9/17/2016

Financial Statements and Taxes

Key Financial Statements
Balance Sheet
Income Statement
Statement of Cash Flows
Statement of Stockholders Equity

Federal Tax System

3-1
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The Annual Report

Balance sheet provides a snapshot of a firms

financial position at one point in time.
Income statement summarizes a firms revenues
and expenses over a given period of time.
Statement of cash flows reports the impact of a
firms activities on cash flows over a given period of
time.
Statement of stockholders equity shows how
much of the firms earnings were retained, rather
than paid out as dividends.

3-2
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The Balance Sheet

Total Assets = Total Liabilities +
Total Shareholders Equity

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The Balance Sheet (cont.)

Total assets - resources owned by the firm.

Total shareholders equity - difference in the value

of the firms total assets and the firms total
liabilities.

Total liabilities - total amount of money the firm

owes its creditors

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The Balance Sheet (cont.)

Assets whose value is expected to decline over time

is reported as net asset which is equal to the
historical cost minus accumulated depreciation.

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The Balance
Sheet (cont.)

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The Balance Sheet (cont.)

Current assets - firms cash plus other assets the firm

expects to convert to cash within 12 months or less,

Fixed assets are assets that the firm does not expect
to sell within one year.

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The Balance Sheet (cont.)

Current liabilities - amount that the firm owes to

creditors; repaid within a period of 12 months or less

Long-term liabilities -debt with maturities longer

than a year

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The Balance Sheet (cont.)

The stockholders equity is broken down into two

components:
The amount the company received from selling stock to
investors.
Two Components:
Par value - stated or face value a firm puts on each share of
stock.
Paid in capital is the additional amount the firm raised when
it sold the shares.

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The Balance Sheet (cont.)

For example, DLK corporations par value per share is
$2.00 and the firm has 30 million shares outstanding

What is the par value of the firms common equity?

If the stocks were issued to investors for $240 million,
what is the paid in capital?

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9/17/2016

The Balance Sheet (cont.)

Retained earnings - portion of net income that has

been retained from prior years operations.

Stockholders Equity
= Par value of common stock + Paid in Capital +
Retained Earnings
Or:

Shareholders' equity = Total Assets Total Liabilities

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Firm Liquidity and Net Working Capital

Liquidity - speed with which an the asset can be

converted to cash without loss of value.

For example, a firms bank account is perfectly liquid.

Net Working Capital = current assets current

liabilities
Note: an important indicator of firms ability to repay its
loans.

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9/17/2016

Constructing a Balance Sheet

Construct a balance sheet for Gap, Inc. (GPS)
using the following list of jumbled accounts for
January 31, 2009. Identify the firms total assets
and net working capital:

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Current Assets

4,005,000,000.00 Current Liabilities

2,158,000,000.00

Long-Term Liabilities

1,019,000,000.00

Total Liabilities

3,177,000,000.00

Long-Term
Assets

3,559,000,000.00 Common Equity

4,387,000,000.00

Total Assets

7,564,000,000.00 Total Liabilities and Equity

7,564,000,000.00

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9/17/2016

Checkpoint 3.2: Check Yourself

Reconstruct the Gaps balance sheet to

reflect the repayment of $1 billion in
short-term debt using a like amount of
the firms cash. What is the balance for
total assets and current liabilities?

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Step 1: Picture the Problem

The firms balance sheet can be expressed as follows:

Total Shareholders Equity +
Total Liabilities
= Total Assets

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9/17/2016

Sample Balance Sheet

Current Assets
Cash
Accounts Receivable
Inventories
Other current assets
Total current assets
Long-term (fixed) assets
Gross PPE
Less: Accumulated depreciation
Net property, plant and equip.
Other long-term assets
Total long-term assets

Total Assets

Current Liabilities
Accounts payable
Short-term debt
Other current liabilities
Total current liabilities
Long-term Liabilities
Long-term debt
Owners Equity
Par value of common stock
Paid-in-capital
Retained earnings
Total equity

Total Liabilities and

Owners equity

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Decide on a Solution Strategy

We are given the account balances so in order to

construct the balance sheet we need to substitute
the appropriate balances into the template shown
earlier.

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9/17/2016

Solution:
Cash
Inventories
Other current
assets

756,000,000
1,506,000,000
743,000,000

Current liabilities

1,158,000,000

Total current
assets

3,005,000,000

Total current
liabilities

1,158,000,000

Net Property,
Plant and
equipment

2,993,000,000

Long-term
liabilities

1,019,000,000

Other long-term
assets

626,000,000

Common Equity

4,387,000,000

Total Assets

$6,564,000,000

Total Liabilities
and Equity

$6,564,000,000

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Analysis of Balance Sheet

The total assets of

$6,564,000,000 is financed by a
combination of current liabilities, long-term liabilities
and owners equity.

The firm has a healthy net working capital

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Debt and Equity Financing

sources of money used to finance the purchase of

the firms assets

It shows how much was borrowed and how much

was provided by firms owners

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Debt versus Equity

Payment
Seniority
Maturity

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Book Values and Market Values

Book values reported in the balance sheet can differ

from market values.

The gap between book value and market value is

likely to be higher for fixed assets relative to current
assets

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Income Statement

3-24
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An Income Statement

profit and loss statement.

measures the amount of profits generated by a firm

over a given time period

Equation:
Revenues (or Sales) Expenses = Profits

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An Income Statement (cont.)

Basic Elements:

Revenues
Expenses

Cost of goods sold, Interest expenses, SGA (selling, general and

administrative) expense, depreciation expense, Income tax
expense

Profits

Gross profit, net operating income (also known as EBIT),

earnings before taxes (EBT), and net income

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An Income Statement (cont.)

Sales

= Gross Profit
Minus Operating Expenses

Minus Cost of Goods Sold

Selling expenses
General and Administrative expenses
Depreciation and Amortization Expense

= Operating income (EBIT)

Minus Interest Expense
= Earnings before taxes (EBT)
Minus Income taxes
= Net income (EAT)

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EBIT = Earnings before interest and taxes; EBT = Earnings before taxes; EAT =
Earnings after taxes

Sample Income Statement

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Evaluating a Firms EPS and Dividends (cont.)

EPS = Net income Number of shares outstanding
Example 1: A firm reports a net income $90 million and
has 35 million shares outstanding, what will be the
earnings per share (EPS)?
EPS = Net income Number of shares
= $90 million $35 million
= $2.57
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Evaluating a Firms EPS and Dividends (cont.)

Dividends per share = Net income Number of shares
Example 2: A firm reports dividend payment of $20
million on its income statement and has 35 million
shares outstanding. What will be the dividends per
share?

Dividends per share = Net income Number of

shares
= $20 million $35 million
= $0.57

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Connecting the Income Statement and the

Balance Sheet

What can the firm do with the net income?:

Pay dividends to shareholders, and/or

Reinvest in the firm

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Connecting the Income Statement and the

Balance Sheet (cont.)

How much was retained or reinvested by the firm?

Amount retained = Net Income Dividends
= $90m - $20m = $70m

What will happen to the $70m?

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Interpreting Firm Profitability using the Income

Statement

What can we learn from H.J. Boswell Inc.s income

statement (Table 3-1)?

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Interpreting Firm Profitability using the Income

Statement (cont.)
The gross profit margin (GPM)
= gross profits sales
= $675 million $2,700 million
= 25%
mark-up on its cost of goods sold per dollar of sales.

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Interpreting Firm Profitability using the Income

Statement (cont.)
The operating profit margin
= net operating income sales
= $382.5 million $2,700 million
= 14.17%
ratio of net operating income or EBIT divided by firms sales.

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Interpreting Firm Profitability using the Income

Statement (cont.)
Net profit margin:
= net profits sales
= $204.75 million $2,700 million
= 7.58%
percentage of revenues left after all expenses have been
considered.

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Interpreting Firm Profitability using the Income

Statement (cont.)

What will the company do with these profit margins?

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Constructing an I/S
Constructing an Income Statement
Use the following information to construct an income statement for Gap, Inc.
(GPS). The Gap is a specialty retailing company that sells clothing, accessories,
and personal care products under the Gap, Old Navy, Banana Republic,
Piperlime, and Athleta brand names. Use the scrambled information below to
calculate the firms gross profits, operating income, and net income for the year
ended January 31, 2009. Calculate the firms earnings per share and dividends
per share.

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Checkpoint 3.1: Check Yourself

Reconstruct the Gaps income statement

assuming the firm is able to cut its cost of goods
sold by 10% and where the firm pays taxes at
40% tax rate. What is the firms net income and
earnings per share?

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Income Statement Format

Revenues

Less: Cost of goods sold

Less: Operating expenses

Equals Gross
profit
Equals: net
Operating income

Less: Interest expense

Equals: earnings
Before taxes

Less: Income taxes

Equals:
NET INCOME

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Construct the I/S

Revenues = $14,526,000,000
Less: Cost of goods sold
= $8,171,100,000

Less: Operating expenses

=$3,899,000,000

Equals: profit
=$6,354,900,000
Equals: net
Operating income
=$2,455,900,000

Less: Interest expense

=$1,000,000

Less: Income taxes (40%)

=$9,819,600,000

Equals: earnings
Before taxes
=$2,454,900,000

Equals:
NET INCOME
=$1,472,940,000
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Earnings and Dividends Computations

Earnings per share:

= net income number of shares
= $1,472,940,000 716,296,296
= $2.06

Dividends per share

= dividends number of shares
= $243,000,000 716,296,296 = $0.34

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Analysis of Income Statement

Is the firm profitable?

Did the shareholders earn from their investments in
the company?

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Taxes

3-44
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Federal Income Tax System

Individual Taxes
Corporate Taxes

3-45
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Corporate and Personal Taxes

Individuals

Rates begin at 10% and rise to 35% for individuals

with income over $373,650.

May be subject to state tax.

3-46
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Corporate Taxes

A firms income tax liability is calculated using its

taxable income and the tax rates on corporate
income.

See the table on next slide for corporate tax rates.

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Corporate tax rates

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Marginal and Average Tax Rates

Marginal tax rate is the tax rate that the company

will pay on its next dollar of taxable income.

Average tax rate is total taxes paid divided by the

taxable income.

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Marginal and Average Tax Rates

Example 3: What is the average and marginal tax

liability for a firm reporting $100,000 as taxable
income.

Taxable
Income

Marginal
tax rate

Incrementa Cumulativ
l Tax
e Tax
Liability
Liability

Average
Tax Rate

$50,000

15%

7,500

7,500

15.00%

$75,000

25%

6,250

13,750

18.33%

$100,000

34%

8,500

22,250

22.25%

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Marginal and Average Tax Rates

Average tax rate

= Total tax liability Total taxable income

= $22,250 $100,000
= 22.25%

Marginal tax rate

= 39% as the firm will have to pay 39% on its next

dollar of taxable income i.e. if its taxable income
increases from $100,000 to $100,001.

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