Fundamentals of Corporate Finance: Chapter 2 - Financial Statements, Taxes, and Cash Flows

What is liquidity?

-Ease of conversion to cash -Without significant loss of value

What is the difference between accounting income and cash flow?

Accounting income is net income on the income statement. Cash flow or operating cash flow (OFC) = EBIT + Dep - Taxes Dep is added back because it is a non cash expense Taxes are subtracted out as they are not available for growth.

Balance Sheet Identity

Assets = Liabilities + Stockholders' Equity

What is the difference between average and marginal tax rates?

Average tax rate is total taxes divided by total taxable income. (the tax bill / taxable income) Marginal tax rate is the rate that the next dollar is taxed.

How do we determine a firm's cash flows? What are the equations?

CFFA = CFC + CFS CFFA = OCF - NCS - Changes in NWC

Matching principle

GAAP say to show revenue when it accrues and match the expenses required to generate the revenue

What is the difference between book value and market value?

The balance sheet provides the book value of the assets, liabilities and equity. Market value is the price at which the assets, liabilities or equity can actually be bought or sold.

Should we use average or marginal tax rates when making financial decisions?

The marginal rate should be used for financial decisions.

Market value

The price at which the assets, liabilities or equity can actually be bought or sold.

Book value

The value of the assets, liabilities and equity that the balance sheet provides

Where do we find cash flow information?

These numbers are found on the balance sheet and income statement, not the statement of cash flows.

Which should we use for decision making purposes?

Use Market Value for decision making

Which do we need to use, accounting income and cash flow, when making decisions?

We need OCF for making financial decisions.

Balance sheet

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

Net working capital

current assets - current liabilities

How are assets are listed?

in order of liquidity

Income statement

like a video of the firm's operations for a specified period of time.

What do you generally report first income statements

revenues