Ch. 2 Financial Statements, Taxes, and Cash Flow

What are the three things to keep in mind when looking at an income statement?

1.) GAAP (Generally Accepted Accounting Principles) 2.) cash versus non-cash items 3.) time and costs

What is the income statement equation?

Revenues - Expenses = Income

what is liquidity? why is it important?

liquidity refers to the speed and ease with which an asset can be converted to cash ex: gold IS, custom manufacturing is NOT. It's important b/c the more liquidity your business has the less likely it's to experience financial distress (paying off debts).

Why is accounting income not the same as cash flow? Give two reasons.

1.) accounting income is not the same as cash flow b/c an income statement contains Non-cash Items. Non-cash items are expenses charged against revenues that do not directly affect cash flow, such as depreciation. 2.) The deduction or depreciation is just an accounting number, its not ACTUAL cash spent. The depreciation deduction is simply another application of the matching principle in accounting.

explain the difference b/w accounting value and market value. Which is more important to the financial manager? Why?

Accounting Value-- not what the assets are actually worth, what the firm paid for them, no mater how long ago they were purchased or how much they are worth. Market Value-- what the asset COULD be sold for the marketing value of an asset depends on things like its riskiness and cash flows, neither of which have nothing to do w/ accounting. More important? The market value is more important to a financial manager b/c the market value is what goes up and down in value

what is the balance sheet identity?

Assets = Liabilities + Shareholders' equity

what do we mean by 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.