Chapter 2: Summary of Learning Goals (pgs. 55-56)

(LG2-2) Differentiate between book (or accounting) value and market value.

A firm's balance sheet shows its book (or historical cost) value based on generally accepted accounting principles (GAAP). Under GAAP, assets are listed on the balance sheet at the amount the firm paid for them, regardless of what they might be worth today. Market value is the amount the firm would get if it actually sold an asset. The book value and market value of a firm's fixed assets is often very different from the market value.

(LG2-6) Observe cautions that should be taken when examining financial statements.

Firms must prepare their financial statements according to GAAP, which provides a common set of standards intended to produce financial statements that are objective and precise. However, GAAP also allows managers significant discretion over the firm's reported earnings. Managers and financial analysts have recognized for years that firms use considerable latitude in accounting rules to manage their reported earnings in a wide variety of contexts.

(LG2-3) Explain how taxes influence corporate managers' and investors' decisions.

Firms pay out a large portion of their earnings as taxes. The U.S. Congress sets (and often changes) the U.S. tax code, which in turn determines corporate tax obligations. The U.S. tax system is extremely complicated and we do not attempt to cover it in detail here. However, taxes are a major expense item for a firm and they are a crucial part of many financial decisions.

(LG2-1) Recall the major financial statements that firms must prepare and provide.

In any annual report, you will find the four basic financial statements-- the balance sheet, the income statement, the statement of cash flows, and the statement of retained earnings. These four statements provide an accounting-based picture of a firm's financial position. These statements often provide a key source of information for firm managers to make financial decisions and for investors to decide whether to invest in the firm.

(LG2-4) Differentiate between accounting income and cash flows.

The income statement is prepared using GAAP. Following GAAP, revenue is recognized at the time of sale, which is not necessarily when cash is received. Likewise, under GAAP, expenses appear on the income statement as they match sales. That is, production and other expenses associated with the sales reported on the income statement (for example, COGS and Depreciation) are recognized at the time the product is sold. Again, the actual cash outflow associated with these expenses may occur at a very different point in time. In addition, the income statement contains several noncash items. The largest is depreciation. As a result, figures shown on an income statement may not represent the actual cash inflows and outflows for a firm during a particular period. For the financial manager and investors, however, these cash flows are precisely the most important information available among the financial documents---- more important than the accounting profit listed on the income statement. Cash, not accounting profit, is needed to pay the firm's obligations as they come due, to fund operations and growth, and to compensate firm owners. (Cash is King)

(LG2-5) Demonstrate how to use a firm's financial statements to calculate its cash flows.

The statement of cash flows is the financial statement that shows the firm's cash flows over a given period of time. The statement of cash flows reports how much cash the firm generates and distributes during the time period analyzed. The bottom line of the statement of cash flows--- the difference between cash sources and cash uses--- equals the change in cash and marketable securities on the firm's balance sheet. That is, the statement of cash flows reconciles income statement items and noncash balance sheet items to get to the change in the cash and marketable securities account on the balance sheet over the period of analysis.