Chapter 2 Financial Statements, Taxes, and Cash Flow

Which of the following do not directly affect cash flow?

Depreciation

Noncash Items

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

For financial analysis, financial statements and accounting numbers are more important than cash flows.

False

Operating cash flow includes capital spending and working capital requirements.

False

A customer has yet to pay the bill for products purchased on credit. The seller records this debt in which balance sheet account?

Accounts receivable

Which of the following are current assets?

inventory and accounts receivable

Cash flow to stockholders equals ____.

dividends paid minus net new equity raised

Depreciation is the accountant's estimate of the cost of ______ used up in the production process.

equipment

Operating cash flow includes capital spending and working capital requirements. (T/F)

False

Average Tax Rate

Total taxes paid divided by total taxable income.

The difference between the total assets and total liabilities is shareholders' or ___ equity.

owners

The purpose of a(n) ______ is to measure performance over a set period of time.

income statement

If you make an extra $1,000 in income and your marginal tax rate is 30 percent while your average tax rate is 20 percent, then you will pay an extra ______ in taxes.

$300

______ income is money earned after interest and taxes.

Net

Free cash flow is better described as ____.

total distributable cash flow

The common set of standards and procedures by which audited financial statements are prepared are called _____.

GAAP

In recent years, U.S. accounting standards have become more closely tied to _____.

IFRS

The passage of the Tax Cuts and Jobs Act of 2017 was to make the federal corporate tax rate in the United States a _____ tax.

flat

The matching principle of GAAP requires revenues be matched with _____.

expenses

The price at which willing buyers and sellers would trade is called ____ value.

market

Holding too many liquid assets can be harmful for a firm because such assets are generally _____.

less profitable

Costs that do not change in the short run arise because of ______.

fixed commitments

A decrease in depreciation expense ______ earnings per share.

increases

Assets are recorded at historical cost, not market value, because _____.

it is hard to keep up with the market value

Which of the following are fixed assets?

land, plant, buildings

The shareholders are the _____ in line to receive payment when a firm is forced to sell assets to pay off debt.

last

For financial managers, the accounting value of the stock is not an especially important concern; it is the ___ value that matters.

market

Net working capital equals current assets ______ current liabilities.

minus

A company's _____ cash flows reflect whether its cash flows from business operations can cover its everyday cash outflows.

operating

Cash generated from a firm's normal business activities is called _____.

operating cash flow

The short run for a firm is the period of time during which ______.

output can vary and some costs are fixed

Net capital spending is equal to ending net fixed assets minus beginning net fixed assets ____.

plus depreciation

In general, revenue should be recognized at the time of ___ which is not necessarily the same time as the money is collected.

sale

When looking at the income statement, the financial manager should keep in mind GAAP, cash versus noncash items, and ___ and costs.

time

In the long run, all costs are _____.

variable

Another name for short-term financial management is ___ management.

working capital

If a firm's net working capital goes from $150 in 2020 to $130 in 2021, then the change in net working capital is:

−$20

If ending net fixed assets are $100, beginning net fixed assets are $60, and depreciation is $10, then the net capital spending is ____.

$50

If a firm's net working capital is $120 in 2021 and $100 in 2020, then the change in net working capital is:

+$20

The cash flow identity reflects the fact that:

-Cash flow from the firm's assets equals the total of cash flow to creditors and cash flow to stockholders. -A firm generates cash through its various activities -Cash is either used to produce the product or service, pay creditors or pay out to the owners of the firm.

If you earn an extra $100 of taxable income this year and owe taxes of $34 on that income, then your marginal tax rate is _____ percent.

34

Free Cash Flow

Another name for cash flow from assets.

Which one of the following is true?

Cash flows can be derived from financial statements.

Net Working Capital

Current assets - current liabilities

Which one of these is the most illiquid?

Fixed assets

Increasing its noncash liquid assets will enable a firm to do which of the following?

Increase its ability to avoid financial distress; Increase its ability to meet short-term obligations

Why is it important for accounting standards to become more comparable across countries?

Increasing globalization of business makes it necessary to understand financial reporting by firms that follow other accounting standards.

Which of these items do NOT appear on a balance sheet?

Knowledge that has no patent; Favorable economic conditions; Good management

______ refers to the speed and ease with which an asset can be converted to cash.

Liquidity

___ costs include such things as raw materials, direct labor expense, and manufacturing overhead.

Product

How is income defined?

Revenue minus expenses.

Which of the following are period costs?

Selling costs; General expenses; Administrative expenses

Financial Leverage

The use of debt in a firm's capital structure

Which of the following are included in the fixed asset portion of a balance sheet?

Trademarks, Buildings

Free cash flow is the total of cash flow that the firm can distribute to creditors and to stockholders.

True

Most importantly, assets provide ______ to the firm.

Value

______ costs change as the output of the firm changes.

Variable

According to GAAP, when is income reported?

When it is earned or accrued

When is revenue recognized on an income statement?

When the value of an exchange of goods or services can be reliably determined; When the earnings process is virtually completed

A balance sheet reflects a firm's ______ value on a particular date.

accounting

In the long run, ________ are variable.

at all costs

Cash flow ___ to is interest paid less net new borrowing.

creditors

The cash flow identity states that cash flow from assets equals cash flows to ____.

creditors and stockholders

What does a balance sheet reflect about a firm?

Accounting value on a specific date.

Rank the ease (from easiest to hardest) of turning the following assets into cash.

1. cash 2. accounts receivable 3. inventory 4. plant and equipment

The Tax Cuts and Jobs Act of 2017 set the corporate tax rate to be ______ regardless of the level of taxable income.

21%

Income Statement

A financial statement showing the revenue and expenses for a fiscal period. Revenues - Expense = Income

Cash Flow To Creditors

A firm's interest payments to creditors less net new borrowing.

What does stockholders' equity represent?

A residual claim against the book value of the firm's assets. (The book value of the firm's assets less the book value of its liabilities.)

Operating Cash Flow

Cash generated from a firm's normal business activities.

The use of financial leverage can:

Increase the potential reward for investors. Increase the chance of financial distress and business failure. Greatly magnify both gains and losses.

Whose responsibility is it to create value for a firm?

Management

How is the average income tax rate computed?

Total tax bill/Total taxable income

The short run is ______.

an imprecise period of time

The cash flow identity states that cash flows from ______ should equal cash flows to creditors and equity investors.

assets

James is an owner of J & Jo Company. If he wants to find out the cash flow of his bakery, he should look into the firm's _____.

financial statements

If ending net fixed assets are $100, beginning fixed assets are $40, and depreciation is $10, then the change in capital spending is _____.

($100 − 40) + 10 = $70

The more debt a firm has, the greater its:

Degree of financial leverage.

The corporate tax code is simplistic and makes good economic sense.

False

Balance Sheet

Financial statement showing a firm's accounting value on a particular date.

Why is positive net working capital important?

It means the firm should have sufficient cash to meet its current obligations.

Which of the following are classified as liabilities on a firm's balance sheet?

Notes payable and Accounts payable

What are two classifications of costs used by financial accountants?

Product costs and Period costs

Which are true concerning product costs?

Product costs are reported as costs of goods sold. Product costs contain both fixed and variable costs.

Which of the following is a variable cost in the short run?

Raw materials used in production.

Which of the following are examples of short-run fixed costs?

Rent and Bond interest

Which of these are generally considered to be short-run fixed costs?

Rent payments for a warehouse; Property taxes; Management salaries

Who is entitled to the residual value of a firm's cash flows?

Shareholders

Assets can be described as items that _____.

a firm owns, provide market value to the firm, and generate revenue

Noncash items do not affect _____.

cash flow

The total of cash flow to creditors and cash flow to stockholders is called _____.

cash flow from assets

In finance, the value of a firm depends on its ability to generate ______.

cash flows

Net capital spending is equal to the change in net fixed assets plus _____.

depreciation

Accounting profit ____ cash flow.

differs from

How are assets on a balance sheet listed?

in order of decreasing liquidity

Fixed costs are costs that will not change ______.

in the short run

If you think of the balance sheets as a snapshot, then the _____ can be thought of as a video covering the period between before and after pictures.

income statement

Cash flow to stockholders is dividends paid ___ net new equity raised.

minus

Cash flow to stockholders is dividends paid ____ net new equity raised.

minus

Noncash items are expenses that directly affect _____ but do not directly affect ______.

net income; cash flow

A positive operating cash flow indicates that the firm is generating enough cash to ______.

pay operating costs

On a balance sheet, total assets must always equal total liabilities plus ______.

shareholders' equity

A company's ______ tax rate is its tax bill divided by its total taxable income, and its ______ tax rate is the tax rate it pays on the next dollar of income.

average; marginal

Cash flow to creditors is equal to _____.

interest paid less net new borrowing

Period costs are the costs that are allocated to a specific ______.

interval of time

Accountants usually distinguish between _____ costs and _____ costs.

product; period

A supplier may look at the size of _____ to see how promptly the firm pays its bills.

accounts payable

Liquidity refers to the ease of changing _____

assets to cash

The fact that the balance sheets are listed at _____ means that there is no necessary connection between the total assets and the value of the firm.

at cost

Residual value is the amount left over after paying ________________.

bondholders, other debt holders, accounts payable

The statement of cash flow explains changes in _____.

cash and equivalents

For a ___ asset, it would be purely a coincidence if the actual market value were equal to its book value.

fixed

An official accounting statement that helps to explain the change in cash and cash equivalents is called the _____.

statement of cash flows

Marginal Tax Rate

Amount of tax payable on the next dollar earned.

What should you keep in mind when examining an income statement?

GAAP; time and costs; cash versus noncash items

What does GAAP stand for?

Generally Accepted Accounting Principles

Which of these questions can be answered by reviewing a firm's balance sheet?

How much debt is used to finance the firm?; What is the total amount of assets the firm owns?

If your tax bill is $200 and your taxable income is $2,000, then your average tax rate is _____ percent.

10

A long-term liability represents a(n) _____.

A debt that is not due in the coming year.

What is depreciation?

A systematic expensing of an asset based on the asset's estimated life

In March, Al's paid cash for a video game for the store's inventory. In April, it sold the game on credit. In May, Al's received payment for the sale. Based on matching principle, the expense should be recorded in ___ and the income should be reported in ____.

April; April

Which of the following are examples of noncash items on an income statement?

Depreciation

Cash Flow To Stockholders

Dividends paid out by a firm less net new equity raised.

An income statement reflects activity that occurs _____ while a balance sheet reflects values ____.

over a period of time; as of a specific date

Liquidity

The ease with which an asset can be converted into cash

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, and change in net working capital.

Which is true of taxes?

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

What is the purpose of the income statement?

To measure performance over a set period of time

On the balance sheet, assets are listed at their _____ value

book

Under GAAP, U.S. firms must carry assets at:

book value

The short run is a period when there are ______ costs.

both fixed and variable

The ___________ principle of GAAP states that costs associated with a good or service should be recorded at the same time as the revenue from selling that good or service.

matching

What is a primary concern for a bank lending funds to a business for the short term?

Liquidity

The last (residual) claimants to be paid by a firm are the ______.

stockholders

Which of the following will be found in the liabilities section of a firm's balance sheet?

Long-term bonds issued by the firm and Notes payable

Which of the following is true about the difference between the income statement and cash inflows and outflows?

Sales on credit are accounts receivable rather than cash inflows until they are collected, which may be in a different period. Cost of raw materials purchased on credit are accounts payable rather than cash outflows until they are paid, which may be in a different period. Income taxes are often deferred, so the amount on the income statement may not represent the amount of the check to the IRS.