Corporate Finance

Ronald F. Singer
FINA 4330

Finance and Accounting

Lecture 2

Fall, 2010

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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

Current Assets Current Liabilities

Cash 1,000 Accounts payable 500
Accounts Receivable 1,000 Notes payable
75
Inventory 450 Accrued expenses 75
Other 50 Total Current Liabilities 650
Total Current Assets $2,500 Long term Liabilities
Fixed Assets Deferred Taxes 1,000
Property, Plant & equip. 4,600 Long term debt 2,000
Less Accumulated Dep. 600 Total long term liability 3,000
Net PP&E 4,000
Intangible & 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, 2009
(BV $ thousands)
Assets Liabilities and Stockholders Equity

Current Assets Current Liabilities

Cash 800 Accounts payable 650
Accounts Receivable 1,200 Notes payable
25
Inventory 550 Accrued expenses 75
Other 150 Total Current Liabilities 750
Total Current Assets $2,700 Long term Liabilities
Fixed Assets Deferred Taxes 1,000
Property, Plant & equip. 4,600 Long term debt 2,000
Less Accumulated Dep. 600 Total long term liability 3,000
Net PP&E 4,000
Intangible & Other assets 1,000 Stockholders Equity ???
Total Assets $7,500 Total Liabilities and
Stockholders Equity ???

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 Macintosh Enterprises
Pro-Forma Income Statement
(Year ending December 31, 2009)
($ thousand)
Sales $5,000
Less: Operating Expenses (COGS) 2,000
Depreciation & Amortization 600
Selling, general and administrative exp. 300
Operating Income $2,100
Other income 100
Earnings Before Interest and Taxes (EBIT) 2,200
Less: Interest Expense 770
Pretax (Taxable) Income 1,430
Less Tax (@ 40%) 572
Net Income (Earnings after Tax) $858
Addition to retained earnings 58
Dividends 800
Earnings per Share (EPS) = Net Income/Shares = $0.858
Dividends per share (DPS) = $0.80

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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

2. 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 (+100)
Change in cash -200
a/c receivable +200 a/c payable +150
Inventory +100 Notes payable -50
Other S.T.A +100
Total change 200 100

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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 (@ 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
Increase (decrease) in cash holdings -200
increase (decrease) in accounts receivable 200
increase (decrease) in Inventory 100
increase (decrease) in other Short Term Assets 100
Change in Short Term Assets 200
Less: increase (decrease) in accounts payable 150
increase (decrease) in Short Term Liabilities (50)
Changer in Short Term Liabilities 100
Less: Net 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

EBITDA (2,200 + 500)

$2,700

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