ch 2 finance

Three reasons for why net income is not the same as cash flow

-accrual accounting -non cash expense items -preference to classify interest expense as past of financial cash flow

Net income is not the same as cash flow

Firm earned an income of $5,642 million Cash account decreased by 65 million

EPS → earnings per share want to go down or up?

If EPS goes down, that's a bad things because you want the earnings to be as high as possible

Use the cash flow identity to explain cash flow.

The cash flow identity simply states that the cash from assets is always equal to the cash to lenders and the cash to owners. Put another way, it allows a financier to reconstruct the balance sheet and income statement accounts to show where cash was generated and where cash was used during a particular time period.

Explain the foundations of the balance sheet and income statement.

There are four financial statements that report the performance of a firm: (1) the balance sheet, (2) the income statement, (3) the statement of retained earnings, and (4) the statement of cash flow. -In finance, we are generally concerned with how a company is generating cash and where the company is spending cash.

Which of the following statements is true?

Three fundamental issues separate net income and cash flow: accrual accounting, noncash expense items, and interest expense.

Balance sheet →

a snapshot ("as of..") at that particular moment of your assets/liabilities/shareholder equity - assets= liabilities + shareholders equity They have to balance and equal each other A balance sheet won't tell you necessarily if the change is a good or bad thing Assets are our resources (PPE=property, equipment) Liabilities are debt (bank loans) Shareholders equity is the ownership (contribute capital as owners)

Income statement

a video ("for the period ending) all of your expenses to get to the bottom line over a period of time, the net income Doesn't show actual cash flow coming in and out of our business

Statement of retained earnings

a video.....companies can distribute to shareholders or reinvest that money, a review since the start of that company -Net income that was reinvested, not distributed to shareholders -Why subtract dividends? Because you are paying that to the investors -The ending balance is the new beginning balance of our new retained earnings -You have a beginning balance (everything you reinvested since the start) you add your net income and deduct the distribution Change in retained earnings= net income - distributed earnings

accounting identity formula

assets ≡ liabilities + owners' equity

4 main financial statements

balance sheet, income statement, statement of retained earnings, statement of cash flow

cash flow from assets formula

cash flow from assets ≡ cash flow to creditors + cash flow to owners

Accounting system debits =

credits → double entry

long term liabilities vs current →

current you should pay in less than 1 year

whats non cash expense items

depreciation -we purchase an asset worth $100, put it on our balance sheet, depreciation ( 5 year useful life) by 20 every year until it is fully depreciated , after 1 year the value will be (net PPE) $80 - the 20 will be on the balance sheet as "expense"

The income statement begins with revenue and subtracts various operating expenses until arriving at .

ebit

whats accrual accounting

how we recognize our revenues and expenses and do not speak to actual cash we have on hand (cash may come in the future)

It is important to remember that the fundamental of accounting is the debit and credit recording activity in which debits always equal credits.

identity

Where do you look for (servicing) interest expense?

income statement

net income equation

net income = revenues − expenses`

Purpose of statement of retained earnings →

net income that hasn't been distributed to shareholders, all net income that has been reinvested

operating cash flow formula

operating cash flow = earnings before interest and taxes + depreciation − taxes

Which of the following equations is true?

operating cash flow=EBIT+depreciation−taxes

3 components of cash flow from assets →

operating, net capital spending and change in net working capital

How company return money to debt lenders? →

shows up as liability on balance sheet, you have to pay off the principal and interest (loan),

Cash Flow Identity and the Statement of Cash Flows

the cash flow identity states that the cash flow on the left-hand side of the balance sheet is equal to the cash flow on the right-hand side of the balance sheet Cash flow from assets= cash flow to creditors + cash flow to owners

The Income Statement

the expenses and revenues generated by a firm over a past period, typically a quarter or a year Net income= revenues - expenses EBIT= revenues - operating expenses (Earnings Before Interests and Taxes?) EBITDA → They do this to look good for investors

Who receives annual report? →

the regulator and SEC The company needs to publish that financial statement

The purpose of studying financial statements is

to understand those portions of the statements that have relevance for financial decision making

Increase in NWC means →

you bought inventory, marketing (anything that can turn into cash in short term) Our current assets have increased It's more of an inflow or outflow, cash perspective??

Statement of cash flow

→ it shows us the flows of money of actual cash Actual cash that is coming in and out

Cash and equivalents are $1,561; short-term investments are $1,052; accounts receivable are $3,616; accounts payable are $5,173; short-term debt is $288; inventories are $1,816; other current liabilities are $1,401; and other current assets are $707. What is the amount of total current liabilities?

$8,752

Net income vs operating cash flow →

(1) net income takes into account depreciation (2) when you recognize expenses (3) net income includes interest expense

what are the 5 main sections of the balance sheet

(1)Cash account → where did the $65 million decline come from? (2)Working capital accounts → net working capital = current assets - current liabilities ----Long term asset accounts → plant and equipment; land and buildings -----Gross value- accumulated depreciation=net value (3)Long term liabilities (debt) accounts (4)Loans maturing in over 1 year 4. Ownership account (5)

Provide some context for financial reporting.

All public firms are required by law to submit annual (10-K) and quarterly (10-Q) performance reports to the U.S. Securities and Exchange Commission. Regulation fair disclosure requires that information be released to the public and not to special groups or individuals. The notes to the financial statements often provide a rich store of information about how the statements were constructed or more commentary that is relevant to the future operations of the company.

Financial Statements on the Internet

EDGAR Yahoo! Finance Many many more websites

Our focus...

Interrelationship between the balance sheet and the income statement The process by which these statements can be used to project a firm's future cash flows We do this to look towards the future, looking at the health based on the past and the financial managers look at this -----Can we expand? What are our resources?

If we started with Net PPE $100 and ending is $150, did we buy anything?

Looking at balance sheet, you would say you bought something The $50 reflects something we bought

3 components of cash flow

Operating cash flow Net capital spending Change in net working capital

Annual reports to shareholders

Quarterly (10-Q) and annual (10-K) reports filed with the SEC Regulation fair disclosure (Reg. FD) Notes to the financial statements b/c they will explain what has happened. Greater clarity and transparency

Recognize and view Internet sites that provide financial information.

The Internet has many sites that provide financial statements as well as other significant information about publicly traded firms. Not all sites are free or comprehensive. In addition, the formatting of financial data is not always consistent across different sites. Sometimes it is necessary to dig through the financial statements to get the information necessary to examine the performance of a firm.

change in retained earnings formula

change in retained earnings = net income − distributed earnings

Current asset vs long term →

expected to turn current into cash within that 1 year period

debtors claim vs. owners claim→

it's the way in which the organizations has to satisfy that claim Debtors → have to service it with interest and pay back the principle Owner's → not a fixed amount, the owner's get paid last, you have to pay back your creditors first

"Net fixed assets" is

net of depreciation

net working capital equation

net working capital= current assets − current liabilities

Understanding the sources and uses of cash in the recent past will enable a manager to the cash flow for a potential project of the firm.

predict more accurately

Which of the following sections is not contained in the annual report?

prediction of creditors return

earnings before interest and taxes formula

revenue − operating expenses = earnings before interest and taxes