Financial Statements Exercise & Solution A. Peerawich Thoviriyavej [email protected] Income Statement 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 firm’s gross profits, operating income, and net income for the year ended January 31, 2009. Calculate the firm’s earnings per share and dividends per share. Income Statement Income Statement Evaluating a Firm’s EPS • 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 Income Statement: Check Yourself Reconstruct the Gap’s 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 firm’s net income and earnings per share? Picture the IS 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 Finishing the Math Revenues = $14,526,000,000 Less: Cost of goods sold = $8,171,100,000 Less: Operating expenses =$3,899,000,000 Less: Interest expense =$1,000,000 Less: Income taxes (40%) =$9,819,600,000 Equals: profit =$6,354,900,000 Equals: net Operating income =$2,455,900,000 Equals: earnings Before taxes =$2,454,900,000 Equals: NET INCOME =$1,472,940,000 Conclusion • The firm is profitable since it earned net income of $1,472,940,000. • The shareholders were able to earn $2.06 per share. New EPS:= net income ÷ #of shares = $1,472,940,000 ÷ 716,296,296 = $2.06 The Balance Sheet Balance Sheet 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 firm’s total assets and net working capital: Balance Sheet The Balance Sheet Speaking in Finance…. Balance Sheet: Check Yourself Reconstruct the Gap’s balance sheet to reflect the repayment of $1 billion in short-term debt using a like amount of the firm’s cash. What is the balance for total assets and current liabilities? Our New Balance Sheet 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 Conclusion • We can make the following observations from Gap’s Balance sheet: – The total assets of $6,564,000,000 is financed by a combination of current liabilities, long-term liabilities and owner’s equity. Owner’s equity accounts for $4,387,000,000 of the total. – The firm has a healthy net working capital of $1,847,000,000 (3,005,000,000 minus 1,158,000,000). Cash Flow Statement Recall: • Source of cash is any activity that brings cash into the firm. For example, sale of equipment. • Use of cash is any activity that causes cash to leave the firm. For example, payment of taxes. Require Financial Statement: Balance Sheet Cash Flow Analysis • Why did the cash balance decline by $4.5 million from 2009 to 2010? 1.Accounts receivable increased by $22.5 million representing an increase in uncollected cash from credit sales. Thus it represents $22.5m of use of cash to invest in accounts receivable. Cash Flow Analysis (cont.) 2. Inventory increased by $148.50 million indicating use of cash to procure inventory. 3. Equipment increased by $175.50 million indicating use of cash to invest in equipment. In general, – an increase in an asset account = use of cash Cash Flow Analysis (cont.) 4. Accounts Payable, credit extended to the firm, increased by $4.5million. Thus source of cash increased by $4.5million due to accounts payable. 5. Long-term debt increased by $51.75 million indicating a source of cash. 6. Short-term debt decreased by $9 million indicating use of cash to pay off the debt. Cash Flow Analysis (cont.) 7. Retained earnings increased by $159.75 million representing a source of cash to the firm from the firm’s operations. In general, – An increase in a liability account = source of cash Cash Flow Analysis (cont.) • Change in cash balance = Sources of cash – Use of Cash = $216 - $220.50 = -$4.50 Sources of Cash Uses of Cash Increase in Accounts Payable = $4.50 Increase in Accounts Receivable $22.50 Increase in long-term debt =$51.75 Increase in inventory = $148.50 Increase in retained earnings = $159.75 Increase in net plant and equipment = $40.50 Decrease in short-term notes = $9 Total Sources of cash = $216.00 Total Uses of cash = $220.50 Cash Flow Analysis (cont.) • An analysis of H.J. Boswell’s operations reveals the following for 2010: – The firm used more cash than it generated, resulting in a deficit of $4.5 million – The primary source of cash flow was retained earnings ($159.75 million) followed by long-term debt ($51.75 million) – The largest use of cash was for acquiring inventory at $148.5 million. Cash Flow Analysis Summary Sources of Cash Uses of Cash Decrease in an asset account Increase in an asset account Increase in a liability account Decrease in a liability account Increase in an owner’s equity account Decrease in an owners’ equity account H.J. Boswell, Inc. Statement of Cash Flows Interpreting the SCF You are in your second rotation in the management training program at a firm that finance new start up and your supervisor calls you into her office on Monday morning to discuss your next training rotation. When you enter her office you are surprised to learn that you will be responsible for compiling a financial analysis of new venture. Thus, your boss askes you to practice with this Chesapeake Energy Inc. (CHK). Your boss suggests that you begin your analysis by reviewing the firm’s cash flow statements for 2004 through 2007 (found below): Analysis Your Verdict Source: Copyright © 2011 Pearson Prentice Hall. All rights reserved.