corprate finance lecture 2 flashcards

What is the essential accounting equation?

Assets = Liabilities + Equity (or, in finance terminology, Assets = Debt + Equity).

What are the four financial statements?

Income statement; Statement of Retained Earnings (SRE); Balance sheet; Statement of cash flows.

What does the income statement describe?

A company's revenues and expenses and the resulting net income or loss over a period of time.

What does the Statement of Retained Earnings (SRE) explain?

Changes in retained earnings from net income (or loss) and dividends declared over a period of time.

What does the balance sheet describe?

A company's financial position—the types and amounts of assets, liabilities, and equity—at a point in time.

What does the statement of cash flows identify?

Cash inflows (receipts) and cash outflows (payments) over a period of time.

How do the income statement, SRE, and balance sheet relate to each other?

They 'feed' into each other.

What does the income statement show about a company's earnings?

It shows how much net income a company has after expenses are taken out; this represents earnings from its operations.

What does the SRE show a company does with its income?

It shows whether earnings are retained in the company or paid to shareholders as dividends.

What are the two ways a company can use its income?

Retain the money in the company, or pay the money back to shareholders as dividends.

What does retaining earnings mean?

Re-investing the income back into the company.

What are dividends?

Cash paid to shareholders as part of the return they receive from owning shares of the company.

What happens to equity when a company reinvests its earnings?

Equity on the balance sheet increases, rather than the debt side.

Why does reinvesting earnings increase equity rather than debt?

The debt holder's return does not increase as the company makes more money; the shareholder's return does.

What does the balance sheet always satisfy?

The accounting equation: Assets = Liabilities + Equity, or in finance terminology, Assets = Debt + Equity.

What does the SRE start with?

Retained earnings from the previous period.

What effect did the $3,195 retained amount have on the balance sheet?

It increased the Equity value.

After retained earnings of $3,195, what was the equity amount in the example?

$33,195.

After the retained earnings increase, what did total assets have to equal in the example?

$42,395, because the balance sheet must balance: $9,200 + $33,195 = $42,395.

What is the basic shape of an income statement?

Net Sales (or Revenue) − Expenses = Earnings before taxes; − Taxes = Earnings after taxes.

Why are expenses categorized separately on an income statement?

Managers want to see the impact of each expense separately so they can manage them individually.

What is cost of revenue (or cost of sales)?

How much it cost the company to buy or make the items it sold.

What is gross profit?

The amount remaining after cost of sales is subtracted from revenue.

What is a margin?

A percentage of the total.

How is gross profit margin calculated?

Gross Profit / Revenue.

What does SG&A stand for?

Selling, General and Administrative Expenses.

What are SG&A expenses?

Operating costs that are not directly related to the items sold.

Why are SG&A expenses shown separately?

A company may have a strong profit margin on its products but still lose money because of other operating expenses; managers need to see this separately.

What is EBITDA?

Earnings before interest, taxes, depreciation and amortization.

How does depreciation affect taxes?

Depreciation is an expense that lowers income; lower income means lower taxes.

What is depreciation typically used for?

Tangible items.

What is amortization typically used for?

Intangible items, such as a trademark or license.

What is EBIT?

Earnings before interest and taxes.

What remains after taxes and interest are paid on debt?

Net Income (or Net Earnings).

How does a real-life balance sheet categorize assets?

Into subcategories such as current assets and long-term assets.

What are current assets?

Short-term assets that are usually anticipated to turn into cash in less than a year.

What are examples of current assets?

Cash, accounts receivable, inventory, and prepaid expenses.

What are current liabilities?

Short-term debt expected to be paid in less than a year.

What are examples of current liabilities?

Accounts payable, current (or short-term) notes payable, and taxes.

Why are current vs. long-term classifications important?

They are important later when calculating free cash flows.