Another area in which people step into the shadows of ignorance through mis-unde

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Another area in which people step into the shadows of ignorance through mis-understanding is business records. These are the reporting instruments used to inform investors of the companies health. They are also used to report income to the government so the government can steal--sorry!---tax those earnings away. What are some of these instruments? let's look at them one at a time. The most used instrument of business is the Balance Sheet. This is a list of of a firms assets and the claims against those assets, which are called liabilities. On one side everything a company owns is listed. On the other side it lists all the claims against those assets. Incidentally, for you are a math lover, a balance sheet is a mathematical identity. The left side must equal the right side. When we subtract the liabilities from the assets we are left with net worth. If this is either zero or negative it's time to figure out where your problems are or go bankrupt. Accountants want a positive balance sheet. Financial managers, and especially economists, don't worry about a positive balance sheet. They worry about positive cash flow. You can't always pay your bills with a positive balance sheet. A positive balance sheet represents assets which may be physical assets---buildings, equipment, raw materials, work-in-progress, etc.---and not liquid assets. You can have a positive balance sheet and still go bankrupt simply because those assets may take time to liquidate. It happened to American Airlines, Capital Airlines, etc. This is why two other instruments are perhaps a better indicator of corporate health. These are: the Income Statement and the Statement of Cash Flow. Incidentally, on the slides you will find one called a Business Model. My wife, who is an excellent business person, created this to demonstrate that one can have increasing business orders but still go bankrupt. She speaks from experience. Her first business went belly-up. She learned from her mistakes and her second business was very successful. The Income Statement is a very important report. I am not going into it in detail because it is beyond the scope of this course. It's part of an analysis called the Capital Asset Pricing Model (CAPM). I will mention some important points. The top of the statement lists gross revenue. The next line usually lists the dollar amount of rebates, returns,coupons, etc. These are then subtracted from the gross revenue and reduce tax liabilities. This is why a company does not lower it's prices. Rather it gives refunds, etc., so it can report the sales essentially at a drop or loss, at least on paper. The next line is Research and Development costs. These too are subtracted from the gross revenue. This is why they do not recover R&D costs in the price of the product. Once again it's the tax code. R&D costs are called sunk costs. I almost forgot depreciation! Depreciation is also called the consumption of fixed capital. It is also deducted. Depreciation is a way of allowing firms to free up cash flow so that they might, at some future point, replace worn-out machinery. If you buy a new car, the minute you start the engine it begins to wear out. At some point it will have to be replaced. This is also why, when you buy a new car, you haven't even started the engine, but you have signed your name as the new owner, it loses up to 30 percent! It is now a used car! it's wearing out! This is also true of manufacturing equipment. It's the Second Law of Thermodynamics in action. Once something is born it begins to die. Once you start using a machine it begins to wear out. Depreciation is nothing more than an accounting trick to free up cash flow. Depreciation reduces earnings but increases cash flow. Don't you love accounting? Once Rebates and R&D have been subtracted, we are left with something called EBITAD (earnings before interest and taxes, glamorizations and depreciation). Once interest on loans and taxes have been paid, and subtracted, along with depreciation being accounted for, what is left is called EAT (earnings after taxes). This is then divided into two primary categories: dividends and retained earnings. Usually it is divided as 30% dividends and 70% retained earnings. These are national averages and do not hold true for all corporations. Dividends are paid to the shareholders, the true owners of the firm. This is their share of the earnings. They are after all investors (owners) who require a return on their investment. Retained earnings are also called undistributed shareholders wealth. They belong to the the shareholders but they are retained to help cover the next years operating expenses. Notice that corporate taxes have been paid. The true owners of the firm are the common stockholders (shareholders). They have just paid taxes on their earnings. The dividends now go out to the shareholders. At the end of the year--tax time--the shareholders receive a Form 1099 which lists the amount of the dividend received. They take this amount and put it on the front side of their IRS Form 1040 under interest, dividends, etc. It now becomes part of their gross income for the year and they pay taxes on it again. This is double taxation. We are the only country in the world that does that. Do you think we need to correct our tax code to compensate for this? If a large portion of your income comes from dividends then you fill out another form and pay a tax rate of 14%. This is why most millionaires are all for an income tax increase--they have no earned income! You only pay income tax on earned income---wages, salaries, bonuses, etc. Warren Buffit has no earned income. His money is in investments. These earnings are taxed at 14% so his secretary did pay more in income tax than he did! However, to be fair, Mr. Buffit paid 35% on his holdings--the taxes paid by the corporation before dividends----which meant his true tax rate, overall, was approximately 42 percent. Did he lie about taxes? Not by commission but rather through omission. He simply didn't tell the whole story. We are now left with the Statement of Cash Flow. which is a measure of profitability. It lists how much cash is coming in and how much is going out. It should, obviously, have more coming in than going out. The income is then divided into two categories: cash flow from investments and cash flow from operations. This helps highlight trouble areas. If two much is coming in from investment--perhaps over half--the company must look at improving products or service, etc. You may be over-looking your own operations and relying to heavily on income from sources you cannot control. This is what Tesla Motors is currently doing. In 2016 they had a negative $1.4B in operating cash flow. Their Tesla 3 which was introduced in the Spring of 2016 will be produced at a loss for each car. They will however earn a positive cash flow of $2B because of a $7000 government subsidy on every car produced. In addition they will have positive cash flow from the sale of their carbon credits. So much for free enterprise! Their cars are electric so they produce little or no pollutants. The stock is up because of those factors and are not due to the sale of their cars. They sold 4 more cars this year for the same period as they did last year. I am in love with a flat tax. What is a flat tax? Have you ever heard of it? Should we have a tax code with 3 flat tax rates? Why or why not? There are 8 embedded questions.

Explanation / Answer

a) Some of these instruments are : Balance Sheet, Profit and Loss Statement and Earnings per share of the company,Income tax and Statement of Cash Flow.

b) Our tax code should be corrected in order to compensate fordoubletaxation. Double taxation should be avoided, as it is a loss for the end shareholders who have to pay tax twice on their earnings.

c) A flat tax is a tax system which has constant marginal rate,and is usually applied in individual or corporate income.

Yeah it is applicable in individualor corporate income.

We should have a tax code with three flat tax rates as it would allow the taxes to be levied based on the income earned.It should be aprogressive tax system, where the tax amount paid rises as the income of the individual rises.

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