2. Financial Statements, Tax, and Cash Flow

What is the Balance Sheet?

A snapshot of a firm, detailing its assets, liabilities and equity.

What are Assets?

Assets are what a company owns.

What are the two classifications of Assets?

Current Assets and Fixed Assets

What are Current Assets?

Assets that are to be converted into cash within 12 months.

What are Fixed Assets?

Assets with a long life, can be tangible or intangible.

What is an example of a Current Asset?

Inventory, Cash, Accounts Receivable, etc

What is an example of a Fixed Asset?

Land, Equipment, Copyright, Patent, etc

What are Liabilities?

It's what a firm owes

What are the two classifications of Liabilities?

Current liabilities and Long Term liabilities

What are Current Liabilities?

Liabilities that must be paid within 12 months.

What are Long Term Liabilities?

Liabilities that are not due within the coming 12 months.

What is an example of a Current Liability?

Accounts Payable

What is an example of a Long Term liability?

Long term loans

What is Owner's Equity

It's the difference between liabilities and assets. It reflects what is left over if the firm sold all of their assets and paid off all of their liabilities.

What is net working capital?

It's the difference between a firm's current assets and current liabilities.

What is important to keep in mind when examining a balance sheet?

Liquidity

Debt to Equity

Market Value vs Book Value

What is Liquidity?

It's the speed and ease that an asset can be converted to cash.

Why is liquidity important?

Liquidity is important because the more liquid a business the less likely it is to experience financial distress.

What is the opportunity cost of liquidity?

Potential Profits.

What is financial leverage?

The use of debt in a firm's capital structure.

What is book value?

Book value is the value of assets listed in the balance sheet.

What is historical costs basis?

An accounting technique that requires corporations to price assets at the price that they purchased them rather than their current worth.

What is market value?

It's the actual worth of assets, not listed on the balance sheet.

With current assets, why are their book value and market value similar?

Their book value and market value is similar because current assets are converted into cash over a short period of time.

What matters more when evaluating a company's assets, market value or book value?

Market Value (because it deals with their actual worth)

What is the income statement?

A document that reports a company's financial performance over a specific period of time.

What does the income statement tell us?

It tells us the net income or loss (bottom line) over a specific period of time.

What is listed on the income statement from top to bottom

First we have net sales, from which we deduct COGS and Depreciation. This gives us EBIT. From EBIT we deduct any interest paid. From that We have Earning Before Taxes, and from that we deduct taxes. The number after this is our Net income. If dividends are paid we deduct those and the remainder is the retained earnings.

What are the three things you should keep in mind when looking at the interest statement?

GAAP

Time and Costs

Non Cash Items

What is GAAP

They are the rules that are used when preparing the income statement.

What is the GAAP principle for recognizing revenue?

The GAAP principle for recognizing revenue is the Realization Principle.

What is the realization principle?

It's the rule that requires revenue to be recognized at the time of sale, not necessarily the time of collection.

What is the GAAP principle for recognizing expenses?

The Matching Principle

What is the Matching Principle?

It's a rule that states that expenses for a good is realized when revenue is realized.

What are Non-Cash Items?

They are expenses charged against revenues that do not directly affect cash flow.

What is an example of a non-cash items?

Depreciation

Are business expenses fixed or variable in the long run?

Business expenses are variable in the long run.

Are business expenses typically fixed or variable in the short run?

Business expenses tend to be more fixed in the short run.

What are the two ways accountants classify costs?

Accountants classify cost as Product Costs and Period Costs.

What are Product Costs?

They are the costs incurred to create a product. Typically reported as cost of goods sold.

What are Period Costs

They are costs incurred that are not tied into the product.

What determine's the size of a company's tax bill?

The size of a company's tax bill is determined by the tax code

What is the tax code?

Tax code is an often amended set of rules typically determined by political forces.

What is your average tax rate?

Your average tax rate is your tax bill divided by your taxable income.

What is your marginal tax rate?

The amount of tax payable on the next dollar earned.

Why is the marginal tax rate important?

Marginal Tax Rate is important because it helps firms make financial decisions involving new tax flows or changes in existing ones.

What is Cash Flow ?

Cash flow is the difference between the number of dollars that came in and the number of dollars that went out.

What is Cash Flow From Assets?

Cash Flow From Assets is the total cash flow to creditors and stockholders.

What are the three components of cash flow?

Operating Cash Flow

Capital Spending

Net Working Capital

What is Operating Cash Flow (OCF) ?

OCF is the cash generated from a firm's normal business activities.

Why isn't depreciation included in the Operating Cash Flow?

Depreciation isn't included because it isn't an actual cash outflow. It's a non cash item and bookkeeping expense.

How is OCF calculated?

OCF = EBIT + Depreciation - Taxes

Why is Operating Cash Flow important?

Operating Cash Flow is important because it tells us whether a firm's cash inflows from business operations is enough to cover its everyday cash outflows.

What is Net Capital Spending?

Net Capital Spending is money spent on fixed assets.

How is Net Capital Spending calculated?

NCS = Ending Net Fixed Assets - Beginning Fixed Assets + Depreciation

What is Change in Net Working Capital?

Change in Net Working Capital measures changes in current assets and liabilities.

Why is Change in Net Working Capital (NWC) important?

It helps us see whether a firm has invested more or less in current assets or has taken on more or less current liabilities.

How is Change in Net Working Capital calculated?

NWC = Ending NWC - Beginning NWC

How is Cash Flow from Asset Calculated?

Cash Flow from Assets = OCF - (NCS + CNWC)

What is Cash Flow to Creditors?

Cash Flow to creditors represents the cash flow paid out to creditors

How is Cash Flow to Creditors calculated?

Interest Paid - Net New Borrowing

What is Cash Flow to Stockholder?

Cash flow to Stockholders represent the cash flow paid out to creditors.

How do you calculate Cash Flow to Stockholder?

Dividends - Net New Equity Raised

How do you find Net New Equity Raised?

Net New Equity Raised is found by looking at the common stock and paid in surplus account. They tell us how much money was raised.