Notes 9/8

Chapter 2: Financial Statements, Taxes, and Cash Flow

Balance Sheet

• The balance sheet is a snapshot of the firm’s assets and liabilities at a given point in time

• Assets are listed in order of decreasing liquidity

  • Ease of conversion to cash

  • Without significant loss of value

• Balance Sheet Identity

  • Assets = Liabilities + Stockholders’ Equity

• 

• Net Working Capital and Liquidity

  • Net Working Capital

    • = Current Assets – Current Liabilities

    • Positive when the cash that will be received over the next 12 months exceeds the cash that will be paid out

    • Usually positive in a healthy firm

  • Liquidity

    • Ability to convert to cash quickly without a significant loss in value

    • Liquid firms are less likely to experience financial distress

    • But liquid assets typically earn a lower return

    • Trade-off to find balance between liquid and illiquid assets

• Market Value vs. Book Value

  • The balance sheet provides the book value of the assets, liabilities, and equity.

  • Market value is the price at which the assets, liabilities, or equity can actually be bought or sold.

• Income Statement

  • The income statement is more like a video of the firm’s operations for a specified period of time.

  • You generally report revenues first and then deduct any expenses for the period

    • Matching principle – GAAP says to show revenue when it accrues and match the expenses required to generate the revenue

• Taxes

  • The one thing we can rely on with taxes is that they are always changing

  • Marginal vs. average tax rates

  • Marginal tax rate – the percentage paid on the next dollar earned

  • Average tax rate – the tax bill / taxable income

  • Average tax rates vary widely across different companies and industries

  • Other taxes

• Practice Taxable income

  • $100,000 in mass

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