Chapter 2: Financial Statements, Taxes, and Cash Flow

Balance Sheet Equation

Assets = Liabilities + Owner's Equity

Cash Flow Identity

Cash flow from assets=Cash flow to creditors+ Cash flow to stockholders

Changes in NWC

Ending NWC - Beginning NWC (Current assests - current liabilities).

Change in NWC

Ending NWC − Beginning NWC

non cash items

Expenses charged against revenue that do not directly affect cash flow, such as depreciation.

fixed and variable costs

If our time horizon is relatively short, however, some costs are effectively fixed—they must be paid no matter what (e.g., property taxes). Other costs, such as wages to laborers and payments to suppliers, are still variable. As a result, even in the short run, the firm can vary its output level by varying expenditures in these areas.

Cash uses (outflows)

Increase asset acct. Decrease liabilities/equity acct.

Equity Holders

Only entitled to the residual value, portion left once creditors are paid.

net income

Revenues - Expenses. Consist of dividends paid to shareholders addition to retained earnings.

Marginal Tax Rate (MTR)

The additional tax liability a person faces divided by his or her additional taxable income. It is the percentage of an extra dollar of income earned that must be paid in taxes. It is the marginal tax rate that is relevant in personal decision-making.

Net Capital Spending (NCS)

The amount the firms spends on acquiring fixed assests. (Ending Fixed Assets - Beginning Fixed Assets + Depreciation).

cash flows

The difference in the amount of money that came in and went out. Negative cash flow means that the firm raised more money by borrowing and selling stock than it paid out to creditors and stockholders that year.

financial leverage

The use of debt in a firm's capital structure. The more debt a firm has as a percentage of assets, the greater is its degree of financial leverage. Financial leverage increases the potential reward to shareholders, but it also increases the potential for financial distress and business failure.

Debt versus Equity

To the extent that a firm borrows money, it usually gives first claim to the firm's cash flow to creditors. Equity holders are only entitled to the residual value, the portion left after creditors are paid.

Taxes

a contribution for the support of a government required of persons, groups or businesses within the domain of that government.

Balance Sheet

a snapshot of the firm's assets and liabilities at a given point in time

fixed assets

assets that are relatively permanent, such as land, buildings, and equipment

illiquid assets

assets which are not able to be sold quickly which carry higher risk of losing money. Buildings and equipment.

Net Working Capital (NWC)

current assets - current liabilities. Measures the short term liquidity of a business. Also used to obtain general impression of companies ability.

Net Working Capital (NWC)

current assets - current liabilities. Usually positive in a healthy firm.

Product Costs

direct materials, direct labor, manufacturing overhead

In preparing a balance sheet, why do you think standard accounting practice focuses on historical cost rather than market value?

historical cost can be meausres, where the market value is more difficult to determine/estimate. There is a trade off between relevance (market value) and objectivity (book value).

Period Costs

incurred during a particular time period and might be reported as selling, general, and administrative expenses.

Cash flow to creditors

interest paid - net new borrowing

Current Liabilities

liabilities due within a short time, usually within a year.

long-term liabilities

liabilities owed for more than a year.

Earnings Per Share (EPS)

measures the net income earned on each share of common stock. Net income/total shares outstanding.

capital spending

money spent by a business for an item that will be used over a long period (purchases of fixed assets less sales of fixed assets).

statement of cash flows

provides a summary of the firm's operating, investment, and financing cash flows and reconciles them with changes in its cash and marketable securities during the period.

GAAP Income Statement

recognizes revenues when its fully earned. Matches expenses required to generate revenue with the period of recognization.

Assets

resources owned by a business. (left hand side)

Statement of Shareholders' Equity

statement disclosing the source of changes in the shareholders' equity accounts (common stock, treasury stock, and retained earnings).

Average Tax Rate (ATR)

the amount of total taxes paid divided by income

Operating Cash Flow (OCF)

the cash flow a firm generates from normal operations—from the production and sale of its goods and services (EBIT+Depreciation-taxes).

free cashflow

the cashflow generated by the business above and beyond the capital needed to operate it, is free to distribute to creditors and stockholders.

Book Value

the difference between the cost of a depreciable asset and its related accumulated depreciation. Generally on the balance sheet. (asset=what firm paid-accumulated depreciation).

Dividends Per Share (DPS)

the dollar amount of cash distributed during the period on behalf of each outstanding share of common stock. Total dividends paid/Total shares outstanding.

Market Value

the price at which property would sell. The true value. What managers and investors are more interested in.

Liquidity

the speed and ease with which an asset can be converted to cash (cash-most liquid, inventory-least liquid). More liquid a business, less financial distress.

cash flow from assets

the total of cash flow to creditors and cash flow to stockholders, consisting of the following: operating cash flow - capital spending - change in net working capital.

Shareholders' Equity

total value of assets - total value of liabilities. Resididual money belongs to shareholders.

Income Statement

A financial statement that reports a company's revenues first and deducts expenses. Resulting in net income or net loss for a specific period of time.

liability

An amount owed by a business. right hand side.

Sources of Cash (Inflows)

Decrease asset acct. Increase liabilities/equity acct. Net income, depreciation, decreasing non cash current asset, decreasing a fixed asset, increasing a current liability, increasing a long term debt, selling stock.

Cash Flows to Stockholders

Dividends paid - Net New Equity raised

On its 12/31/15 balance sheet, Barnes Inc showed $510 million of retained earnings, and exactly that same amount was shown the following year. Assuming that no earnings restatements were issued, which of the following statements is CORRECT?

E.) Dividends could have been paid in 2011 but they would have had to be equal to earnings for the following year.

An owners equity can be negative when companies liabilities exceed its assets. Can this happen with market values?

Market value can never be negative.

Highly liquid assets:

can be sold quickly at close to full value

current assets

cash and other assets expected to be exchanged for cash or consumed within a year.