Financial Management Week 2

Shareholders' Equity

A = Current Assets + Fixed Assets L = Current Liability + Long term liability Shareholders' Equity = A - L

Financial Statements

A key source of information for financial decisions. Includes Balance Sheet (Statement of Financial Position), Income Statement (Statement of Operations), Statement of Cash Flows, and Statement of Retained Earnings. For any public corporation, all these are required by the SEC to disclose.

Balance Sheet

A snapshot of the firm (for a time point). On the left (debit): assets of the firm (current asset, long-term asset). On the right (credit): liabilities (current liabilities, long-term debt). Also includes Shareholder's Equity: common stock and retained earnings (net income stayed within corporate).

Meaning 1

All the assets of the firm are financed by either borrowed or invested money.

Accounting Equation (associated with the balance sheet)

Assets = Liabilities + Stockholders' Equity

Why does it often make sense to scale the net income by the number of shares?

Because companies are different sizes.

Balance Sheet (Net Working Capital)

Difference between current assets and current liability (Net Working Capital (NWC) = Current Assets - Current Liability). Working capital is a measure of liquidity. Since the current assets of the company will be used in the near future to pay off current liability, a positive working capital would imply financial health.

The 2 Dimensions of Liquidity

Ease of conversion: how fast the asset can be sold. Loss of value: how much value should be discounted.

Cost Principle (GAAP)

How the value of assets are recorded in the Balance Sheet. The principle stipulates that all the assets of the firm are valuated at the purchase price (Land on which the diner is located on Center City, 100 bushels of corn in the inventory, etc).

The trade-off between the 2 dimensions of Liquidity

If we cut the price enough, we will sell fast. And even if we don't discount, it may sell sooner or later

Meaning 2

Investors have residual claim over the firm's assets after creditors are paid back (Assets - Liabilities = Shareholder's Equity).

Liquidity

Is the speed and ease with which an asset can be converted into cash, or liquidated. Liquidity is valued and priced (from an accounting perspective), and has an implied relationship between risk and return.

Net working capital

Net working capital = Current Assets - Current Liabilities

Income Statement Equation

Revenue - Expenses = Income (Loss)

Taxable Income (Pretax Income)

Revenue - all expenses = Taxable Income (Pretax Income)

EBITDA

Revenue - all expenses but depreciation and interest expense = Earnings Before Interest, Tax, Depreciation, and Amortization (EBITDA)

EBIT

Revenue - all expenses but interest expense = Earnings Before Interest and Taxes (EBIT)

Balance Sheet (Book Value of Assets) has little to do with...

The market value of the firm.

Income Statement

The performance of the firm throughout a timespan (quarter or year). On top: revenue (if there are multiple sources) On the middle: all expenses (costs of goods sold (cost of sales), depreciation, and period costs. On the bottom: net income (this is calculated after tax is taken out).