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Unformatted text preview: Chapter 2 Understanding Financial Statements, Taxes, and Cash Flows By Keown, Martin, Petty & Scott A Learning Objectives 1. Compute a company’s profit as reflected by an income statement. 2. Determine a firm’s accounting book value, as presented in a balance sheet. 3. Compute a company’s taxes. 4. Measure a company’s free cash flows, both from an asset perspective and a financing perspective. I. Basic Financial Statements A. The Income Statement 1. The income statement reports the results from operating the business for a period of time, such as a year. I. Basic Financial Statements A. The Income Statement 2. It is helpful to think of the income statement as comprising five types of activities: a. Selling the product b. The cost of producing or acquiring the goods or services sold c. The expenses incurred in marketing and distributing the product or service to the customer along with administrative operating expenses d. The financing costs of doing business: for example, interest paid to creditors and dividend payments to the preferred stockholders e. The taxes owed based on a firm’s taxable income The Income Statement Harley-Davidson, Inc. Annual Income Statement for the year ending December 31, 2002 2002 % to Sales Sales 4,195,197 Cost of goods sold 2,673,129 (-) Gross profit 1,522,068 (=) 36.3% GP/Sales Selling, general, and administrative expen 465,831 Depreciation 160,119 (+) Total operating expenses 625,950 (=) Operating profit (EBIT/ OI) 896,118 (- =) 21.4% EBIT/Sales Interest expense 17,849 (-) Earnings before taxes (EBT) 878,269 (=) Provision for income taxes 298,052 (-) Net income after taxes (NIAT/ EAT) 580,217 (=) 13.8% NIAT/Sales For every dollar of sales, H-D earns $.363 in gross profits, $.214 in operating profit, and $.138 in net income The Income Statement • Operating income (earnings before interest and taxes) is not affected by how the firm is financed, whether with debt of equity. – It is the firm’s profits from all of its assets, regardless of whether the assets are financed from debt or stock. – It is affected only by management’s investment decisions, and not by how the firm is financed. The Income Statement • Interest expense is subtracted from income before computing the firm’s tax liability, which is not true for dividends paid. – Interest is a tax-deductible expense, i.e. for every dollar a company spends on interest, its tax expense is reduced proportionately. • A positive net income does not necessarily mean it has cash. Income Statement SALES SALES- EXPENSES EXPENSES = PROFIT = PROFIT • Cost of Goods Sold • Operating Expenses (marketing, administrative) • Financing Costs • Taxes Income Statement SALES SALES- Cost of Goods Sold GROSS PROFIT GROSS PROFIT- Operating Expenses OPERATING INCOME (EBIT) OPERATING INCOME (EBIT)- Interest Expense EARNINGS BEFORE TAXES (EBT) EARNINGS BEFORE TAXES (EBT)- Income Taxes EARNINGS AFTER TAXES (EAT) EARNINGS AFTER TAXES (EAT)- Preferred Stock Dividends...
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This note was uploaded on 09/22/2011 for the course ECON 101 taught by Professor Mr.tull during the Spring '11 term at De La Salle University.
- Spring '11