benchmarking, we will calculate Staples 2004 ratios and will compare to s 2004 ratios. Areas Examined by Ratio Analysis Liquidity - measures the ability to meet short-term obligations Activity - measures the ability to contain the growth of assets, and the ability to effectively utilize assets Debt Management - measures the use of financial leverage (debt) and its impact Profitability - measures the profitability of various segments of a company 7
Liquidity Ratios Current ratio = current assets current liabilities current assets- inventory Quick ratio = current liabilities Current ratio =1.64 Quick ratio = 0.95 Current ratio = 1.57 Quick ratio = 0.98 Activity Ratios Inventory turnover = Fixed asset turnover = cost of goods sold inventory sales net fixed assets Inventory turnover = 6.52 Fixed asset turnover = 4.36 Inventory turnover = 6.35 Fixed asset turnover = 4.81 Activity Ratios (Continued) Average collection period = Accounts receivable Average sales per day Annual sales Average sales per day = 365 sales Total asset turnover = total assets Average sales per day = $36,112,936.99 Average collection period =11.36 days Total asset turnover = 2.03 Average sales per day = $33,859,084.93 Average collection period = 37.86 days Total asset turnover = 2.01 8
Debt Ratios total liabilities Debt ratio = total assets Long term debt Debt- equity ratio = Stockholders'equity Debt ratio = 0.44 Debt- equity ratio = 0.16 Debt ratio = 0.55 Debt- equity ratio = 0.30 Debt Ratios (Continued) earnings before interest and taxes Times interest earned = interest Times interest earned = 39.57 Times interest earned = 9.12 Profitability Ratios Gross profits Gross profit margin = sales Earnings before interest & taxes Operating profit margin = sales Gross profit margin = 27.5% Operating profit margin = 6.06% Gross profit margin = 31.35% Operating profit margin = 4.04% 9
Profitability Ratios (Continued) Net income Net profit margin = sales Earnings per share = number of Net income shares of common stock outstanding Net profit margin = 3.72% Earnings per share = $0.98 Net profit margin = 2.24% Earnings per share = $0.89 Profitability Ratios (Continued) Net income Return on total assets = Total assets Net income Return on common equity = Stockholders' equity Return on total assets = 7.54% Return on common equity =13.4% Return on total assets = 4.50% Return on common equity = 9.89% Breaking Down ROE: DuPont Equation ROE(NI/Eq) = Return on Assets (NI/TA) x Assets/Equity (TA/Eq) ROE = Net Profit Margin (NI/S) x Total Asset Turnover (S/TA) x TA/Eq Profit margin is a measure of the firm s operating efficiency how well does it control costs Total asset turnover is a measure of the firm s asset use efficiency how well does it manage its assets Assets to Equity (sometimes called Equity multiplier) is a measure of the firm s financial leverage 10
DuPont Equation: Staples vs. Office Depot 2004 Net Profit Margin Asset Turnover Assets to Equity* ROE Staples 3.72% 2.03 1.78 13.4% Office Depot 2.24% 2.01 2.22 9.9% *Since Assets = Liabilities + Equity, 1 debt ratio = equity/assets meaning for : assets 1 1 = = = 2.22 equity 1 total debt ratio 1 0.55 Market Ratios market price per share of common stock Price/earnings (P/E) ratio = earnings per share common stock equity Book valueper share = number of shares of common stock outstanding Price/earnings (P/E) ratio = 28.04 Book valueper share = $6.05 Price/earnings (P/E) ratio = 17.87 Book valueper share = $5.40 Market Ratios Market value per share of common stock Market/boo k (M/B) ratio = Book valuepershareof common stock Market/boo k (M/B) ratio= 4.55 Market/boo k (M/B) ratio= 2.94 11
Corporate Income Taxes Corporate deductions from income: operating expenses, depreciation, interest expense. Dividends paid are NOT deductible. Interest and capital gain income is fully taxable. 30% (in general) of Dividend income is taxable. Losses can be carried back (for refund of past taxes paid) and carried forward (to reduce future taxable income & taxes). Corporate Tax Rates (2002) Taxable Income over($) Not over ($) Tax Rate (%) 0 50,000 15 50,000 75,000 25 75,000 100,000 34 100,000 335,000 39 335,000 10,000,000 34 10,000,000 15,000,000 35 15,000,000 18,333,333 38 18,333,333 35 Corporate Tax Example Kramerica has taxable income of $90,000. What is their tax liability, marginal and average tax rates? Marginal tax rate = the tax rate on the next dollar of income. Average Tax Rate = taxes paid divided by taxable income. 12