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Chapter 2

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10 views5 pages

Chapter 2

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23006022
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Chapter 2.

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Chapter 2: Financial Statements and Cash Flow

1. The Balance Sheet

 The balance sheet is an accountant’s snapshot of a firm’s accounting value on a


particular date, as though the firm stood momentarily still.

 stockholders’ equity is defined to be the difference between the assets and the
liabilities of the firm.
 equity is what the stockholders would have if the firm were to discharge its
obligations.

1. LIQUIDITY
 Liquidity refers to the ease and quickness with which assets can be converted to
cash (without significant loss in value).
 Current assets are the most liquid and include cash and assets that will be turned
into cash within a year from the date of the balance sheet.
 Accounts receivable are amounts not yet collected from customers for goods or
services sold to them (after adjustment for potential bad debts).
 Inventory is composed of raw materials to be used in production, work in
process, and finished goods.
 Fixed assets are the least liquid kind of assets.
 Tangible fixed assets include property, plant, and equipment.
 Intangible fixed assets: trademarks, patent
 The more liquid a firm’s assets, the less likely the firm is to experience problems
meeting short-term obligations.
 liquid assets frequently have lower rates of return than fixed assets

1. DEBT VERSUS EQUITY


 Liabilities are obligations of the firm that require a payout of cash within a
stipulated period.

1. VALUE VERSUS COST


 The accounting value of a firm’s assets is frequently referred to as the carrying
value or the book value of the assets.
 Under generally accepted accounting principles (GAAP), audited financial
statements of firms in the United States carry assets at cost.
 carrying value and book value are misleading and cause many readers of financial
statements to believe the firm’s assets are recorded at true market values.
 Market value is the price at which willing buyers and sellers would trade the
assets.
 whenever we refer to the value of an asset or the value of the firm, we will
normally mean its market value.
 the Financial Accounting Standards Board is in charge of GAAP policies
 the International Accounting Standards Board is in charge of IFRS polices

2. The Income Statement

 The income statement measures performance over a specific period—say a year.

 income statement includes several sections:


 operations section reports the firm’s revenues and expenses from
principal operations
 Earnings before interest and taxes (EBIT), which summarizes
earnings before taxes and financing costs
 nonoperating section: includes all financing costs, such as interest
expense.
 the bottom line, or net income:
 Net income is frequently expressed per share of common stock—
that is, earnings per share.

2. GENERALLY ACCEPTED ACCOUNTING


PRINCIPLES

 Revenue is recognized on an income statement when the earnings process is


virtually completed and an exchange of goods or services has occurred.
 Income is reported when it is earned, or accrued, even though no cash flow has
necessarily occurred

1. NONCASH ITEMS
 Depreciation reflects the accountant’s estimate of the cost of equipment used up
in the production process.
 Deferred taxes result from differences between accounting income and true
taxable income.
 accounting tax can be broken down as current taxes and deferred taxes.
 current tax portion is actually sent to the tax authorities
 if taxable income is less than accounting income in the current year, it will be
more than accounting income later on. => the taxes that are not paid today will
have to be paid in the future (deferred tax liability)
 deferred tax is not a cash outflow.

1. TIME AND COSTS


 in the short run have some fixed costs & Variable costs
 In the long run, all costs are variable.
 Product costs are the total production costs incurred during a period—raw
materials, direct labor, and manufacturing overhead—and are reported on the
income statement as cost of goods sold. Both variable and fixed costs are included
in product costs.

3. Taxes

 Taxes can be one of the largest cash outflows a firm experiences.

1. CORPORATE AND PERSONAL TAX RATES


 the federal corporate tax rate in the United States became a flat 21 percent.

1. AVERAGE VERSUS MARGINAL TAX RATES


 average tax rate is your tax bill divided by your taxable income—in other words,
the percentage of your income that goes to pay taxes.
 marginal tax rate is the tax you would pay (in percent) if you earned one more
dollar.

Figure 1 Personal Tax Rates for 2021 (Unmarried Individuals)

4. Net Working Capital

 Net working capital is positive when current assets are greater than current
liabilities. This means the cash that will become available over the next 12 months
will be greater than the cash that must be paid out.
 The change in net working capital is usually positive in a growing firm.

5. Cash Flow of the Firm

- Creditors are paid an amount generally referred to as debt service.

 Operating cash flow measures the cash generated from operations not counting
capital spending or working capital requirements.

 Total cash flow of the firm includes adjustments for capital spending and
additions to net working capital. It will frequently be negative. When a firm is
growing at a rapid rate, spending on inventory and fixed assets can be higher than
operating cash flow.
 Net income is not cash flow.
 free cash flow: cash that the firm is free to distribute to creditors and stockholders
because it is not needed for working capital or fixed asset investments.
 cash flow from assets that can be distributed to investors.

6. The Accounting Statement of Cash Flows

1. CASH FLOW FROM OPERATING ACTIVITIES


 need to add back noncash expenses and adjust for changes in current assets and
liabilities (other than cash and notes payable).
2. CASH FLOW FROM INVESTING ACTIVITIES
 involves changes in capital assets: acquisition of fixed assets and sales of fixed
assets (i.e., net capital expenditures).

3. CASH FLOW FROM FINANCING ACTIVITIES


 include changes in equity and debt

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