Financial Statements Main Source: BE Chapter 3
Basic forms of financial statements • Balance sheet • Income statement • Statement of retained earnings • Statement of cash flows
Balance sheet • Represents “snapshots” of company’s financial position at a point of time. • The left side lists assets while the right side lists the claims to be paid. • See table 3-1 for an example
Income statement • Informs company’s financial performance over a period of time. • Usually prepared monthly, quarterly, or annually. • See table 3-2 for an example.
Statement of retained earnings • Shows the last cumulative balance of undistributed earnings. • See table 3-3 for an example
MicroDrive: Statement of Retained Earnings for Year Ending December 31, 2004 (million of dollars)
Statement of Cash Flows • Cash position (reported in the balance sheet) is affected by: • Net income before preferred dividends • Non cash adjustments to net income • Changes in working capital • Changes in fixed assets • Security transactions • Dividend payments, etc.
Free cash flow: Cash flow actually available for distribution to investors after the company has made all investments in fixed assets and working capital necessary to sustain ongoing operations. • FCF = NOPAT-net investment in operating capital
Note: • Even though two companies have the same EBIT, their net income (EAT) might be different due to different level of debt. Thus, EAT does not always reflect true performance of company’s operations. • So, we need to calculate NOPAT (Net operating profit after tax), i.e. the amount of profit a company would generate if it had no debt and held no financial assets. • NOPAT = EBIT (1-T), while EAT=(EBIT-i)(1-T)
Uses of FCF • Debt repayments • Dividend payments • Stock repurchase • Purchase of stock and other non operating assets
Market Value Added (MVA) • Note: Shareholders’ wealth is maximized by maximizing market value added, i.e. the difference between the market value of stock and the amount of equity capital that was supplied by the shareholders. • MVA = (shares outstd)(stock price)-total common equity
Economic Value Added (EVA) • Note: • MVA reflects the effects of managerial actions since the very inception of the company. • EVA shows managerial effectiveness in a given year. • EVA = NOPAT-after tax cost of capital used to support operation = EBIT(1-T)-(ttl net opcap)(WACC) • See table 3-4 for MVA and EVA