FIN 201 Ch2: Balance Sheet, Income Statement, Cash Flow

CFF (cost flow from financing)

(either borrowing or issuing equity to finance the company, when to repay debts or repurchase stock, and whether or not to pay dividends.) -Change in Gross Fixed Assets = -(Change in Net Fixed Assets + Depr Exp)

Income statement

A financial statement that reports a company's revenues and expenses and resulting net income or net loss for a specific period of time. More susceptible to misinterpretation than balance sheet Show profitability

he describes the revenues and expenses associated with a company's operations for a given period of time (that is why it is dated "for the period ended").

A. income statement

current liabilities

Accounts Payable Notes Payable Accrued Salaries

retained earnings

An amount earned by a corporation and not yet distributed to stockholders.

Balance Sheet Equation

Assets = Liabilities + Owner's Equity

he balance sheet equation states: Assets = Liabilities + Owners' Equity. Which of the following best describes the logic behind this equation? Assets must generate revenues equal to the firm's liabilities and owners' equity. Assets have to be financed by either by other people's money or the owner's money. Assets are financial resources used to obtain debt and equity. A firm must use assets to payback debt and equity.

Assets have to be financed by either by other people's money or the owner's money.

The is a snapshot of the firm's assets and financing of those assets at a given point in time (that's why it's dated "as of" a particular date)

B. balance sheet

financing expenses include

BSD (i.e. Borrowing, Stock, Dividends

free cash flow vs CFO

CFO does not consider required reinvestment in the firm. Hence, CFO is not a measure of the CFs available to investors. Free Cash Flow (FCF): measures cash flow available to all investors after: 1) Required investment in fixed assets (CapEx) 2) Required additions to working capital (WC) Note: FCFF measures the CFs that are available to the providers of capital (both debt and equity).

current assets

Cash Marketable Securities Accounts Receivable Prepaid Expenses Inventories

What reveals the true health of a business?

Cash flow not net income

owners equity

Common Stock ($1 Par) Add'l Paid In Capital Retained Earnings

non cash sources

Depreciation Accounts receivable is used on income statement but excluded from cash flow means sales were received on credit not in cash so it is NOT a source of cash A decrease in common stock means that the firm must have bought back shares, meaning an outflow of cash. Thus, this is NOT a source of cash. A decrease in AP means that the firm paid off its debts to its suppliers; thus, this is NOT a source of cash, but an outflow of cash.

How can you increase current assets?

For assets to increase, cash must have been used to acquire the asset. (ex. Buying a car with cash)

operating accounts charges

Generally, current assets and current liabilities are interpreted as operating accounts we have to note whether the change from last year to this year indicates a source or use of cash and then adjust net income accordingly

Ways that earnings can lie (fictions) RED FLAG

Inventory (if the chosen system is changed from original) Rising receivables (they become more lenient on credit but then people are less likely to make payments) Extraordinary expenses Investigate asset sales sale-leaseback impact: the seller regains use of the capital that otherwise would be tied up in property ownership; at the same time, the seller retains possession and continued use of the property for the lease term. Ex bank sells building they had originally bought for $10 which is now worth $20 and then begins to lease it for 30 yrs Skimping on research and development Changing what counts as revenue policies Spot out of balance growth

fixed assets

Land Intangibles Plant & Equipment Less: Accum. Depreciation

long term liabilities

Mortgage Debt Debentures

Gross Fixed Assets =

Net Fixed Assets + Accumulated Depr

cash flow from operations formula

Net Income + Depreciation + Decrease in operating asset accounts - Increase in operating asset accounts + Increase in operating liability accounts - Decrease in operating liability accounts = CFO

Is CFO the cash flow available to distribute to the firm's investors [i.e. creditors and stockholders]?

No! It does not consider the firm's investment needs in working capital or fixed assets.

Revenues minus Cost of Goods Sold minus Operating Expenses equals:

Operating Profit Earnings Before Interest and Taxes Operating Income All of the above

Accounts payable represent money a firm: Owes to a lender under a borrowing arrangement with an explicit interest rate. Owes to suppliers for purchases made on credit. Owes to its employees. Owes to a landlord or leasing agent for rental costs.

Owes to suppliers for purchases made on credit.

investing expenses include

PP&E, Land, LT Assets

what is a critical difference between the income statement and the balance sheet

Remember that the balance sheet is a snapshot of the firm's financial standing at one moment in time, while the income statement covers the firm's results over a period of time (usually one year)

How can you decrease current assets?

To assets to decrease, cash must increase (example selling the car for cash)

Operating Accounts

What type of accounts are accounts receivable and inventory?

examples of current liabilities

accounts payable (no interest, with open line of credit to the supplier), notes payable (has interest), accrued salary( salaries paid owed but not paid)

Which is better: accural or cash accounting?

accural because you can see the operations Accrual basis accounting applies the matching principle - matching revenue with expenses in the time period in which the revenue was earned and the expenses actually occurred. This is more complex than cash basis accounting but provides a significantly better view of what is going on in your company

The is a snapshot of the firm's assets and financing of those assets at a given point in time (that's why it's dated "as of" a particular date).

balance sheet

why will net income often differ from CFO?

because of accounts receivable

can the liabilities side of a balance sheet just liabilities without equity and vice versa?

can be 100% equity but not 100% liability

What are some examples of current assets?

cash marketable securities (example CDs) prepaid expenses ( rent, insurance, utilities or anything you pay for before you use it)

assets increase

cash decrease

equity decrease

cash decrease

liabilities decrease

cash decrease

assets decrease

cash increases

equity increases

cash increases

liabilities increase

cash increases

cash flow from investing formula

change in net PP&E plus depreciation expense (*?)

what makes up owner's equity

common stock additional paid in capital retained earnings

the sum of all of these cash flow sources should equa

company's change in cash for the year.

CFI (cost flow from investing)

cost flow from investing (purchase and sale of long-term assets, such as the installation of conveyor belts or the construction of new production facilities.)

CFO (Cash Flow from Operations)

cost flow from operations (what to produce, how to produce it, whom to sell it to, how to collect on debts, whom to use for suppliers, etc.)

The is an example of a non-cash expense. A. tax expense B. accrual expense C. depreciation expense D. sale-leaseback expense

depreciation

net income is the same as

earnings before interest and taxes

When creating an income statement, what is sales revenue, minus cost of goods sold and operating expenses?

earnings before interest and taxes (EBIT)

Manager's never practice earnings management in order to fabricate or "smooth" earnings.

false

T/F accumulated depreciation is listed on the income statement

false

T/F the amount of dividends is listed on the balance sheet

false

when calculating for the investing section, do you use the gross or net PP&E?

gross PP&E Note: If gross PP&E and accumulated depreciation are not listed separately, use net PP&E plus depreciation expense

what is sales - cost of goods sold?

gross profit

The describes the revenues and expenses associated with a company's operations for a given period of time (that is why it is dated "for the period ended").

income statement

_____ in liabilities current liabilities signal a source of cash while ______ a in current liabilities signals a a use

increases; decreases

A decrease in a financing account

indicates that the company used cash to pay lenders or to buy back stock

Historical cost accounting

items that appear on the financial statements are stated at their historical cost Does no reflect true market value

What are some examples of fixed assets (>1yr)

land (at historical cost) intangible (reputation, intellectual property, brand) plants and equipment accounts depreciation= sum of depreciation/ yr

The is the notion that revenues recognized and expenses incurred to generate those revenues must be reported together.

matching principle

is an increase of long term debt a source of cash?

means that the firm took on new loans during the year, meaning that the firm brought in new cash. Thus, this IS a source of cash.

examples of long term liabilies

mortgage debt debenture (unsecured bond without collateral)

assets are listed in order of

most to least liquid (how fast they will turn into cash)

what must be done with depreciation in cash flow problems (esp regarding operating expenses?

must be added back to net income

calculating CFO

net income + depreciation (change in depreciation) change in AR change in I change in AP change in other CL

can you find the value of a firm on the balance sheet?

no because assets are listed at historical cost; true value of employees, etc

can you pay bills with retained earnings?

no because it is not cash--it is to fund existing assets

calculating CFF

notes payable LT debt equity dividends

dividends formula

old RE+ net income- new RE

what are the three parts of a cash flow

operating expenses, investing, and financing

what are the only two things you an do with net income?

pay it out as dividends (payout) retain it within the firm (plowback)

PP&E

property, plant, and equipment An increase in gross PP&E from one year to the next represents a use of cash

Matching principle

requires that expenses be recorded when incurred in earning revenue

ebit aka operating income

sales - COGS - depreciation- operating expenses

Cash flow statement

shows the flow of money in and out of the business and where it went most honest

is depreciation a cash or non cash expense on the income statment?

since this expense is created solely for taxation purposes and does not involve actual cash flow, we have to add back depreciation expense to net income (non cash)

An increase in a financing account (e.g., debt, including notes payable, and equity) signals

source of cash (cash flowed into the company)

Which of the following is not a red flag that earnings are being manipulated? A. rising receivables B. changes in inventory policies C. skimping on research D. steady growth in revenues

steady growth in revenues

Earnings management

the practice of using flexibility in accounting rules to manipulate the apparent profitability of the firm

The accrual accounting system enables much better financial analysis than would be possible under a cash-based system.

true

accounts receivable decreases when

we collect what our customers owe us on credit

Balance sheet

what you have and what you owe lists assets to the left and liabilities and equity to the right the two sides must equal each other

accounts receivable increases

when we have sold things on credit to our customers