prelim 2

Identify the three major sections of a balance sheet. Be prepared to provide (or identify) examples of information that might be included in each section.

• Assets: items you own that can provide future benefit to your business

  • Cash, accounts receivable

• Liabilities: What you owe other parties

  • Accounts payable, short-term loans

• Owners’ Equity: the amount of money that belongs to the owners of a business after all assets and liabilities have been accounted for

  • common stock, preferred stock, retained earnings

As it pertains to balance sheets, what is the distinction between a current asset and a long-term asset? What is the distinction between a current liability and a long-term liability?

• Current Asset

  • anything that can be turned into cash in less than a year

• Long-Term Asset

  • physical assets that have a useful life of more than a year

• Current Liabilities 

  • obligations that need to be paid off in less than a year

• Long-Term Liabilities

  • obligations that are due to be paid off over a longer timeframe

Define intangibles. What are some examples of intangibles that might be included on a balance sheet?

• anything that has value but that you can’t touch or spend (patents, brand value, copyrights)

  • provide future economic benefit but are often subjective and based on estimates

Be prepared to distinguish between the three different types of inventory. (FWR)

• Finished goods: value of products ready to be sold

• Work-in-progress (WIP): value of products under construction

• Raw materials: value of the raw materials that will be used for later production

What does it mean for a company to “smooth” its earnings? Why would a company want to do this? (PAMM)

• the use of accounting estimates or adjustments to reduce fluctuations in reported profit over time, making earnings appear more stable.

• Companies do this to:

  • Present consistent and predictable financial performance

  • Avoid large swings in profit that could raise concerns 

  • Make the company appear less risky to investors

  • Meet expectations from analysts or shareholder

Define goodwill.

• Calculated as the difference between what a company paid for another company and what the physical assets of the acquired company are worth

Define deferred revenue.

• Financial obligation a company owes to another; money received for products or services that have not yet been delivered (airlines)

What is the distinction between preferred shares and common shares (or common stock)?

• Preferred Shares (TSD)

  • Type of stock that carries a fixed dividend

  • Sold to investors at a certain initial price

  • Does not typically carry voting rights

• Common Stock (TT)

  • These usually carry voting rights (Board of Directors)

  • These may pay dividends

Explain why the balance sheet “balances.” Be prepared to perform simple calculations to show this “in action.”

• The balance sheet balances because everything a company owns (assets) must be financed by either liabilities or owners’ equity.

What is mark-to-marketing accounting?

• the practice of valuing certain assets at their current market value rather than their original purchase (historical) cost.

Define cash flow statement. Generally, what does a cash-flow statement tell you about a company?

• Provides a detailed analysis of what happened to a company’s cash during a given period of time. This document shows how the business generated and spent its cash by including an overview of cash flows from operating, investing, and financing activities during the reporting period.

  • Cash keeps a company alive, and cash flow is a key indicator of a company’s financial health

Explain how owner earnings are calculated. What can this metric tell someone about a company? (SIH)

Owner earnings = cash generated from operations - necessary capital expenditures (CapEx)

• This metric:

  • Measures cash a business generates over time

  • Indicates the company’s ability to sustain operations and invest in the future

  • Helps assess overall financial health and long-term value

Explain why profit does not equal cash. (REC)

• Revenue is booked at sale

  • Profit reflects a promise to pay (not cash coming in)

• Expenses are matched to revenue

  • Expenses do not always reflect cash going out

• Capital expenditures don’t count against profit

  • These appear on the income statement as the item depreciates (but they have likely been paid for already)

Identify the three major categories of cash flows. Be prepared to provide (or identify) examples of information that might be included in each category. Which of these categories are managers in a position to impact most? (OIF)

• Operating Activities

  • Cash flow (in and out) related to actual operations of the business (cash customers send in when they pay their bills, cash companies pay out in salaries) 

• Investing Activities

  • Cash flow (in and out) related to investments made by the company, NOT by its owner (purchase of assets) 

• Financing Activities

  • Cash flow (in and out) related to proceeds from loans, equity investments from shareholders, paying dividends to shareholders, etc. 

Define reconciliation.

• the process of explaining the difference between two related financial numbers, typically by adjusting from one measure to another.

What are some examples of ways that managers affect cash? For instance, how do managers’ activities impact inventory? Expenses? Accounts receivable?

• Inventory (HE)

  • Holding too much inventory ties up cash

  • Efficient inventory management frees up cash

• Expenses (HC)

  • Higher or poorly timed expenses reduce cash

  • Controlling costs and timing payments can improve cash flow

• Accounts Receivable (EF)

  • Extending credit increases sales but delays cash inflow

  • Faster collection of receivables improves cash flow

“Buying back stock”

• A company may buy back some of its shares if it has extra cash and believes its stock is trading at a price that is lower than it should be

  • The effect is to decrease the number of shares outstanding and hence to increase the possibility that the price will rise

Retained Earnings (Accumulated Earnings)

• Profits that have been reinvested in the business instead of being paid out in dividends

Allowance for bad debt

• An estimate of the money owed by customers that won’t be paid to the company (this is subtracted from A/R) (may be used to smooth earnings)

Accumulated Depreciation

• sum of the depreciation charges that have occurred since the asset was purchased (this must be subtracted from PPE)

Assessing a Company’s Health (SLEC)

• Solvency:
  Are assets > liabilities?

• Liquidity:
  Can the company pay short-term debts?

• Equity growth:
  Is owner’s equity increasing over time?

• Cash trends:
  Is cash increasing or decreasing?